QSBS stands for “Qualified Small Business Stock” and is regulated by the Internal Revenue Service (IRS) under code Section 1202. It offers tax benefits to accredited investors, investment funds, employees, and founders on a federal level and in some cases also a state level. The tax benefit excludes 100% of capital gains on the sale of QSBS held for 5 years with tax savings up to the greater of $10 million or 10x the initial investment if the company qualifies as a Section 1202 qualified small business.
The Section 1045 rollover allows you to reinvest your QSBS sale proceeds into one or more newly issued QSB stocks if you have recently sold your QSBS with a realized gain before the five year holding period concluded. There is a timeframe on electing the 1045 rollover though, as you have 60 days to reinvest your sale proceeds.
How do I apply for a 1045 Rollover?
Do I have to reinvest my full gain to elect the section 1045 rollover?
If you have recently sold your QSBS with a realized gain before the five year holding period has concluded you may want to elect the Section 1045 rollover. After the stock is sold you have 60 days to reinvest your QSBS sale proceeds into one or more newly issued QSB stocks.
When filing taxes, QSBS exclusions are listed on several forms depending on the year the stock was obtained. These forms include Form 8949, Schedule D, Form 1045, Form 6251 (if purchased before September 27, 2010), and Form 8960 (if there is a portion of the gain that is not excludable). See Detailed filing instructions for section 1202 for step by step instructions on reporting a QSBS exclusion.
When a shareholder sells QSBS, the total gain that may be taken into account for each issuing corporation is limited to the greater of:
1. $10 million less the total amount of gain previously excluded from such QSBS (the “cumulative limitation”), or
2. Ten times the adjusted basis of the QSBS issued to the taxpayer from the corporation.
You can use our QSBS Calculator to find out how much taxes could be saved for QSBS that you hold.
When creating a company that will raise investment capital, it is important to ensure that the company is formed as an entity type that is eligible to qualify for QSBS, and that shares are issued in with an increased emphasis on qualifying and maintaining Qualified Small Business Stock (QSBS) status. It is becoming increasingly common to see investors request that QSBS reps and covenants are included in agreements. The NVCA now includes QSBS reps and covenants in its model documents.
Contact us for help ensuring that your company is QSBS-eligible prior to signing your QSBS reps.
Section 1202 defines Qualified Trades or Businesses in the negative, noting the types of businesses that are not eligible to issue QSBS.
According to Section 1202(e)(3) a “qualified trade or business” is any company other than:
“Any trade or business where the principal asset is the reputation or skill of one or more of its employees, such as performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.
Any banking, insurance, financing, leasing, investing, or similar business.
Any farming business.
Any business involving the production or extraction of products, such as mining.
Any business of operating a hotel, motel, restaurant, or similar business.”
The vagueness of the phrase “performance of services” or determining whether the “principal asset” of a business comes from the skill or reputation of a particular employee can be subjective, however, some clarity has been offered by certain case rulings by the IRS.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.