If there was a simple “yes or no” equation for this question, this would be a very short article. The reality is more complex, since individual circumstances will impact how companies handle QSBS-related requests. Because both the company and the individual shares held need to qualify, this creates logistical challenges for companies in evaluating each shareholder’s situation.
For example, if the company was a Qualified Small Business when your shares were issued but your securities were through stock options, your individual holding period would first start on the date you exercised your securities. In this case, if the Company no longer qualifies as a Qualified Small Business at the time you exercise your options (e.g. maybe they surpassed the $50 million gross asset threshold), your stock may not qualify as QSBS. If this sounds like your scenario, you may want to start by reaching out to the Investor Relations department at the company (or the CFO or CEO’s offices as an alternative) to clarify your situation as determining the point at which the Company is no longer a Qualified Small Business is critical.
In other cases, if your shares were obtained through a preferred equity round of financing, an Investor Rights Agreement might be in place, which could stipulate how much assistance you can expect from the company in evaluating their QSB qualifications.
How might an Investor Rights Agreement (IRA) impact QSBS?
An IRA outlines the rights and privileges these new stockholders are entitled to receive. This document is negotiated between the company and a venture capitalist or other investors at the time of a financing round.
Though not every IRA will make a statement about QSBS, some agreements may include a clear representation regarding QSBS status. Here’s an example:
As of the date of this Agreement, the Shares, to the Company’s knowledge, constitute “qualified small business stock” within the meaning of Section 1202 of the Internal Revenue Code of 1986, as amended.
An IRA might also include a covenant saying that the company will take measures to maintain the QSBS qualifications. This clause could look like the following:
Company shall not take, or fail to take, any action which would cause the stock to fail to qualify as “qualified small business stock” within the meaning of Sections 1045 and 1202 of the Code provided that, notwithstanding the foregoing, the Company shall not be obligated to
(A) take any action, which in its good faith business judgment, is not in the best interests of the Company or its stockholders or
(B) refrain from taking any action, which in its good faith business judgment, is in the best interests of the Company or its stockholders.
Sometimes an IRA will even require that the company perform an analysis of the QSBS qualifications of stock at the request of a shareholder. Take Poshmark’s IRA as a recent example from early 2021:
Upon request by Investor, the Company shall conduct a reasonable investigation to determine whether the Stock qualifies as “qualified small business stock” within the meaning of Code Sections 1045 and 1202, and shall transmit, in writing, the results of such investigation to Investor as expeditiously as reasonably possible, but in no event later than 15 days following the Company’s receipt of such request.
If you’re able to obtain an analysis directly from the Company, this provides good supporting evidence that you can take the QSBS exemption, but you should expect the company’s analysis to include qualifying statements like this:
“(the firm) cannot guarantee that the Internal Revenue Service will not successfully assert a contrary definition.”
“(the Company) is not providing tax advice to any shareholder with respect to the applicability of Section 1202 to shares of stock held by the shareholder. Shareholders should seek advice from their own tax advisors. With the Analysis performed by (firm) and the resulting conclusions described above, you and your tax advisors should be able to determine the applicability of Section 1202 to your personal circumstances.”
Overall, if an Investor Rights Agreement is in place, reviewing the terms is a great first step in determining if you can pursue a QSBS analysis and may even provide evidence as to the QSBS status of your shares.
What are my next steps if I want to pursue a QSBS analysis?
A QSBS analysis is best performed at the company level and shared with the shareholders, since individual shareholders are unlikely to have access to the information needed for an analysis. This is why we at QSBS Expert created our own assessment tool to help corporations evaluate whether they qualify at the outset and ensure that they continue to maintain their QSB status as they continue.
If you would like a company in which you hold stock to perform a QSBS assessment, you can use the email template below to send your request:
Dear Company X,
As you may be aware, Qualified Small Business Stock, as per Section 1202 of the US Federal Tax Code provides for up to a 100% capital gains tax exemption, if certain conditions are met.
I would like to request that you conduct a reasonable investigation to determine whether the Stock qualifies as “qualified small business stock” within the meaning of Code Section 1202.
QSBS Expert (https://www.qsbsexpert.com/) offers a service to both perform an initial QSBS assessment and then provide ongoing monitoring to help ensure the Company continues to maintain its QSBS status. Please reach out to them at email@example.com to learn more about their process.
If you would like to learn more about the QSBS Expert assessment process for your company or a company you hold securities in, contact us today.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.