Qualified Small Business Stock – Preferential Tax Treatment for Small Business Owners or Investors

Limited liability companies, or LLCs, have become the most popular form of business entity. This is largely due to the simplicity of registration, reduced reporting requirements, and flexibility of governance and ownership structures. Even though LLCs are often considered the most advantageous entity type, businesses formed as corporations have a significant economical advantage. This blog post highlights a benefit that is exclusive to corporations – the Qualified Small Business Stock, or QSBS. This type of stock is defined under Section 1202 of the Internal Revenue Code.

QSBS only applies to certain stocks held in Qualified Small Business (“QSB”). A Qualified Small Business, as defined by the IRS, is generally defined a company in the technology, retail, wholesale and manufacturing sectors that has under $50 million in assets. The main benefit of QSBS is that under certain specific circumstances, capital gains taxes from the sale of stock held in small corporations are exempt from federal taxes. Unfortunately, businesses in the hospitality industry, personal services, financial sector, farming, or mining do not qualify for these benefits.

To qualify for the QSBS deduction, the stockholder must have acquired the stock when it is originally issued. The stock must be issued in exchange for capital or services provided to the business. In addition, the stock must be held for at least five years, and during this time the business must use at least 80% of its assets in active conduct of the primary purpose that qualifies for the QSBS deduction. If all the requirements are met, the QSBS deduction allows the taxpayer to avoid capital gains taxes on the greater of the first $10 million gain on the sale, or ten times the adjusted bases of the investment.

This post is a general overview of the potential benefits of QSBS. Please note that QSBS deductions and tax benefits are very fact specific, and clients should engage legal and accounting professions to ensure compliance. McNeelyLaw regularly works with a large variety of business, from small to large and from start-up to multi-generational. Additional details on McNeelyLaw’s business practice can be found here.

Unsure whether to register your business as an LLC or a corporation? This blog post offers an overview of other benefits and drawbacks of LLCs and corporations as entity forms.

This McNeelyLaw LLP publication should not be construed as legal advice or legal opinion of any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.