What Every Entrepreneur Needs to Know About Qualified Small Business Stock LLC
April 26, 2016
Since 1993, the federal government has incentivized investment in small businesses through favorable tax rate treatment in order to keep the economic engine running. Those efforts have proven successful, as small businesses created nearly two million of the roughly three million private-sector jobs generated in 2014 and more than seven million of the 11 million jobs created during the economic recovery have been generated by startups and small enterprises.* For entrepreneurs and investors in startups, further incentives can be found in the Protecting Americans from Tax Hikes (PATH) Act of 2015, that when signed by President Obama made certain and significant tax incentives permanent.**
The new law makes permanent the exclusion of 100% of the gain on the sale or exchange of qualified small business stock (QSBS) acquired after September 27, 2010 and held for more than 5 years by individual tax payers, subject to certain limitations discussed below. The Act also permanently extends the elimination of QSBS gain as a preference item for Alternative Minimum Tax (AMT).
To Qualify as QSBS:
The stock must be in a domestic C corporation (not an S corporation or LLC, etc.), and it must be a C corporation stock during substantially the entire holding period.
The corporation may not exceed $50 million in assets as of the date the stock was originally issued and immediately after.
Your stock may not have been acquired from a secondary market offering, but instead must be an original issuance.
During the holding period, at least 80% of the value of the corporation’s assets must be used in the active conduct of one or more qualified businesses.
Most early-stage investments in C corporation technology companies meet these requirements.
If you’ve acquired the stock qualifying as QSBS for at least five years when it’s sold, all of your gain may be excluded from federal tax code. The maximum gain eligible for exclusion on any one private investment is the greater of $10 million or 10 times the taxpayer’s adjusted basis in the stock. If your gain exceeds that, the remainder is taxed at a Federal tax code rate of 28%. This assumes you are in the 15% or 20% bracket for long-term capital gains.
Keeping good records will ease the burden when it comes time to report a stock sale. In your records you should include the date of the original purchase, the amount paid, a copy of the account statement showing the transaction, and a copy of the original share certificate. If you think your founder equity award may qualify as QSBS, ask the company to certify to the qualifications listed above.
The five year holding period is a critical detail. Keep track of the date when your investment reaches the five-year holding period. Selling right before the five year holding period mark would disqualify this significant tax free break.
Lastly, it’s important to review the details of your equity holdings with your accountant and wealth advisor to determine if you can take advantage of this meaningful tax benefit.
With this incentive, the US government has permanently thanked entrepreneurs for their impact on our country’s growth, innovation and employment – so be sure to say ‘you’re welcome’ by seizing the opportunity.
*https://www.sba.gov/blogs/small-businesses-create-2-million-jobs
** http://waysandmeans.house.gov/wp-content/uploads/2015/12/SECTION-BY-SECTION-SUMMARY-OF-THE-PROPOSED-PATH-ACT.pdf
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