Many Californians are familiar with the tax-favored treatment allowed under some conditions with regard to the sale of their principal residence. In many cases, married sellers can exclude up to $500,000 of the gain on the sale. But are you familiar with another important tax benefit called the “qualified small business stock” (QSBS) exclusion? If you are involved in a small business, you should be.
IRC § 1202
Internal Revenue Code § 1202 allows the seller of a “qualified small business” to exclude up to 100 percent of the gain attributable to the sale or exchange of qualified small business stock from taxation. In order for the “stock” to qualify for the favored tax treatment, it must have the following characteristics:
• The stock must have been originally issued by a “qualified small business.” Generally speaking, such a business must be a “C Corporation” that did not have $50 million or more in assets at the time when it was formed.
• The taxpayer must have acquired the stock at its original issue in exchange for money, property, or as compensation for services provided to the corporation.
• During the time when the taxpayer owned the stock, at least 80 percent of the corporation’s assets must have been actively used to conduct one or more qualified businesses. Generally, any active trade or business qualifies – except certain excluded businesses such as health, law, and engineering financial businesses including banking, insurance and financing, and certain other businesses (farming, mining, and hotel or restaurant operation).
• The corporation must be an “eligible corporation” within the meaning of the statute.
• The corporation must not have redeemed more than a de minimus amount of stock from the taxpayer (as well as certain related parties) during the four-year period beginning two years prior to the issuance of stock to the taxpayer.
Exclusion Percentage Depends on Date When Stock Was Acquired
Those sellers who have held QSBS for more than five years may be eligible to exclude the gain on a sliding scale, depending upon acquisition dates. For example:
• QSBS acquired after September 27, 2010 is eligible for the 100 percent exclusion
• QSBS acquired before February 18, 2009 is eligible for a 50 percent exclusion
• QSBS acquired after February 18, 2009, but before September 27, 2010, is eligible for a 75 percent exclusion
Under any circumstances, however, the excluded gain is limited to the greater of $10 million or ten (10) times the taxpayer’s adjusted basis in the QSBS.
Favorable Tax Treatment Would Have Expired
The favorable tax treatment allowed under § 1202 would have expired this year, but Congress extended it in December 2015 by passage of The Protecting Americans From Tax Hikes Act. Anyone contemplating the sale of an interest in a small business should consult with a business law expert to determine if the transaction can be crafted so as to take advantage of the exclusion.
CKB VIENNA LLP: A Full-Service Consulting and Law Firm
The law firm of CKB VENNA has a long history of representing high-net-worth individuals, substantial closely held and family businesses – many of which qualify for QSBS favorable tax treatment. We help others with all sorts of business and wealth management issues. Our attorneys provide counsel on sales of corporate stock and other appreciated assets. We have designed special client plans to foster estate, gift, and generation-skipping transfer tax planning and sophisticated charitable giving. We have counseled others regarding complex tax controversies. We don’t stamp out cookie-cutter solutions; we first gain a true understanding of the client’s goals, concerns, and unique issues. Then we work with the client to achieve success. CKB VENNA has offices in Rancho Cucamonga, San Bernardino, and Los Angeles. Contact us by telephone at 909.980.1040 or complete our online form.