Qualified Small Business Stock

Definition

Qualified small business stock (QSBS) refers to shares in a qualified small business that meet specific requirements under the Internal Revenue Code, allowing investors to potentially exclude a portion of their capital gains from taxation when they sell the stock. This tax incentive aims to encourage investment in small businesses by offering favorable tax treatment for long-term investors, thereby promoting entrepreneurship and job creation.

5 Must Know Facts For Your Next Test

1. To qualify as QSBS, the stock must be issued by a domestic C corporation with gross assets not exceeding $50 million at the time of issuance.
2. Investors can potentially exclude up to 100% of capital gains from the sale of QSBS if held for more than five years, depending on when the stock was acquired.
3. The maximum amount of gain eligible for exclusion is capped at the greater of $10 million or 10 times the investor's basis in the stock.
4. The company must be engaged in an active trade or business and not in specific excluded industries, such as finance, insurance, or professional services.
5. Investors must acquire QSBS at original issue and cannot simply purchase it from another shareholder to qualify for the tax exclusion.

Review Questions

• What are the key requirements for a stock to be classified as qualified small business stock?
  • For a stock to be classified as qualified small business stock, it must be issued by a domestic C corporation with gross assets not exceeding $50 million at issuance. Additionally, it must be held for at least five years by the investor to potentially qualify for capital gains tax exclusion. The corporation must be engaged in an active trade or business and cannot operate in certain excluded industries such as finance or insurance.
• How does Section 1202 incentivize investments in small businesses through qualified small business stock?
  • Section 1202 provides significant tax benefits to investors who hold qualified small business stock. Specifically, it allows investors to exclude up to 100% of capital gains on the sale of QSBS if held for more than five years. This incentivizes individuals to invest in small businesses, supporting entrepreneurship and growth while providing them with a substantial tax advantage compared to other investments.
• Evaluate the impact of qualified small business stock provisions on startup funding and economic growth in small enterprises.
  • The provisions surrounding qualified small business stock play a crucial role in enhancing startup funding and driving economic growth within small enterprises. By offering substantial capital gains tax exclusions, these incentives encourage investors to allocate resources towards new ventures, thus fostering innovation and job creation. Furthermore, this influx of investment can help stabilize and grow local economies, demonstrating how targeted tax policies can effectively promote entrepreneurial activity and bolster economic development.

Related terms

Capital Gains Tax: A tax on the profit from the sale of an asset or investment, calculated as the difference between the sale price and the purchase price.

Small Business Investment Company (SBIC): A government-backed program designed to provide funding to small businesses through private investment firms, offering various forms of financial support.

Section 1202: A provision of the Internal Revenue Code that outlines the rules and qualifications for claiming capital gains tax exclusions on the sale of qualified small business stock.