In their hope to bolster investment in small businesses, Congress has granted a number of tax breaks to investors of Qualified Small Business Stock.
Assuming certain requirements are met and the stock is held greater than 5 years, then a portion of the gain from the sale of such stock can be excluded from tax. The exclusion is 50% for stock acquired after August 10, 1993. The exclusion was subsequently increased to 75% for stock acquired after February 17, 2009, and before September 28, 2010, and to 100% for stock acquired after September 27, 2010. The change to the 100% exclusion was made permanent as part of The Taxpayer Increase Prevention Act of 2014.
Any amounts not excluded are subject to tax at a 28% rate. In addition, 7% of the excluded gain is considered a preference for Alternative Minimum Tax purposes, but not for gains eligible for the 100% exclusion. However, any amount excluded will be excluded from the Net Investment Income Tax.
The gain eligible for exclusion for each taxpayer is limited on a per issuer basis and cannot exceed the greater of (1) $10 million reduced by the taxpayer's aggregate prior-year gains from stock of the same issuer, or (2) 10 times the taxpayer's basis in his or her QSBS from such corporation disposed of during the year.
Rollover of QSBS Gain
In addition to the exclusion, QSBS investors can also defer the recognition of the gain on the disposition of QSBS stock by reinvesting the proceeds into another QSBS investment. In order to do this to take advantage of the tax deferral, the eligible QSBS stock must be owned at least 6 months prior to the rollover, and the proceeds are invested in the new company within 60 days.
QSBS Stock Defined
Qualified small business stock (QSBS) is stock originally issued after August 10, 1993, by a C corporation with aggregate gross assets not exceeding $50 million at any time from August 10, 1993, to immediately after the issuance of the stock. The taxpayer must have acquired the stock at its original issue. In addition, the corporation must meet an active business requirement whereby 80% or more of its assets are used in one or more businesses other than those specifically excluded. Ineligible businesses include certain personal service activities, banking and other financial services, farming, mineral extraction businesses, and hotels and restaurants. Eligible businesses include manufacturing, wholesale or retail trade, and transportation activities.
1244 Stock Losses
Taxpayers who incur a loss on an original investment may be able to claim Section 1244 loss treatment. If eligible, the loss on the investment is treated as an ordinary loss as opposed to a capital loss, which may be subject to limitations.
Section 1244 stock generally can be either common or preferred stock. However, stock issued before July 19, 1984, must be common stock to qualify for Section 1244 treatment. In addition, the corporation must be considered a small business corporation when the stock is issued. Additionally, a corporation will only be treated as a small business corporation if the aggregate amount of money and other property received by the corporation for the stock, as a contribution to capital, and as paid-in capital does not exceed $1 million. Furthermore, the corporation must have derived more than 50% of its aggregate gross receipts from sources other than investments (such as interest, dividends, royalties) during the five most recent tax years ending before the date the taxpayer's loss is sustained (or since inception if the corporation is in existence for less than five years).
The maximum amount that can be claimed as an ordinary loss in a tax year is $50,000 for a single taxpayer or $100,000 on a joint return.
Claiming qualified small business stock benefits can be complex but the potential benefits can be substantial. Please consult with your BPM Tax advisor for additional guidance.