Qualified Small Business Stock Tax Exemption: What Is It and How to Use It

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The Qualified Small Business Stock (QSBS) tax exemption is a little-known perk that can potentially save substantial amounts in federal taxes, and in some cases state taxes, for qualified businesses.

This exemption allows certain shareholders to avoid paying capital gains tax on up to $10 million in profits or 10 times the adjusted basis in the stock, whichever is greater, for stock acquired on or after September 28, 2010.

While the QSBS tax exemption can offer significant tax savings to small business owners and startups, there are specific requirements that must be met in order for it to be utilized.

First, the business must be a C Corporation. This excludes any type of pass-through entity such as a Sub-S Corporation. The definition of qualified small business is complex, but expressly excludes service firms (such as health, law, engineering, consulting, financial services, banking and similar businesses) as well as farming, natural resource businesses and hospitality businesses. The most common business types that qualify for the QSBS exemption are technology and manufacturing.

In addition, a business hoping to use the QSBS exemption must use a minimum of 80% of its assets to conduct its business, and shares must be issued when the company has gross assets of $50 million or less (cash plus adjusted basis of property). Any shares issued after the corporation exceeds $50 million in gross assets will no longer qualify for the QSBS exemption, even if assets drop back below that level at a later date. The company valuation is irrelevant for the purposes of determining qualification for this exemption.

Lastly, the stock must have been held for a minimum of five years prior to selling in order to take advantage of the tax exemption. In the case where an employee has been granted shares, the five-year holding period begins on the day shares are exercised, not the day they are granted (subject to a few complex exceptions). Shareholders wishing to use the QSBS exemption must have acquired the stock directly from the issuing company and must be non-corporate taxpayers.

The QSBS exemption creates a unique gifting opportunity in that gifted stock retains its QSBS status as well as the original owner’s holding period. This makes QSBS ideal for gifts to family members!

In order to utilize this unique tax savings method, it is imperative that you consult with a knowledgeable tax professional and keep diligent records. Your Freestone Client Advisor can assist with an initial review of your business and can serve as a liaison between you and your accountant or can recommend a qualified accountant if needed. In addition, your Freestone Client Advisor can assist you in understanding the planning opportunities available through the use of Qualified Small Business Stock.

Important Disclosures: Nothing in this document is intended to provide, and you should not rely upon it for, accounting, legal, tax, or investment advice or recommendations. We are not making any specific tax recommendations and you should not make any investment or decisions on your qualified small business stocks based on the information in this document. The intention of this document is educational, and it is intended only to discuss limited aspects of the qualified small business tax exemption. This document is not a comprehensive or complete summary of considerations regarding this tax exemption. Each individual is in a different situation and has different items to address, and the options in this document are not appropriate for everyone. Please consult your Freestone client advisor regarding options specific to your needs.

Posted By: Stephanie d'Ippolito, CFP®

Stephanie d’Ippolito, CFP®, is our Managing Director of Financial Planning. She is passionate about helping people and believes that financial planning can be a valuable tool for clients to understand and solve their unique financial problems. She lives in Seattle with her husband and two dogs, Toby and Thurman.