The qualified small business stock (QSBS) exclusion is a tax benefit that applies to eligible shareholders of a qualified small business (QSB). It was originally enacted in 1993 as a partial exclusion, and was later expanded to a 100% exclusion as part of the Small Business Jobs Act in 2010. The exclusion is governed by Section 1202 of the U.S. Internal Revenue Code and can provide a break on capital gains tax, potentially up to 100%.
Qualified business stock is defined as any stock in a C corporation which is originally issued after the date of the enactment of the Revenue Reconciliation Act of 1993 if (1) at the date of issuance, the corporation is a qualified small business; and (2) the stock is acquired by the taxpayer at its original issue in exchange for money or other property (not including stock) or as compensation for services provided to the corporation.
In addition, the stock in the corporation will not be treated as QSBS unless it satisfies the active business requirement. This requires at least 80 percent (by value) of the assets of the corporation be used by the corporation in the active conduct of one or more qualified trades or businesses and the corporation is an eligible corporation (domestic corporation).
For purposes of the QSBS exclusion, a qualified trade or business does not include performing services in certain fields such as, health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business in which the principal asset is the reputation or skill of one or more of its employees. Further, the definition of a qualified trade or business excludes any business in banking, insurance, financing, leasing, investing, farming, and any hotel, motel, or restaurant.
A corporation is a “qualified small business” if the C corporation is a domestic corporation in which (1) the aggregate gross assets of the corporation at all times on or after the date of enactment of the Revenue Reconciliation Act of 1993 and before the issuance did not exceed $50,000,000; (2) the aggregate gross assets of the corporation immediately after the issuance do not exceed $50,000,000; and (3) the corporation agrees to submit reports to the Secretary of Treasury and to shareholders as the Secretary of Treasury may require.
In the case of QSBS acquired after the date of the enactment of the Revenue Reconciliation Act of 1993 but before February 17, 2009, gross income shall not include 50% of any gain from the sale or exchange of QSBS held for more than 5 years. If the QSBS was acquired after February 17, 2009 but before the enactment of the Creating Small Business Jobs Act of 2010, the gross income shall not include 75% of any gain from the sale or exchange of QSBS. Finally, for QSBS acquired after the enactment of the Creating Small Business Jobs Act of 2010, the gross income exclusion is 100% of any gain from the sale or exchange of QSBS held for more than 5 years.