Qualified Small Business Stock

Last updated

Qualified Small Business Stock (QSBS) is a tax incentive to drive the investment and founding of small businesses in the United States of America. [1] The QSBS regulations are under U.S. Code Section 1202 [2] of the Internal Revenue Code (IRC). QSBS is a tax exemption on a federal, and in some cases, a state level. [3] The tax benefit can exclude up to 100% of capital gains on the sale of QSBS held for five years. [4] The tax exemption allows savings up to the greater of $10 million or 10x the shareholder's basis in their stock (i.e. initial investment in the company). [5]

Contents

History of QSBS

QSBS was first enacted in August 1993. [6] Expansion and modification of these original aspects of QSBS legislations have occurred over the years to further motivate taxpayers to invest in, or even create, certain types of small businesses to boost job creation and to prevent economic recession. [7]

Over the decades, several legislative events have contributed to investor interest in the QSBS Section 1202 capital gains tax exclusion:

1993 – P.L 103-66 Section 1202 Passed

August 10, 1993, the Public Law No. 103-66 Title VIII Part II Subpart B – Capital Gains Provision was passed by the House of Representatives Budget Committee and added to the Internal Revenue Code (IRC) as Section 1202.4. [8] It was introduced by Martin Olav Sabo of the Minnesota House of Representatives. Section 1202 provided investors a 50% tax exclusion on capital gains up to the greater of $10M or 10x the taxpayer's basis. [9] The capital gains rate was 28% at the time, and therefore QSBS provided up to a 14% tax savings. [10]

1998 – Congress Lowered the Top Capital Gains Rate

The capital gains rate was lowered to 20% for non-QSBS but kept at 28% for QSBS, which lowered the tax savings to 6%. [11] 2003 – Congress Lowered the Top Capital Gains Rate The capital gains rate was lowered to 15% for non-QSBS but kept at 28% with a 50% exclusion for QSBS, which lowered the tax savings to 1%. [12]

2009 – Congress Increased the Section 1202 Exclusion

The 50% tax exclusion on QSBS was increased to 75%, which raised the tax savings from 1% to 8%. [11] 2010 – Congress Temporarily Increased the Section 1202 Exclusion The 75% tax exclusion on QSBS was increased to 100%, which raised the tax savings from 8% to 15%. [11]

2015 – PATH ACT 2015

Congress passed the Protecting Americans from Tax Hikes Act (PATH), which permanently increased the Section 1202 tax exclusion to 100% if the original issuance of the stock was made after September 27, 2010. [13]

2017 – Tax Cuts and Jobs Act (TCJA)

The TCJA was signed and enacted, which reduced the corporate tax rate from 35% to 21%, encouraging more companies to choose to be taxed as C-corporations and potentially benefit from the QSBS tax exemptions. [14]

Eligibility, Recording, and Filing Qualified Small Business Stock (QSBS)

QSBS eligibility and tax exemption benefits aim to fuel job growth on a national level by incentivizing investments in C-corporations located in the United States. However, QSBS eligibility excludes companies where individuals or groups of employees are considered the "product," such as healthcare workers, accountants, or lawyers. [15] Additionally, specific requirements must be met at the corporate level, security level, and individual taxpayer level for a company or investor to qualify and remain QSBS eligible. [16] Some of these requirements are at issuance of the stock, and others are during the shareholder's holding period. [17]

General criteria for QSBS Eligible Stock

QSBS Rules by State

On a national level, each state has a specific treatment of QSBS gains at the state income tax level. [23] There are three ways states typically address the exclusion:

Some states fully conform to the Federal QSBS guidelines and allow full exemption if the stock meets the Section 1202 QSBS criteria. These states conform to the federal tax code on either a "static" or "rolling" basis. "Static" conformity means the state starts complying with the Internal Revenue Code as of a specific date. "Rolling" conformity means that the state adopts IRC changes as they occur. [24]

Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state. [25]

Certain states do not have state income taxes, and therefore there is no QSBS implication at the state level. Additionally, select states do not allow any capital gains exclusions for QSBS.

States that Conform to Federal QSBS (IRC Section 1202) [26]

States that do not conform to Federal QSBS (IRC Section 1202) [27]

States that Partially Conform to Federal QSBS (IRC Section 1202) [27]

States Without State Income Tax (conform with IRC Section 1202) [27]

States Without State Capital Gains Tax (conform with IRC Section 1202) [27]

Criticisms of QSBS

Due to practices that multiply the tax benefit, there are some criticisms over the uses of the QSBS tax exemption. Majority of these practices being used to multiply the tax benefit are not initially intended within the tax code. Originally, the enactment of the QSBS tax exemption legislation worked to incentivize investments in certain types of small businesses within the United States. However, as the popularity of the tax benefit began to grow, some investors found ways to make the most of the tax benefit by multiplying their personal tax savings and, in some cases, to family, friends, and acquaintances. [28]

Related Research Articles

In the United States, a 401(k) plan is an employer-sponsored, defined-contribution, personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their paychecks, and may be matched by the employer. This legal option is what makes 401(k) plans attractive to employees, and many employers offer this option to their (full-time) workers. 401(k) payable is a general ledger account that contains the amount of 401(k) plan pension payments that an employer has an obligation to remit to a pension plan administrator. This account is classified as a payroll liability, since the amount owed should be paid within one year.

A dividend tax is a tax imposed by a jurisdiction on dividends paid by a corporation to its shareholders (stockholders). The primary tax liability is that of the shareholder, though a tax obligation may also be imposed on the corporation in the form of a withholding tax. In some cases the withholding tax may be the extent of the tax liability in relation to the dividend. A dividend tax is in addition to any tax imposed directly on the corporation on its profits. Some jurisdictions do not tax dividends.

Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares.

An individual retirement account (IRA) in the United States is a form of pension provided by many financial institutions that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer's earned income for the taxpayer's eventual benefit in old age. An individual retirement account is a type of individual retirement arrangement as described in IRS Publication 590, Individual Retirement Arrangements (IRAs). Other arrangements include employer-established benefit trusts and individual retirement annuities, by which a taxpayer purchases an annuity contract or an endowment contract from a life insurance company.

A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property.

A 529 plan, also called a Qualified Tuition Program, is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary. In 2017, K–12 public, private, and religious school tuition were included as qualified expenses for 529 plans along with post-secondary education costs after passage of the Tax Cuts and Jobs Act.

<span class="mw-page-title-main">Economic Growth and Tax Relief Reconciliation Act of 2001</span> The "EGTRRA"

The Economic Growth and Tax Relief Reconciliation Act of 2001 was a major piece of tax legislation passed by the 107th United States Congress and signed by President George W. Bush. It is also known by its abbreviation EGTRRA, and is often referred to as one of the two "Bush tax cuts".

Double taxation is the levying of tax by two or more jurisdictions on the same income, asset, or financial transaction.

<span class="mw-page-title-main">Taxpayer Relief Act of 1997</span> United States tax cut law

The Taxpayer Relief Act of 1997 was enacted by the 105th United States Congress and signed into law by President Bill Clinton. The legislation reduced several federal taxes in the United States and notably created the Roth IRA.

The Internal Revenue Code of 1986 (IRC), is the domestic portion of federal statutory tax law in the United States. It is codified in statute as Title 26 of the United States Code. The IRC is organized topically into subtitles and sections, covering federal income tax in the United States, payroll taxes, estate taxes, gift taxes, and excise taxes; as well as procedure and administration. The Code's implementing federal agency is the Internal Revenue Service.

A gift tax, known originally as inheritance tax, is a tax imposed on the transfer of ownership of property during the giver's life. The United States Internal Revenue Service says that a gift is "Any transfer to an individual, either directly or indirectly, where full compensation is not received in return."

A 501(c) organization is a nonprofit organization in the federal law of the United States according to Internal Revenue Code and is one of over 29 types of nonprofit organizations exempt from some federal income taxes. Sections 503 through 505 set out the requirements for obtaining such exemptions. Many states refer to Section 501(c) for definitions of organizations exempt from state taxation as well. 501(c) organizations can receive unlimited contributions from individuals, corporations, and unions.

<span class="mw-page-title-main">Income tax in the United States</span> Form of taxation in the United States

The United States federal government and most state governments impose an income tax. They are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. Most business expenses are deductible. Individuals may deduct certain personal expenses, including home mortgage interest, state taxes, contributions to charity, and some other items. Some deductions are subject to limits, and an Alternative Minimum Tax (AMT) applies at the federal and some state levels.

Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international tax laws.

A venture capital trust or VCT is a tax efficient UK closed-end collective investment scheme designed to provide venture capital for small expanding companies, and income and/or capital gains for investors. VCTs are a form of publicly traded private equity, comparable to investment trusts in the UK or business development companies in the United States. They were introduced by the Conservative government in the Finance Act 1995 to encourage investment into new UK businesses.

In the United States, individuals and corporations pay a tax on the net total of all their capital gains. The tax rate depends on both the investor's tax bracket and the amount of time the investment was held. Short-term capital gains are taxed at the investor's ordinary income tax rate and are defined as investments held for a year or less before being sold. Long-term capital gains, on dispositions of assets held for more than one year, are taxed at a lower rate.

In economics, a gift tax is the tax on money or property that one living person or corporate entity gives to another. A gift tax is a type of transfer tax that is imposed when someone gives something of value to someone else. The transfer must be gratuitous or the receiving party must pay a lesser amount than the item's full value to be considered a gift. Items received upon the death of another are considered separately under the inheritance tax. Many gifts are not subject to taxation because of exemptions given in tax laws. The gift tax amount varies by jurisdiction, and international comparison of rates is complex and fluid.

Under U.S. Federal income tax law, a net operating loss (NOL) occurs when certain tax-deductible expenses exceed taxable revenues for a taxable year. If a taxpayer is taxed during profitable periods without receiving any tax relief during periods of NOLs, an unbalanced tax burden results. Consequently, in some situations, Congress allows taxpayers to use the losses in one year to offset the profits of other years.

In the United States, the estate tax is a federal tax on the transfer of the estate of a person who dies. The tax applies to property that is transferred by will or, if the person has no will, according to state laws of intestacy. Other transfers that are subject to the tax can include those made through a trust and the payment of certain life insurance benefits or financial accounts. The estate tax is part of the federal unified gift and estate tax in the United States. The other part of the system, the gift tax, applies to transfers of property during a person's life.

An Employee Stock Ownership Plan (ESOP) in the United States is a defined contribution plan, a form of retirement plan as defined by 4975(e)(7)of IRS codes, which became a qualified retirement plan in 1974. It is one of the methods of employee participation in corporate ownership.

References

  1. ↑ Tiffany Lam-Balfour, "Qualified Small-Business Stock, or QSBS: How to Use it", NerdWallet (Dec. 06, 2021).
  2. ↑ 26 U.S.C. § 1202 (2018)
  3. ↑ The Carta Team, "The qualified small business stock (QSBS) tax benefit", Carta (Jan. 26, 2022), https://carta.com/blog/qsbs/.
  4. ↑ "Qualified Small Business Stock (QSBS) Definition and Tax Benefits". Investopedia. Retrieved 2024-02-15.
  5. ↑ Calhoun, Brett (2021-01-19). "QSBS Exemption". QSBS Expert. Retrieved 2024-02-15.
  6. ↑ "Almost too good to be true: The Section 1202 qualified small business stock gain exclusion | Our Insights | Plante Moran". www.plantemoran.com. Retrieved 2024-02-15.
  7. ↑ Interview by Founders Circle Capital with Ray Thornson, Managing Director, Andersen Tax, https://www.founderscircle.com/what-startup-founders-and-employees-need-to-know-about-qualified-business-stock-qsbs/; QSBS Expert, Small Business Survey Shows Increasing Economic Optimism—Investors Can Partner in Growth Through QSBS, QSBS Expert (July 19, 2021), https://www.qsbsexpert.com/small-business-survey-shows-increasing-economic-optimism-investors-can-partner-in-growth-through-qsbs/.
  8. ↑ Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, 107 Stat. 312.
  9. ↑ "Qualified Small Business Stock: What Is It and How to Use It | U.S. Small Business Administration". www.sba.gov. 2017-04-13. Retrieved 2024-02-15.
  10. ↑ "History of Section 1202 Qualified Small Business Stock (QSBS)". QSBS Expert. 2020-05-31. Retrieved 2024-02-15.
  11. 1 2 3 QSBS Expert, History of Section 1202 Qualified Small Business Stock (QSBS), QSBS Expert (May 31, 2020), https://www.qsbsexpert.com/history-of-qualified-small-business-stock-qsbs-section-1202/; Mark Luscombe, JD, LLM, CPA, "Historical Capital Gains Rates", Wolters Kluwer (Mar. 09, 2022), https://www.wolterskluwer.com/en/expert-insights/whole-ball-of-tax-historical-capital-gains-rates.
  12. ↑ QSBS Expert, History of Section 1202 Qualified Small Business Stock (QSBS), QSBS Expert (May 31, 2020), https://www.qsbsexpert.com/history-of-qualified-small-business-stock-qsbs-section-1202/; Mark Luscombe, JD, LLM, CPA, "Historical Capital Gains Rates", Wolters Kluwer (Mar. 09, 2022), https://www.wolterskluwer.com/en/expert-insights/whole-ball-of-tax-historical-capital-gains-rates.
  13. ↑ "PATH Act Protects QSBS". QSBS Expert. 2021-07-15. Retrieved 2024-02-15.
  14. ↑ Tax Cuts and Jobs Act, Pub. L. No. 115-97, 131 Stat. 2052; Tax Policy Center Briefing Book, How did the Tax Cuts and Jobs Act change business taxes?, Tax Policy Center, https://www.taxpolicycenter.org/briefing-book/how-did-tax-cuts-and-jobs-act-change-business-taxes; TaxEDU, Tax Cuts and Jobs Act (TCJA), Tax Foundation, https://taxfoundation.org/tax-basics/tax-cuts-and-jobs-act/; see also QSBS Expert, History of Section 1202 Qualified Small Business Stock (QSBS), QSBS Expert (May 31, 2020), https://www.qsbsexpert.com/history-of-qualified-small-business-stock-qsbs-section-1202/.
  15. ↑ Meghan Andersson, J.D., LL.M., Qualified small business stock exclusion: Who’s eligible?, The Tax Advisor (Nov. 01, 2021)(Mark G. Cook, CPA, CGMA, ed.), https://www.thetaxadviser.com/issues/2021/nov/qualified-small-business-stock-exclusion-eligible.html; QSBS Expert, Which Types of Companies Qualify as QSBs and Which Don’t?, QSBS Expert (Jan. 01, 2021), https://www.qsbsexpert.com/which-types-of-companies-qualify-as-qsbs-and-which-dont/.
  16. ↑ "Understanding the qualified small business stock gain exclusion". rsmus.com. Retrieved 2024-02-15.
  17. ↑ Kenton, supra note 4.
  18. ↑ 26 U.S.C. §1202(d)(1) (2018)
  19. ↑ 26 U.S.C. §1202(d)(1)(A), (B) (2018)
  20. ↑ 26 U.S.C. §1202(e) (2018)
  21. ↑ 26 U.S.C. §1202(a)(1) (2018)
  22. 1 2 Polsky, Gregg; Yale, Ethan (2022). "A Critical Evaluation of the Qualified Small Business Stock Exclusion". Virginia Tax Review. 42: 353.
  23. ↑ "How the QSBS Tax Exemption Can Lead to Additional Benefits". www.mossadams.com. 2021-04-08. Retrieved 2024-02-15.
  24. ↑ "States' rolling conformity to the Code and CARES Act". Journal of Accountancy. 2021-02-01. Retrieved 2024-02-15.
  25. ↑ Loughead, Katherine (2021-04-01). "State Conformity to Federal Pandemic-Related Tax Provisions in CARES and ARPA". Tax Foundation. Retrieved 2024-02-15.
  26. ↑ "QSBS Rules by State". QSBS Expert. Retrieved 2024-02-15.
  27. 1 2 3 4 Id.
  28. ↑ "Stacking and Packing – Strategies to Maximize the Section 1202 Exclusion". Withum. 2021-08-20. Retrieved 2024-02-15.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.