Tax Benefits of Qualified Small Business Stock Exchanged For Stock
During a Recapitalization, Restructuring, or Sale of an entity, whether a corporation, partnership, or LLC, the tax treatment of qualified small business stock exchanged for stock will depend on the nature of the restructuring or recapitalization. If the stock is exchanged for a stock of a different company, the status of the QSBS will not change, but the amount of the gain will be limited to the amount of gain that could have been excluded from taxable gain.
Selling QSBS within five years of acquiring it
Investing in a small business can be a wise choice for a number of reasons. Aside from the fact that you are investing in your own company, you are gaining the benefit of a tax break. The qualified small business stock exclusion allows you to sell your business at a tax-free gain.
If you’re considering investing in a small business, make sure you’re aware of the QSBS tax exclusion. It can save you a lot of money on your capital gains tax. However, there are several requirements to qualify. You should consult with your accountant or investment advisor before making a decision.
The IRS defines the qualified small business stock exclusion as a provision of the Internal Revenue Code that allows eligible shareholders to exclude gains on the sale of qualified small business stock. The maximum gain allowed is $10 million. This amount is calculated by dividing the shareholder’s basis in shares by 10 times. During the five years that the shareholder holds the stock, the gain will not be subject to federal income tax.
QSBS is not available for other types of securities, such as options and warrants. It is also not available for companies with more than $50 million in assets. There are also restrictions on how much gain you can exclude. The maximum gain that a shareholder can exclude from taxable gain on the QSBS sale is 10 times the shareholder’s basis in shares. This can be spread out over multiple years.
To qualify, your business must meet the requirements of the QSBS. The most important is that you must hold your stock for five years before selling it. If you aren’t able to meet this requirement, your gains will be taxed at regular capital gains rates.
The QSBS exclusion does not apply to shares of stock that were acquired on the secondary market. It is also not applicable to companies that are based in areas such as professional sports or healthcare. It also does not include financial services, hospitality services or farming.
Limitation on the amount of gain that can be excluded from taxable gain
Generally, there is a limit on the amount of gain that can be excluded from taxable gain for qualified small business stock exchanged for stock. There are many factors that will affect the exclusion of gain. Some of these factors include the date of issuance of the stock and the method of acquiring the stock.
The QSBS exemption is intended to protect taxpayers from paying federal taxes on the gain of their shares in qualified small business corporations. The exemption is a per-corporation basis, so the corporation must meet two gross-assets tests in order to qualify. Generally, this means that the corporation must be a C corporation, must have been active in the trade or business of a qualified small business, and must have gross assets of not more than $50 million.
In addition, the corporation must be a qualified small business for the entire five year holding period. There are some exceptions, such as when a corporation issues shares to a related person or to a taxpayer. A corporation that has exceeded its limit on gross assets may still qualify for the QSBS, but it can never issue qualified stock. The corporation issuing stock must meet the two gross-assets tests.
If the corporation meets all of the above requirements, the shareholder is entitled to a QSBS exclusion of up to $10 million. The shareholder’s total QSBS exclusion amount is equal to the greater of $10 million or ten times the adjusted basis of the stock. Depending on the date the stock was acquired, the shareholder may be entitled to a higher amount of exclusion.
There are exceptions to the QSBS exclusion, including when the stock was acquired in exchange for non-cash property. If a shareholder has acquired the stock directly from the issuing corporation, it will be treated as if the shareholder acquired the stock at the date of issuance. If the stock was acquired as a gift or as an inheritance, the holding period may be “tacked” to the previous holding period.
For a company to qualify for the QSBS exclusion, its stock must have been issued as a result of an active trade or business. This means that the stock may have been issued in exchange for property that is used in the active conduct of business. If the property is used in the active conduct of business, the basis is treated as the fair market value at the time the property was contributed.
Recapitalizations and restructurings affect QSBS status
During a recapitalization, or restructuring, a company will usually swap one form of financing for another, usually to improve liquidity and stability of the capital structure. It may be a strategic move to diversify debt, increase liquidity, or minimize tax payments. A company may also use the recapitalization process as an exit strategy for venture capitalists, or to reorganize during bankruptcy. Regardless of the reasons, companies will need to be careful when it comes to obtaining QSBS status.
In order to qualify for QSBS treatment, a corporation must have gross assets of less than $50 million. In addition, incoming cash is included for measurement purposes. Usually, the tax-free reorganization will occur through contributions of assets to a newly-formed corporate subsidiary. Those assets will then be distributed to qualified small business stockholders. A recapitalization or restructuring can be tax-free under Section 355 and Section 368.
However, Section 1202 also contains rules that allow certain transactions without negatively impacting QSBS status. In particular, the stockholder exchange rules in Section 1202 allow for tax-free exchanges of stock. However, a stockholder exchange will only qualify if the stock is QSBS. This is because the tax-free exchange defers gains until the stock is sold.
In addition, the stockholder exchange rules in Section 1202 also allow for a tax-free division. In this scenario, a company will exchange debt for equity. It is rare to see a tax-free division. However, if it is carried out, it should be considered. This type of reorganization would qualify as an “E” reorganization under Section 368. However, it is important to note that this type of reorganization does not allow for a seamless exchange of QSBS.
A recapitalization may also allow for the issuance of additional stock to non-QSBS stockholders. This type of stock is usually issued for stock exchange purposes. Ideally, the acquiring company will exchange stock for controlling interest in the target company. If the acquiring company’s aggregate assets are less than $50 million, the transaction should qualify for Section 1202 status.
Using the stockholder exchange rules in Section 1202 may also allow a company to issue QSBS stock in exchange for non-QSBS stock. For example, if a company has $30 million in assets and wants to increase its assets to $50 million, it could issue 100 shares of non-QSBS stock to five investors.
Documenting the QSBS status of newly issued stock
Whether you are a new company that is raising capital or a growth equity fund, you need to be aware of the QSBS tax break. This tax break was created to provide incentive to shareholders of small businesses to invest in their company. This tax break can be significant and can translate into tax savings.
To qualify for QSBS treatment, a company must be active domestic C corporation. This means that the company’s gross assets must not exceed $50 million. Moreover, the company must acquire QSBS stock from a C corporation, not a financial service or personal services company. It must also be acquired in exchange for money, property or services.
The exclusion rate for QSBS stock ranges from 50% to 75%. The percentage increase was part of the Small Business Jobs Act. In 2010 the QSBS exclusion was increased to 100%.
If you own QSBS stock, you may be able to roll over your gains. However, you must make an election on your tax return. You must hold QSBS for at least six months to qualify for this benefit.
You can also claim the QSBS tax break if you are a shareholder of more than one company. However, if you are working for more than one company, you must claim the QSBS tax break independently.
Qualified small business stock is defined as stock acquired by an active C corporation in exchange for money, property or services. The IRS has a wide interpretation of the term “active business,” which means a company that has been actively conducting business. This can include companies that are involved in mergers and acquisitions (M&A) activity, which can hurt QSBS treatment.
A firm should track QSBS through its holding period. This will help it determine whether a company is qualified for QSBS treatment or not. In addition, it is important to tag QSBS stock. This will help you identify QSBS stock during the acquisition process. You will also want to work with your firm’s deal team to ensure that the firm meets QSBS requirements.