Q: How can I take advantage of the 100% exclusion of the gain from the sale of stock in my small business?
A: The federal income tax code allows you to exclude from your gross income a portion of gain up to $10 million realized from the sale of the “qualified small business stock” (“QSBS”) that you have held for more than five years. For QSBS issued to you after Sept. 28, 2010, 100% of up to $10 million of gain can be excluded.
To qualify for this tax benefit, your stock must meet the following requirements:
1. The issuing corporation must be a C corporation for substantially all of the period during which you held the stock.
2. The aggregate value of the gross assets of the corporation cannot have exceeded $50 million at any time before or immediately after the issuance of the stock to you.
3. You must have acquired the stock at its original issue by the corporation (or by gift or bequest from the person who acquired it at original issue) in exchange for money or other property (not including stock) or as compensation for services. Notably, certain redemptions by the corporation of its own stock within a few years of the original issuance of your stock can cause it to lose its QSBS status.
4. The corporation must have been an “active business” during substantially all of your holding period for the stock. The active business requirement is generally met if at least 80% of the corporation’s assets are used in the active conduct of a “qualified trade or business.” A “qualified trade or business” is any business other than certain service businesses listed in the relevant statute, e.g., law, engineering, health, investing or financial services. By contrast, a business that primarily uses manufacturing or intellectual property to create value for customers will typically qualify.
While these requirements may appear simple, they can be difficult to meet in practice.
You will need access to the corporation’s historical financial records and governance records and its stock ledger to determine whether the active business, qualified small business, and original issuance requirements are met.
If you transfer stock by gift, you may need contemporaneous documentation of which of the donor’s shares have been transferred to substantiate your claim that the shares in the gift were obtained by you at their original issuance and establish their holding period.
Thus, if you believe you may have (or receive) stock eligible for the QSBS exclusion, it is important to work with your tax adviser well before disposition of the shares (whether by sale or gift) to ensure that you have the information necessary to claim the exclusion.