Qualified Small Business Stock

Capital gains taxes can be painful for everyone, but particularly painful for high-bracket clients. They might owe the increased 20% tax on long-term gains, the 3.8% surtax on net investment income and various stealth taxes. An often overlooked tax saving opportunity is Section 1202 of the tax code. The Protecting Americans from Tax Hikes Act of 2015 recently made a 100% exclusion permanent, retroactive to 2015.  It includes one of the best breaks around — and no secret to experienced angel and venture capital investors in Silicon Valley — is qualified small business stock (QSBS).

What Is QSBS?

Small Business

Like all things in tax, the IRS definition of qualified small business can get complicated, and it changes depending on the section of the tax code in question. The Section 1202 exclusion of the Internal Revenue Code (IRC) is generally capped at $10 million of gains per stock issuer and applies to the profits of non-corporate taxpayers on sales of “qualified small business stock.”

To qualify as QSBS under Section 1202:

  • The stock must be in a domestic C corporation (not an S corporation or LLC, etc.), and it must be a C corporation during substantially all the time you hold the stock.
  • The corporation may not have more than $50 million in assets as of the date the stock was issued and immediately after.
  • Your stock must be acquired at its original issue (not from a secondary market).
  • During substantially all the time you hold the stock, at least 80% of the value of the corporation’s assets must be used in the active conduct of one or more qualified businesses.

Someone who owns a QSBS for more than six months but sells it before five years may be able to defer the tax on any gains by buying another QSBS issue within 60 days.

Scant Value

Section 1202 of the tax code has been around for years, but its benefit was minimal. It was enacted in 1993 with a 50% exclusion but the taxable portion of any gain was taxed up to 28%. If 50% of a QSBS gain was taxed at 28%, the effective tax rate would have been 14%, a modest saving when the top capital gain tax rate subsequently was lowered to 15%. In addition, QSBS gains may have been subject to the alternative minimum tax, adding to the ultimate tax bill. Section 1202 has become significantly more attractive, with a 100% exclusion of gains and no AMT exposure, under the PATH Act of 2015.

Exit Planning

The decision to structure a company as a C corporation, with potential tax-free profits in the future, depends on the type of business. Someone starting a business in the hopes of attracting angel investors and eventually going public, for instance, might choose a C corporation. Individuals who invest in privately held companies may not be aware of the Section 1202 opportunity.  Anyone making an investment that eventually may qualify for QSBS treatment should ask the company to certify that it is a domestic C corporation with $50 million or less in assets that would qualify for the exclusion Investors also should keep track of the date when their investment reaches the five-year holding period. You wouldn’t want to sell right before it hits the threshold if waiting would have resulted in significant tax savings.


Small business tax matters can get complicated. The professionals at Apex Financial Advisors have years of experience consulting to privately held business and are available to help.