Qualified small business stock (QSBS) is a type of security that offers tax benefits to its holders. If you are a small business owner, it’s important to understand what these benefits are and how they can help you save money on your taxes. In this article, we will discuss the tax benefits of QSBS and explain how they can help reduce your taxable income.
What is QSBS and How Does It Work?
Qualified small business stock (QSBS) is a tax exemption that offers tax benefits to its owners. QSBS is eligible to certain small businesses that meet certain requirements, including having less than $50 million in assets and being a US based C Corporation.
The QSBS refers to Qualified Small Business Stock Exemption, and it one of the most important tax benefits, either for startup founders, investors, or employees. But this time, we’ll focus on founders mainly. What makes the QSBS rule special, is it allows owners of startup equity to eliminate 100% of their federal capital gains tax when they reach a $10m of gains per asset or 10x the cost basis of an asset.
But, how does it work exactly?
The QSBS tax exclusion is set forth in Section 1202 of the U.S. Internal Revenue Code. The process starts when shareholders sell or exchange their qualified stock (QS), therefore, the exclusion can provide a break on capital gains tax. Which usually reaches a 100% exclusion of tax on capital gains.
What are the Tax Benefits of QSBS?
The tax benefits of QSBS are important for small business owners because they can enable them to sell equity, avoid taxes, and keep more of their hard earned gains. Additionally, QSBS can help small businesses attract investors and grow their businesses due to the tax benefits QSBS offers to investors.
Small business owners can benefit from the tax breaks offered on qualified small business stock (QSBS). The benefits of QSBS include reducing taxable income and attracting investors. But let’s have a look at each of them in-depth!
Zero-percent capital gains tax rate
Today, one of the main benefits for holders of QSBS is the zero-percent capital gains tax rate on eligible gains up to $10 million per company (or 10x your investment whichever is higher), per person. This tax break is highly impactful for high-growth startups and small businesses incorporated as C Corps. And it applies to equity earned during a company’s early years – in most cases.
You might imagine that it’s hard to beat a 0% tax rate on $10 million in gains. And you’d be right: If you live in a high-tax state, that could mean an extra $3.7 million in your pocket.
If you’re interested in multiplying that exemption, well this is the place for you. The Qualified Small Business Stock (QSBS) exclusion is $10 million per taxpayer, per asset. This also means you can multiply this exemption in a variety of ways by getting several exemptions, at the same time, and from the same asset. This process is called QSBS stacking, or claiming multiple exemptions with different principal assets.
Can you maximize benefits from QSBS Tax Treatment?
- Corroborate that your principal asset qualifies for QSBS. You can attempt to do it yourself, but external confirmation will be helpful.
- QSBS also helps maximize benefits. On the off chance your shares are going to be worth more than $10 million, it’s worth considering these strategies to move forward and gain the most out of it. This step might be incredibly helpful if you have more than $10 million of gains.
- QSBS can help you avoid missing out on potentially life-changing tax savings.
Who benefits from QSBS?
There are three groups of people who typically benefit from QSBS:
- Entrepreneurs and small business owners (there are mostly interested in looking to raise capital)
- Small business and venture investors
- Employees of small businesses who receive stock options as part of their compensation package
Now you have a complete overview of QSBS, how it works, and its benefits. Time to decide whether it’s right for you given your situation!