Qualified Small Business Stock Exclusions

IRC Section 1202 provides a large tax exclusion for companies taxed as C-corporations

Upon the sale of QSBS, exclusion from taxation up to $10 million of capital gain (reduced by prior eligible gains attributable to the same issuer) or 10 times adjusted cost basis, whichever is greater.

Strict requirements on which companies can receive the deduction:

1. Gross assets cannot exceed $50 million immediately after issuing stock
2. Corporation must use 80% of its assets in the active conduct of a ‘qualified trade or business’

Can’t be (among other things) a service business that relies on skill of its employees  (health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services)

• Taxpayer must be an individual, trust or pass-through (not a corporation)
• Stock must be acquired at original issuance.  Options, RSUs are considered original issuance.
• Taxpayer must hold the stock for five years or longer. 

Start of 5-year holding Period

Stock:     purchase date

RSU: vesting date or 83(b) election

Stock Option: exercise date

Stacking the QSBS $10M Exemption

Each taxpayer holding QSBS is entitled to separately take advantage of the $10M gain exclusion.

QSBS may be gifted to an unlimited number of separate taxpayers, each of whom will have the taxpayer’s own $10M exclusion or 10X basis exclusion.

Will a gift of QSBS re-start the 5-year holding period?  Depends on who it is gifted to.  For the options outlined herein, it will not.

SLANT as a Separate QSBS Taxpayer

Husband creates a trust for the benefit of Wife and children; Wife creates a trust for the benefit of Husband and children. 

Property gifted to the trust must be the separate property of the gifting spouse.

The Trustee of the trusts can be Husband and/or Wife.

You will have to file a gift tax return for all gifts to trust.  You can allocate generation skipping transfer tax (GST) to the trust, which will allow the assets transferred and any appreciation in those assets to be permanently exempt from estate tax and GST tax for future generations (300-year rule against perpetuities).

The trust would not be a grantor trust for income tax purposes.  This means that the trust pays all income tax associated with the trust. 

By setting the trust up this way, the trust is an additional taxpayer and an additional $10M QSBS exemption is allowed.

Status for QSBS is retained but get an additional taxpayer exemption.

Concerns/Issues

Gifted assets will not receive a step-up in basis on the death of either spouse. 

The gifting spouse cannot receive any distributions from the trust to which they gifted.

Upon the death of the beneficiary spouse, the beneficiaries become the children, even if then non-beneficiary spouse survives.