Starting a small business is full of challenges and an entrepreneur will have many concerns, especially with ensuring adequate operating capital and meeting funding requirements. The federal government does recognize the importance of small business and the challenges faced by entrepreneurs, including cash issues, and reacted by making permanent the 100% qualified small business stock (QSBS) exclusion in December of 2015.
Originally, in 1993, Section 1202 of the Internal Revenue Code was enacted, encouraging investment in small business by excluding 50% of capital gains from the sale of QSBS held for 5 years. Over the years, the exclusion changed and evolved until 100% of capital gains from the sale of QSBS held for 5 years was excluded, if the required conditions were met. The 100% exclusion was set to expire at the end of 2015, but the exclusion was made permanent in the Protecting Americans from Tax Hikes (PATH) Act, enacted in December 2015.
The 100% QSBS exclusion, although permanent, is nuanced and the stock itself must be held for five years, be in a C corporation, be in a Corporation with less than $50 million of assets at the time the stock was issued, have acquired the stock at its original issue, and have over 80% of the corporation assets being used in the active conduct of a qualified business during the entire time holding the stock. Active conduct is similarly defined under the tax code, excluding investment vehicles, brokerage services, farming business, and other inactive business. For those looking to utilize the QSBS exclusion or attract new capital from investors under this exclusion, a proper evaluation should be conducted to ensure the stock qualifies.
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