How to Receive Full Gain Exclusion with Qualified Small Business Stock (QSBS)

By Adam Sweet, J.D., LL.M.

Taxpayers may be surprised to learn that the appreciated stock they hold could, upon sale, be eligible for a full gain exclusion. This means that no federal income tax is owed. 

Generally, this full gain exclusion occurs when a taxpayer other than a corporation holds what is called “qualified small business stock” (QSBS) as defined under section 1202 of the Internal Revenue Code. Although the basic requirements for holding QSBS are relatively straight forward, the application of these requirements can sometimes create uncertainties and potential pitfalls for the unwary.

Basic Requirements for Full Gain Exclusion

Here are some of the requirements when it comes to full gain exclusion:

  • C corporation: The stock at issue must be stock in a business entity (like a state law corporation or LLC) classified as a C corporation for federal tax purposes. Note that LLCs and other state law entities classified as partnerships for tax purposes can potentially change their tax classification to C corporations for QSBS planning purposes (although the holding period requirements begin only upon the date of conversion).

  • Original Issuance: A taxpayer must acquire QSBS at “original issuance” (after August 10, 1993) in exchange for a capital contribution or services. This means a taxpayer cannot purchase QSBS from another taxpayer.

  • Five-year hold: A taxpayer must hold QSBS for more than five years before selling in order to achieve gain exclusion.

  • Qualified small business: The C corporation must be a qualified small business, as defined under section 1202, during substantially all of the taxpayer’s QSBS holding period.

Read the entire article at the EideBailly website: https://www.eidebailly.com/insights/articles/2021/9/how-to-receive-full-gain-exclusion-with-qualified-small-business-stock-qsbs

Gabrielle M. Brackett