Current IRS rules that provide tax breaks on gains of sales of qualified small business stock (QSBS) have been made permanent. More specifically, a taxpayer may be able to exclude from personal income tax up to 100% of any gain realized on the sale or exchange of QSBS held for more than five years (subject to certain limitations discussed below). These rules may provide significant tax advantages to holders of QSBS.

The “Protecting Americans from Tax Hikes Act of 2015”, which was passed into law in late 2015, included provisions making certain QSBS tax breaks retroactive and permanent. Additionally, the gain is excepted from treatment as an alternative minimum tax (AMT) preference item. In other words, the gain with respect to QSBS may escape tax for purposes of both regular income tax and AMT.

In order to take advantage of this favorable tax treatment, however, the stock must qualify as QSBS, and the taxpayer must meet certain objective requirements. To qualify, stock must meet all four of the following tests:

(1) the stock must be in a C corporation originally issued after August 10, 1993;

(2) as of the date the stock was issued, the company was a domestic C corporation with total gross assets of $50 million or less (this size limitation only applies at the time the stock was issued, regardless of how large the corporation subsequently grows);

(3) the taxpayer must have acquired the stock at its original issue (not from a secondary market); and

(4) During the period that the taxpayer held the stock, the corporation was a C corporation, at least 80% of the value of the corporation’s assets were used in the “active conduct” of one of more qualified businesses, and the corporation was not a foreign corporation or other prohibited type of corporation.

The foregoing is merely a summary. In other words, it is important to review the Internal Revenue Code and related regulations for more information on these limitations. For example, although the definition of “qualified businesses” excludes many types of professional corporations, most startup companies would generally qualify. Thus, you should consider all options when determining the choice of entity for your startup company.

Even if stock qualifies as QSBS, there may be additional limitations on the ability to exclude gain on sale of such stock. As always, it is important that you consult with your CPA or tax counsel if you would like more information about the QSBS exemptions. Feel free to contact one of our business/tax attorneys at (206) 624-1230, if you would like to discuss further.