Qualified Small Business Stock Exemption
Running a small business can be a challenging yet rewarding venture. Small family owned businesses have long been associated with the American Dream and often serve as the backbones of local communities. As a business owner, you may be concerned about the possible tax implications of a growing business. As a small business owner it is important to plan ahead to reduce the impact the growth of your business may have on your tax bill. One such way to do so is through the use of a Qualified Small Business Stock Trust. This blog will break down what a Qualified Small Business Stock is, who qualifies for the Qualified Small Business Stock (hereinafter referred to as “QSBS”) exemption, and how to maximize the exemption.
What is Qualified Small Business Stock?
Qualified Small Business Stock is Shares of an active company that is organized as a C-corporation, whose assets do not exceed fifty million dollars at the time of the share issuance. Additionally, the company must use eighty percent of its assets to actively carry out business.
Furthermore, the business must be a qualified trade or business. This means that companies who perform services in the health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where an individual is the main asset of the business will not qualify. The rules also exclude businesses who perform banking, insurance, financing, leasing, investing, farming, hotel, motel, or restaurant services from the definition of QBT.
Lastly, the shares must not have been sold within five years of an issuance, meaning that the owner of the shares must have retained possession of the shares for five years after they were acquired, although under certain less common circumstances exchanges or sales to acquire additional QSBS may still qualify.
What Tax Benefits Does QSBS Provide Me?
If all of the requirements for QSBS are met, the owner of the QSBS can exclude either 10 times the original investment amount in the shares, or ten million dollars, whichever is greater from federal capital gains tax. This is a massive exemption that can save a business owner substantial sums of money paid in tax. But wait, the exemption gets better.
An individual who owns QSBS can gift their QSBS that has yet to be sold, and each individual who receives the QSBS will also get the exemption. Furthermore, the individual can set up a trust for an individual, and the trust will also get a QSBS exemption as well if it is properly drafted. This could potentially allow a person to pass large sums of shares in a business while saving millions in capital gains tax.
Gifting QSBS to a Non-Grantor Trust
In order for a trust to qualify for its own QSBS exemption, it must be considered a non-grantor trust. This means that the Grantor, the person gifting the QSBS, cannot have continued control over the trust or the assets in the trust. It is important to work with a knowledgeable attorney to create a trust eligible for this exclusion, as an error could cause the QSBS to not qualify.
It is also important for a grantor to consider the effects such a gift may have for estate and gift tax purposes. Generally it is advisable that people seeking to make gifts of QSBS should do so while the company is still young, as the shares gifted will be worth less and have less of an impact for estate tax purposes. It is important to work with an attorney to avoid potential negative gift or estate tax consequences in creating such a trust.
Maximizing this exemption can help reduce large tax burdens, allowing small business owners to reap the rewards of their hard work. By working with an attorney, small business owners can ensure that their estate plan works hard to preserve the legacy they have created, and secure their family’s future. If you have any further questions relating to QSBS or your small business, feel free to schedule a free consultation today!