Selling Your Business Income Tax-Free: The Qualified Small Business Stock Election

April 7, 2018

Selling shares in a business completely (or partially) income tax-free sounds too good to be true, right? Perhaps not.

To the delight of many business owners, if certain qualifications are met, shares in a C corporation may be sold completely or partially income tax-free.

The secret is qualified small business stock (QSBS). QSBS is originally issued stock held more than five years in an active C corporation with less than $50 million of assets. An individual, trust, estate or other non-corporate taxpayer that owns QSBS may exclude all or a portion of the gain
from a sale of those shares from federal income taxes.

State rules vary, but the vast majority recognize the QSBS election and allow sales of such stock to escape (in whole or part) state income tax as well. Because the QSBS exclusion can allow for a sale of certain businesses tax-free, it is no wonder the designation has surged in popularity over the past few years. Every business owner selling C corporation shares should walk through the QSBS requirements to see if they are met, as millions of tax dollars could be saved.

Further advice should be obtained from your tax accountant on the following key aspects:
  1. What part of gain can be excluded (not always all but it could be a big number)
  2. Shares must be held for more than five years
  3. Shares must be acquired at original issuance, from the coporation
  4. The business’s gross assets cannot exceed $50 million
  5. The company must be involved in a Qualified Active Trade or Business
  6. The shareholder must elect QSBS Treatment on his or her tax return
  7. If the stock has not been held for five years but otherwise meets the QSBS requirements, what are the other opportunities to reduce or defer income tax on a sale of the shares?
  8. How will the QSBS exclusion be calculated between individually and trust held shares?
  9. Are QSBS gains excluded from state taxes as well? (Check especially if you live in  Alabama, California, Mississippi, Pennsylvania and Wisconsin)
  10. Can pass-through entities such as S corporations and limited liability companies (LLCs) convert to C corporations to become eligible for QSBS treatment?