In some cases yes! Congress has long realized that investment in small businesses is an important driver of U.S. economic growth. Back in 1993, to incentivize investors, they developed a rule that eliminates federal income tax on some (later revised to all) of the gain on the sale of certain C Corporation stock issued after August 10, 1993. As an M&A broker I try to point out potential tax breaks for my clients, and in this article I’ll discuss Qualified Small Business Stock (or “QSBS”) from that perspective.
To qualify for this tax break, your stock has to be deemed Qualified Small Business Stock per Internal Revenue Code Sec. 1202. Here’s a simplified list of requirements:
- Must be a domestic C Corporation
- Stock was acquired at original issuance
- Was acquired after 8/10/1993
- Has been held for 5 years or more at the time of sale
- Is a small business, defined as assets of less than $50 million
- The company is NOT engaged in professional services that are dependent on the reputation or skill of one or more employees, financial services, farming, mining or resource extraction, hotels, restaurants or other similar businesses
Depending on the issue date of the stock, 50%, 75% or 100% of the gain (up to $10 million) may be excluded from federal income tax. The gain exclusion is 50% (subject to a 7% Alternative Minimum Tax (“AMT”) add-back) for stock acquired between August 11, 1993 and February 17, 2009. Stock acquired between February 18, 2009 and September 27, 2010 is eligible for 75% gain exclusion (subject to 7% AMT add-back), and stock acquired after September 27, 2010 receives a 100% exclusion, without an AMT add-back.
Andersen Tax offers a more complete checklist of QSBS requirements. In case you’re wondering, the recent Tax Cuts and Jobs Act of 2017 did not alter QSBS rules, but the reduction of the federal corporate tax rate to 21% affects the magnitude of the QSBS benefit relative to a sale of assets. It is my understanding that California’s Franchise Tax Board no longer allows an exclusion on the gain of QSBS.
Even if you hold stock that meets QSBS requirements, you may not be able to benefit from the rule because acquirers of small private businesses generally prefer to buy assets, not stock. For buyers, buying assets reduces their tax bill, improves their cash flow, and reduces potential legal liabilities. To forgo these benefits (i.e. you ask them to buy stock) buyers usually expect a substantial price discount. Read my recent blog on personal goodwill for more on the C-Corp tax dilemma.
Given the magnitude of the QSBS tax break, especially when eligible for 100% exclusion, a seller of QSBS could give a buyer a substantial discount and still come out well ahead (compared to selling the company’s assets). Even Uncle Sam benefits in the long run!
Do you have QSBS?
The prospect of selling qualified small business stock is compelling, however determining whether your stock qualifies and claiming the benefits is not simple. Be sure to work with a CPA that is well versed in QSBS requirements and the steps needed to comply with them.
If you plan to sell your business, understand that tax minimization strategies can have a big impact, and can take 5 years or more to implement. Start early, and be sure that your tax advisor is up to the task.
Exit Strategies Group’s M&A brokerage professionals dedicate themselves to staying abreast of tax minimization strategies in business sale, merger and acquisition transactions. Al Statz is founder and President of Exit Strategies and is based in Sonoma County California. For further information on this subject or to discuss selling your company, Al can be reached at email@example.com or 707-781-8580.