Qualified Small Business Stock | Requirements, Sale, Checklists, & Holding Period


Qualified Small Business Stock: According to the US Small Business Administration, small firms are at the core of the American economy, accounting for 44% of total economic activity and two-thirds of net new job creation.

Though many fail, if you can invest in one that does, particularly one that qualifies for the qualifying small-business tax exemption, the potential profits and tax benefits may make the risk worthwhile.

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What is a Stock?

A stock is a broad phrase that refers to any company’s ownership certificates.

There are two kinds of stocks: ordinary and preferred. The distinction is that the former holder has voting rights in company decisions, but the latter does not.

However, preferred shareholders are legally entitled to a specific dividend payment amount before ordinary shareholders can receive dividends.

There is also a type of stock known as ‘convertible preferred stock. Tax breaks offered by qualified firms can attract investors and allow them to use shares as bonuses to retain employees.

What is Qualified Small Business Stock (QSBS)?

According to  Internal Revenue Code (IRC), Shares of a qualified small business (QSB) as specified by the Internal Revenue Code are referred to as suitable small business stock (QSBS).

A QSB is an operating domestic C company with less than $50 million in gross assets at the time of stock issuance and soon after.

Key Lessons

  • A qualified small business (QSB) stock is called qualified small business stock (QSBS).
  • If both the investor and the corporation satisfy specific standards, QSBS is considered favorably for capital gains.
  • The amount of the tax reduction depends on when the investor acquired the stock and how long they kept it.
  • Investors who sell their QSBS before the necessary holding period expires might delay capital gains by reinvesting the profits in another company’s QSBS.

What is Section 1202 Small Business Stock?

Section 1202, often known as the Small Business Stock Gains Exclusion, is a section of the Internal Revenue Code (IRC) that exempts capital gains from specific small business stock from federal taxation.

Section 1202 of the Internal Revenue Code applies solely to eligible small company shares purchased after Sept.

Related: Tax Topic 152 Refund Information | Should I Worry About My Tax Refund?

How Does Qualified Small Business Stock (QSBS) Work?

You must also meet shareholder qualification requirements to qualify for tax benefits for small-business shares.

#1. Finding Qualified Small Companies

To benefit from the QSBS exemption, you must invest in a qualifying firm, which means:

The issuer must be a current domestic C-corporation. The firm must be formed as a C corporation in the United States; S companies are not authorized. In addition, unlike a holding company, the corporation must be actively engaged in commercial activities.

The issuer’s assets shall not exceed $50 million before and after stock issuance.

The issuer’s business cannot operate in local industries. Personal services, banking, financing, insurance, investing, leasing, farming, mining, and using a hotel, motel, or restaurant are all prohibited enterprises. Technology, wholesale or retail, and manufacturing are examples of industries that typically qualify.

The shares must be issued directly by the issuer. Under the original issuance rule, the shares must be obtained directly from the issuer, either in return for cash or property or as compensation. Employee perks such as restricted stock units, RSUs, options, and convertible securities are permitted, but stock acquisition from another person or through the secondary markets is forbidden.

According to the IRS, QSBS can be donated as part of wealth transfer and charitable giving, with specific requirements met.

#2. Meeting the Needs of the Shareholders

Investors must follow several rules in addition to locating a suitable firm to invest in:

You cannot exist as a company. The qualifying small-business stock exemption is available only to individuals, trusts, and pass-through corporations.

You must complete a holding period. The length of time a stock is held impacts the amount of a shareholder’s tax benefits:

For equities purchased before February 18, 2009, and held for more than five years, the maximum capital gains exclusion is 50%, with an additional 7% subject to the alternative minimum tax.

For stocks purchased between February 18, 2009, and September 27, 2010, and held for more than five years, the maximum capital gains exclusion is 75%, with an additional 7% subject to the alternative minimum tax.

Also, gains on stocks purchased after September 27, 2010, and held for more than five years, are tax-free. Long-term capital gains taxes apply to equities held for more than a year but less than five years, whereas short-term capital gains taxes apply to stocks held for less than a year.

There is a gain limit. A shareholder can deduct any gain up to ten times the adjusted cost basis — the investment’s initial asset value — or $10 million.

You might be able to postpone your gain. Shareholders who sell shares before holding them for five years can still obtain tax benefits provided the initial qualified small-business stock was kept for more than six months, and the proceeds are reinvested in another QSBS within 60 days.

Related: How to Get a Personal Loan Without a Credit Check

Methods for Using QSBS

Companies that can qualify as a “small business” for this reason might consider using their stock strategically because of the possibility for significant earnings at no tax cost:

Attracting Investors

Companies that are starting or expanding may use QSBS to raise cash. Since the QSBS tax cut only applies to individuals, not businesses, it may benefit individuals and individual partners in partnerships.

The stock can be acquired by a partnership, allowing a partner (who is an individual rather than a company) to exploit the exclusion as long as they were a partner at the time the stock was purchased and at all times after that.

The stock can be acquired by a partnership, allowing a partner (who is an individual rather than a company) to exploit the exclusion as long as they were a partner at the time the stock was purchased and at all times after that.

Stock purchased by the partner when the partnership was formed excluded from the exclusion.

Employees Should be Rewarded

Because QSBS may be issued in exchange for services, it might be a beneficial tool for startups and other businesses short on cash to reward personnel.

It also serves as an incentive to retain personnel; their ownership in the firm motivates them to work hard and contribute to the company’s success.

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Examples of Qualified Small Business Stock (QSBS)

Tax Benefits

Consider a taxpayer with $410,000 in ordinary taxable income who files as a single individual. Their income placed them in the highest capital gains tax rate (20%).

They make a $50,000 profit after selling eligible small company shares purchased on September 30, 2015. Taxpayers can deduct 100% of their capital gains, which means no federal tax is due.

Assume the taxpayer bought the stock on February 10, 2009, and sold it five years later for a $50,000 profit. The federal capital gains tax would be 20% x (50% x 50,000) = $5,000.

Stockholders who desire to sell qualifying small business stock (QSBS) that has not been held for five years can also profit.

Section 1045 of the Internal Revenue Code permits them to postpone the gain by reinvesting the profits from selling that qualified small business stock (QSBS) within 60 days into another QSBS.

Advantages of Using the QSBS Exemption

The above example demonstrates the benefits that shareholders might reap when investing in eligible small-business shares – that investor came away with a $13 million tax-free gain.

Tax breaks offered by qualified firms can attract investors and allow them to use shares as bonuses to retain employees.

Issuing QSBS might appeal to individual investors and encourage them to become long-term shareholders for small firms seeking extra finance.

Qualified Small Business Checklist

It would be best if you answered yes to each of these.

Related: 10 Strategies for Small Business Expansion in 2022

Holding Period for QSBS?

Before it qualifies for the QSBS exclusion, the stock must be held for more than five years. Generally, the holding period begins with the issuance, but rare exceptions exist when the stock is granted in return for non-cash assets or stock conversions.


What is the Qualified Small Business Stock Exclusion?

The QSBS exclusion generally allows an eligible taxpayer to deduct up to 100% of the qualified gain earned through the sale of qualifying stock.

This bulletin covers the fundamentals of the Internal Revenue Code Section 1202 QSBS exclusion and the qualifying requirements for the corporate body and its shareholders.

What is QSBS Stacking?

Because the cumulative $10 million limit applies per taxpayer, a QSBS shareholder must create new taxpayers to benefit from further $10 million exclusions under subparagraph (A) of 1202(b) (1).

Establishing (or involving) more taxpayers is known as “stacking.”

QSBS Rules for Eligibility

The firm must be formed as a C-corporation in the United States. The firm must have had gross assets of $50 million or less before and immediately following the issuance of the shares. The business must not be on the list of prohibited business categories.

What is the Tax Rate for QSBS?

It’s free from income tax, alternative minimum tax, and the 3.8% net investment income tax.


Consider utilizing qualifying small company stock to obtain money or reward key personnel if you have a C corporation or are considering creating one in an eligible sector specified previously.

Before you begin, consult with a tax professional to ensure that all requirements for becoming a qualified small business are satisfied.


  • nerdwallet.com – Qualified Small-Business Stock, or QSBS: How to Use It
  • investopedia.com – Qualified Small Business Stock (QSBS) Definition and Tax Benefits
  • sba.gov – Qualified Small Business Stock: What Is It and How to Use It


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