Qualified Small Business Stock for Tech Companies: Unlock Tax Benefits
October 12, 2023
For small and mid-sized technology companies, the path to success is often paved with groundbreaking ideas, relentless dedication and, increasingly, strategic financial planning. One such financial strategy that has gained prominence in recent years is the utilization of Qualified Small Business Stock (QSBS). This specialized category of stock offers a unique set of tax benefits and incentives for both entrepreneurs and investors, as it allows for the exclusion of capital gains when the stock is sold.
When implemented properly, QSBS can be a powerful tool for fueling growth and attracting investors. Even after launching the business, there are ways to convert from a QSBS-ineligible entity to an eligible one. In this article, we highlight the opportunities that QSBS presents for companies, as well as the requirements for both the corporation and its shareholders.
For non-corporate taxpayers, if all requirements are met:
- The Exclusion Amount is the greater of $10 million or 10 times the shareholder’s basis.
- The benefit is limited to 50 percent, 75 percent or 100 percent of the Exclusion Amount, depending on when the stock was acquired.
The eligibility criteria for a company to be considered a qualified small business:
- It must be taxed as a domestic C corporation.
- The tax basis of assets is less than $50 million, both before and after the issuance of the stock.
- 80% of the assets are used in a qualified trade or business.
- Qualified trade or business cannot be services (accounting, law, medical, consulting, etc.), banking, farming or real estate
If the stock qualifies as QSBS, there are requirements each shareholder must meet so their shares qualify for the exclusion. A shareholder must have:
- Held stock for more than five years (only counted from when the entity is established as a C corporation)
- Received stock directly from the corporation
- Acquired stock in exchange for money, property or services
Accounting for Technology Companies
The rules surrounding QSBS are complex, including how assets are counted for purposes of the $50 million test and how much working capital can be counted in the 80% asset test, as well as issues surrounding redemptions of stock and the type of assets a company may own. If your company started off as an ineligible entity, any change to a qualifying entity must be done properly, or the potential benefits can be lost.
It is important for companies that intend to have their shareholders benefit from the exclusion not to take actions that could terminate those benefits. Don’t miss out on this opportunity to recognize the significant tax benefits when selling QSBS or in making an initial entity selection choice. Contact your Cherry Bekaert advisor today to see how you may benefit.