The Protecting Americans from Tax Hikes Act, passed in December
2015, extended an often overlooked provision of the tax code with
the potential to provide significant savings to small business
owners and non-corporate investors. Section 1202 of the Internal
Revenue Code permits the seller of a "qualified small
business" to exclude up to 100% of the gain attributable to
the sale or exchange of qualified small business stock from
Stock must have the following characteristics to be eligible for
exclusion as "qualified small business stock" (QSBS):
The stock must be originally issued
by a "qualified small business".
The taxpayer must have acquired the
stock at its original issue in exchange for money, property, or as
compensation for services provided to the corporation.
During the time the taxpayer owns the
stock, at least 80% of the corporation's assets must be used in
the active conduct of one or more qualified businesses.
The corporation must be an
"eligible corporation" within the meaning of the
The corporation must not have
redeemed more than a de minimus amount of stock from the
taxpayer (or certain related parties) during the four-year period
beginning two-years prior to the issuance of stock to the
A "qualified small business" means a domestic "C
Corporation" that did not have aggregate assets in excess of
$50 million through and immediately following the issuance of the
QSBS. To meet the active business requirement, the corporation can
generally operate any active trade or business other than certain
excluded businesses. Examples of excluded businesses include
service businesses such as health, law and engineering, financial
businesses such as banking, insurance and financing, and certain
other businesses such as farming, mining and operating hotels or
Sellers of QSBS held for more than five years may be eligible to
exclude 50%, 75% or even 100% of their gain at sale. QSBS acquired
after September 27, 2010 is eligible for the 100% exclusion. QSBS
acquired before February 18, 2009 is eligible for a 50% exclusion;
while stock acquired after February 18, 2009 but before September
27, 2010 eligible for a 75% exclusion. The excluded gain is,
however, limited to the greater of $10 million or ten (10) times
the taxpayer's adjusted basis in the QSBS.
If used correctly, the QSBS exclusion can provide a valuable
tool for small businesses and investors. As capital gains rates
rise, tax efficient exit strategies become increasingly important
for business owners to consider.
Kurt Belongea, Banker, J.P. Morgan Private Bank in Milwaukee
points out, there is potential for a non-grantor irrevocable trust
to claim its own $10 million QSBS gain exclusion (separate from
grantor's gain exclusion, potentially enhancing tax savings and
wealth transfer strategies1 when:
The transferee of QSBS obtained by
gift or bequest is treated as having acquired the stock in the same
manner as the transferor and can tack the transferor's holding
Same result should apply if gift was
originally made to an irrevocable grantor trust whose grantor trust
status terminated prior to sale of the QSBS
Irrevocable trust drafting
consideration: if goal is to maximize the $10 million QSBS gain
exclusion, the grantor could make gifts to separate non-grantor
irrevocable trusts for the benefit of different children, family
members, etc. versus making a gift to a single pot trust, so as to
maximize the number of separate taxpayers able to claim the $10
million gain exclusion
1 It is important to consult your outside tax advisor to
independently determine its technical merits.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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