Qualified Small Business Stock | the Ultimate Guide for Businesses

Starting a new business can be an exciting venture. However, if you want to succeed, you have to pull resources like capital and human resource to start on the right grounds. Capital is an important piece of this puzzle, and without enough of it, the business is bound to fail.

The good news is, that’s not how your dream of establishing a thriving business and offering stellar solutions in the marketplace should end. According to section 1202 of the Tax code, you can use Qualified Small Business Stock to raise enough capital to fund your small start-up business.

How does this work? You’re probably wondering. In the rest of this post, that’s what we’re going to cover. We’ll also help you assess if your business can benefit from it.

So, let’s get to it!

What is a Qualified Small Business Stock?

According to Barbara Weltman, an attorney and the author of the book ‘J.K Lasser’s Small Business Taxes,’ Qualified Small Business Stocks allows investors to own stock in a company, sell it for profit and keep 100% of the proceeds without paying tax.

In an article published on the US Small Business Administration’s blog, she defines Qualified Small Business Stock as the section 1202 stock stipulated in the tax code. This section gives investors a tax relief after selling Qualified Small Business Stock.

At the beginning (1993), companies were allowed a 50% tax exclusion from the sale of Qualified Small Business Stock. Later (2009), the limit was raised to 75% and finally (2010) to 100%. However, for a company to qualify for the tax exclusion, certain conditions are to be met, as we’ll see in a few.

Why Do Qualified Small Business Stocks Exist?

According to the Tax Advisor, Qualified Small Business Stocks exist today after section 1202 was added into the Revenue Reconciliation Act of 1993. The objective behind this move was to provide tax relief and to reward investors who risked their money in small businesses.

Overall, the Qualified Small Business Stocks play the important role of injecting liquidity into small start-up businesses. This is one way the government incentives investors to put money into small businesses to pump up their operations.

Inadequate funds are one of the reasons start-up businesses fail within the first few years of establishment. However, because of Qualified Small Business Stocks, business owners and entrepreneurs don’t have to stress over finding capital for business operations.

Benefits of the Qualified Small Business Stock

This particular stock benefits three categories of stakeholders — the investor, the company, and company employees. Investors get 100% tax exclusion from the sale of stock, and companies get the needed capital to run the business from the sale of stocks.

Lastly, companies can reward their employees with Qualified Small Business Stock for service delivery. So, instead of paying the full salary, part of it is paid as stocks. Eventually, the beneficiary can sell the stock at the right time to make a 100% profit.

Like we’ve already hinted, there are set conditions to be met by the said stakeholders. So, let’s quickly look at them.

  • The company should be established as a C corporation. Therefore, S corporation companies don’t qualify for the Qualified Small Business Stock.
  • The company’s total asset value should never exceed $50 million during its years of active operation. This asset value cap determines whether you run a small business or not.
  • The company should be active in the business. So, if by chance it’s a holding company, it won’t meet the threshold.
  • The stock must have been acquired through direct purchase, property exchange, or service delivery. Other acquisition methods from these three don’t count.
  • There should be legally binding documents between the company and the shareholder.
  • The company must only be operating in particular industries, also known as “qualified trade or business.”

In addition, to be considered an eligible corporation, your business shouldn’t;

  • Be a DISC or former DISC.
  • Be a cooperative.
  • Be a regulated investment company, real estate investment trust, or REMIC.

Businesses that Can Benefit from Qualified Small Business Stock

According to Section 1202 of the Tax Code, the “Qualified trade or business” phrase qualifies most businesses to benefit from the stock. However, if it falls under the following categories, it won’t qualify for the exclusion benefits.

  • Performance of services like health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.
  • Banking, insurance, financing, leasing, investing, or similar business.
  • Farming business (including the business of raising or harvesting trees).
  • Businesses involving the production or extraction of products.
  • Businesses involving the operation of hotels, motels, or restaurants.

There you have it! We hope that your business is able to benefit from this Qualified Small Business Stock.

How to Implement Qualified Small Business Stock in Your Company Structure

Implementing the Qualified Small Business Stock in your company structure shouldn’t be a hassle when you’re meeting the threshold of Eligible Corporation. Therefore, complying with the regulations should be your direct ticket.

Nonetheless, structuring your company for this stock comes at a price. C corporations are subject to double taxation, which takes a toll on the company’s funds. Double taxation can be draining for small start-up businesses, which could be struggling to meet up the cost of running the business.

Therefore, while it’s possible to structure your company to benefit from Qualified Small Business Stock, you’d first have to consider this downside.

Wrapping Up

If you’re a tech start-up or any eligible business, a Qualified Small Business Stock could be a sure way of raising capital for your business. If you’d like to get started, Lanyap Financial is here to offer the help you need to take your business to the next level.

Our accountants are skilled in accounting technologies needed to streamline your operations and leverage data to provide timely insights on financial trends. Therefore, feel free to contact us for a free consultation!

Lanyap Financial is a tech-based accounting and financial services firm that specializes in streamlining their clients’ financial operations through FinTech software and cloud-based applications.