The Often-Overlooked Benefits of Qualified Small Business Stock

If you started a business organized as a C corporation, you may be able to avoid some, and possibly all, tax liability when you sell the stock of the C corporation. As previously written upon by Gray Edmondson,[1] Section 1202 of the Internal Revenue Code (“Code”) provides for the exclusion of gain on Qualified Small Business Stock (“QSBS”). While Section 1202 was enacted more than thirty years ago[2], for reasons provided below, it provided limited utility until amendments enacted in 2015 and the enactment of the Tax Cuts and Jobs Acts (“TCJA”) in 2017. Given its relatively newfound utility, as well as the fact that most buyers in a sales transaction prefer to purchase assets, rather than stock, the benefits of QSBS sometimes go overlooked to the detriment of the taxpayer.

What is Qualified Small Business Stock?

QSBS is any stock in a C corporation which is originally issued after August 10, 1993[3] if the corporation is a “qualified small business” at the date of issuance of such stock, which is acquired at its original issue in exchange for money or other property or as compensation for services provided to the corporation.[4] A “qualified small business” is any domestic C corporation whose aggregate gross assets have never exceeded $50,000,000 since August 10, 1993[5] and at least 80% (by value) of the assets of the corporation are used in the active conduct of one or more qualified trades or businesses.[6]

A qualified trade or business is any trade or business other than (A) those involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or any trade or business where its principal asset is the reputation or skill of one or more employees; (B) any banking, insurance, financing, leasing, or similar business; (C) any farming business; (D) any business involving production or extraction of products with respect to which a deduction is allowed under Section 613 or 613A; or (E) any business operating a hotel, motel, restaurant, or similar business.[7]

Summarizing the separate subsections of Section 1202, QSBS is simply stock, originally issued to a shareholder in exchange for contributions or services provided, of a C corporation, which since August 10, 1993 has never held more than $50,000,000 in assets, uses at least 80% of its assets in the active conduct of its trade or business, which may not be one of the trades or businesses contemplated in the immediately preceding paragraph.

The Benefits of QSBS

When a taxpayer (other than a corporation) sells QSBS held for more than 5 years, a certain portion of gain from the sale of the QSBS will be excluded from the taxpayer’s gross income depending on when the QSBS was issued to the taxpayer.[8] For QSBS issued from August 10, 1993 through February 17, 2000, 50% of gain resulting from the sale of the QSBS will be excluded from the taxpayer’s gross income.[9] For QSBS issued from February 18, 2009 through September 27, 2010[10], 75% of gain resulting from the sale of QSBS will be excluded, and for QSBS issued after September 27, 2010, 100% of the gain resulting from the sale of QSBS will be excluded from the taxpayer’s gross income.

Limitations on Excluded Gain from QSBS

The Code does provide some limitations related to QSBS. For each individual issuer (C corporation) of which a taxpayer holds QSBS, the taxpayer may only apply the aforementioned percentage exclusions to the greater of (A) $10,000,000, or (B) ten times the aggregate adjusted bases of the QSBS, determined without regard to any adjustment after the date of issuance.[11][12] For example, if a taxpayer was issued stock in a C corporation in 2000, and sold such QSBS today[13]  for $20,000,000, $5,000,000 of gain will be excluded (assuming the taxpayer has minimal bases in the QSBS).  This is calculated by applying the 50% exclusion rate to the $10,000,000 limitation. Similarly, if the QSBS was issued in 2009, $7,500,000 would be excluded from gain, and if issued in 2011, $10,000,000 would be excluded.

Note also that this limitation applies to each issuer in the aggregate rather than each tax year. The excluded gain calculated above would be the same if the taxpayer sold half of his QSBS in one year, then sold the other half the following year. The taxpayer would have exhausted the limitation amount upon the first sale, and the sale the subsequent year would be taxed without considering any benefits provided by Section 1202. Additionally, married couples are not given the benefit of each spouse having a $10,000,000 limitation. Instead, those couples filing jointly are subject to a single $10,000,000 limitation, while those filing separately each receive a $5,000,000 limitation.[14]

Furthermore, stock acquired by a taxpayer will not be treated as QSBS if (A) during the four year period, beginning on a date two years prior to the issuance of the stock, the corporation redeemed the stock of the taxpayer[15], or a person related to the taxpayer[16]; and (B) during the two year period beginning on the date one year from the issuance of the stock, the corporation redeemed any of its stock exceeding 5% of the aggregate value of all its stock as of the beginning of the two year period.[17]

Why QSBS Was Not a Historically Viable Planning Option

Despite Section 1202 being enacted over thirty years ago, QSBS planning has not been widely implemented for several reasons. First, QSBS, by definition, must be stock in a C corporation. Prior to the enactment of the TCJA, C corporations were subject to a 35% tax at the entity level, disincentivizing taxpayers from organizing their business as a C corporation. Next, to obtain the benefits from QSBS, a taxpayer must sell his stock, but most buyers prefer, and often demand, a transaction be organized as an asset sale. Lastly, the taxable portion of gain from the sale of QSBS is subject to a maximum tax rate of 28% rather than the maximum long-term capital gain rate of 20%.[18] Therefore, prior to 2009 when Section 1202 was amended to increase the exclusion to 75% of gain, the effective tax rate was 14% (50% of 28%), which provided little to no benefit to taxpayers when considering the maximum long-term capital gain rate from 2003 through 2012 was 15%.

Section 1202 was amended in 2015 to provide for a permanent 100% exclusion on gain for QSBS issued after September 27, 2010. Then, in 2017, the TCJA reduced the corporate tax rate from 35% to 21%. These two changes dramatically increased the utility of QSBS, as more taxpayers were willing to organize their business as a C corporation under the reduced corporate rate, and the 100% exclusion amount provides significant benefits to qualifying taxpayers.

Permitted Transfers

While QSBS must be an original issue, certain transfers are permitted under Section 1202.[19] If a taxpayer transfers QSBS by gift, death, or from a partnership to a partner,[20] the QSBS will be treated as an original issuance in the hands of the transferee, and the transferee will obtain the transferor’s holding period in the QSBS. Furthermore, if a taxpayer acquires stock in a C corporation solely through the conversion of QSBS in such C corporation, the stock acquired in conversion will retain QSBS status, and the taxpayer will retain the holding period of his or her originally held stock. These permitted transfers further incentivize taxpayer to consider organizing as a C corporation, as the taxpayer’s heirs may benefit from the gain exclusion of QSBS if such QSBS is bequeathed to them. Additionally, while not thoroughly covered in this article, these permitted transfers offer additional planning opportunities, such as gifting QSBS to a non-grantor trust.


Section 1202 now provides significant benefits to those taxpayers holding QSBS. Depending on when the stock was issued, taxpayers may be able to exclude a signification portion of their gain from the sale of their business. Taxpayers would receive the most benefit from Section 1202 if the contemplated transaction was structured as a stock sale, thereby avoiding tax at the entity level and excluding a portion (or possibly all) gain at the individual level. Still, Section 1202 can prove beneficial in an asset sale, which, as previously mentioned, is preferable to buyers. While the corporation will be subject to tax at the entity level, if the taxpayer’s stock in the selling C corporation qualifies as QSBS, taxpayers may be able to take advantage of Section 1202 upon redemption of the taxpayer’s stock by the corporation.[21]

Given the historical lack of utility of QSBS, guidance, both administratively and judicially, is sorely lacking for QSBS transactions, and many practitioners may not consider the previously defunct, but now extremely viable, benefits that Section 1202 may provide their clients. While many transactions will not be eligible for the benefits of Section 1202, the benefits are now so great that all practitioners should consider whether their client may qualify and receive the benefits of the same.


[2] Revenue Reconciliation Act of 1993.

[3] The date of enactment of the Revenue Reconciliation Act of 1993.

[4] IRC § 1202(c)(1).

[5] IRC § 1202(d)(1).

[6] IRC § 1202(e)(1)

[7] IRC § 1202(e)(3).

[8] IRC § 1202(a)(1).

[9] IRC § 1202

[10] The date of enactment of the Creating Small Business Jobs Act of 2010.

[11] IRC § 1202(b).

[12] Many practitioners advise gifting QSBS to incomplete non-grantor trusts (“INGs), as such would be a permitted transfer (further discussed herein), and would allow both the taxpayer and the ING(s) to claim its/their own separate $10,000,000 (or 10X basis) exclusion.

[13] Note again the requirement that QSBS must be held for five years for the gain exclusion to apply

[14] IRC § 1202(b)(3).

[15] IRC § 1202(c)(3)(A).

[16] Within the meaning of IRC §§ 267(b) or 707(b).

[17] IRC § 1202(c)(3)(B).

[18] See IRC §§ 1(h)(1)(F) and 1(h)(4)(A)(ii).

[19] IRC § 1202(h).

[20] Subject to limitations under IRC § 1202(g)(3), which limits QSBS treatment to the partner’s interest in the partnership at the time of original issuance to the partnership.

[21] As such constitutes a “sale or exchange” as required in IRC § 1202(a)(1).

Parker Durham, J.D., LL.M.

Parker practices in the areas of business, tax, and estate planning. Parker recently graduated with his Master of Laws in Taxation from the University of Florida Levin College of Law, and he is currently satisfying the requirements necessary to obtain his Certified Public Accountant license. View Full Profile.


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