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"New and Improved" QSBS Tax Break

Maybe you're interested in investing in a new business venture that seems promising. It might even be a business you're trying to kick-start yourself. Either way, you could be in line for a special tax break for investing in "qualified small business stock," (QSBS).

If you hold onto QSBS for at least five years before selling it and you meet other tax law requirements, any profit on your investment is exempt from tax. The Protecting Americans from Tax Hikes (PATH) Act preserved this tax break permanently.

This tax exclusion for QSBS has been kicking around for a while. Prior to 2009, you could exclude only 50% of the gain from the sale of QSBS held at least five years. That effectively reduced the 28% tax rate on QSBS profits to 14%—just one percentage point lower than the maximum long-term capital gains tax rate of 15% (and only 6 percentage points less than the higher 20% long-term capital gains rate for investors in the top tax bracket for ordinary income).

Eventually, the tax exclusion for QSBS was raised to 75%, and after September 27, 2010, it was 100%. And although it was scheduled to fall to 50% after 2014, the PATH Act preserved the full 100% exclusion, retroactive to January 1, 2015, and made it permanent.

Now that the uncertainty is over you can comfortably invest in QSBS, knowing that you might benefit from big tax-free profits in the future if the company is successful.

But the tax exclusion isn't automatic. To qualify, six requirements must be met:

1. The stock must have been issued after August 10, 1993.

2. The stock can't have been acquired in exchange for other stock.

3. The issuing corporation must be a C corporation.

4. At least 80% of the corporation's assets must be used in the active conduct of a qualified trade or business.

5. Certain businesses involving real estate or personal services (for example, law, health, financial services, etc.) are excluded.

6. The corporation can't have had more than $50 million in assets at the time the stock was issued.

In addition to the 100% exclusion for long-term profits, you won't owe any current tax on a gain from the sale of QSBS if you roll over the proceeds into new QSBS within 60 days.

Do keep in mind, however, that investments in new business ventures can be extremely risky, and tax savings won't matter if your QSBS loses all or most of its value. Do your homework before investing and make sure that the investment makes good financial sense as well tax sense.


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This article was written by a professional financial journalist for Larkspur Financial Advisors and is not intended as legal or investment advice.

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