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How to Avoid Capital Gains Tax via Qualified Small Business Stock

Americans miss out on a ton of tax savings. Why? Because many of the opportunities to save are incredibly complicated. You may have noticed… the tax code is a tangled mess. And it gets worse the more wealth you acquire.

That is why we will look at how to avoid capital gains tax with Qualified Small Business Stock. QSBS for short. To keep it simple, the tax code offers an option to save on capital gains by investing in an eligible small business.

Let’s look closer.

Section 1202 of the Tax Code

Section 1202 of the IRS tax code is where you can find the deep and complex QSBS details from the government. Here is their opening summary:

“In the case of a taxpayer other than a corporation, gross income shall not include 50 percent of any gain from the sale or exchange of qualified small business stock held for more than 5 years.”

The page continues with numerous exceptions, dates of eligibility, and amendments. For example:

"Qualified small business stock" means any stock in a C corporation which is originally issued after the date of the enactment of the Revenue Reconciliation Act of 1993. With multiple “if - then” disclaimers.

The “ifs” are what cause so many Americans to throw their hands up and go on paying too much in taxes. That’s understandable since you don’t want to deal with an IRS audit. But ignoring tax-saving opportunities can be a mistake. Because, like any problem you can’t fix yourself, there are professionals available to assist.

You may not understand your vehicle’s air conditioning system. But when it breaks you don’t suffer all summer, right? You take it to a professional who can fix the problem.

Taxes are no different.

Simplified QSBS Rules

You don’t need to know every detail of the IRS’s Section 1202 to learn how to avoid capital gains tax. Here are the key points that will help you decide if you should investigate further and consult a tax professional.

● Capital gains advantages are possible if you and the company you invest in meet the right criteria.

● There are different savings levels depending on when you bought the eligible shares.

● You must meet holding time requirements to see maximum capital gains savings.

● However, it is possible to sell Qualified Small Business Stock then roll that money into another QSBS. This can defer capital gains tax.

What Type of Company Qualifies?

Any active domestic C corporation whose assets don't go over $50 million on or after the issuance of stock. Other restrictions apply. For example, farming and mining companies are ineligible. Retail and tech companies are eligible.

These details and disclaimers are there for good reason, as you can imagine. But they also hinder taxpayers from taking action on beneficial portions of the tax code.

*Aug. 10, 1993 was the effective date of this tax law. However, a higher percentage of tax savings were available if the QSBS was purchased after key amendment dates that came later.

Highest Tax Bracket

If you’re in the highest tax bracket, you have the biggest incentive to investigate options to save on capital gains tax. Paying 0% on capital gains after selling qualified shares is a major win. You’re already paying hefty income taxes so you have to use the tactics available in other areas of taxation.

Sure, a deep dive into Section 1202 is no joyride but one that can pay off.

Also, if you’re wondering why many talented workers take a risk and go to work for a tech startup, this could be one reason. The pay may not be great but there’s potential. Because they get company stock that could be worth quite a bit someday. And with tech, someday can happen fast.

Instagram was launched in 2010, then sold in 2012 for $1 billion.

Existing businesses can also sell this type of stock. For example, to fund expansion.

How Much Can You Save

The amount you can save in taxes overall depends on how deep you’re willing to wade into the tax code, right? Those waters are murky and frustrating. But the more you know, the more you save. Which is a great incentive for investigating further.

With the tax-saving strategy of QSBS, the savings can be impressive.

Maximum of $10 million

Or 10 times the adjusted basis of the stock

Those numbers should get Americans who have built up wealth excited. But will it last?

Tighter IRS Restrictions

In 2021, the federal government became more concerned that they were losing too much tax revenue. And some of their focus landed on QSBS and the IRS’s Section 1202.

One particular court ruling went against an individual who owned a brokerage service. In the past, other such cases had gone in favor of the taxpayer.

Not this time. And to put it in the simplest terms, the IRS has the discretion to determine what category a business is in. So, their determination can deem a company ineligible for the tax break.

For example, you want to invest in your brother’s software company that helps farmers with weather and climate data. Is the company in the tech business or the farming industry?

See how tricky this can become? And why many Americans give up and don’t bother seeking more ways to save on taxes? It’s understandable because no one wants to deal with the IRS, which by the way, just received an $80-million boost in funding.


Taxpayers are hard-pressed to navigate the American tax system alone. And a prime example is the tax-saving strategy we discussed today, the Qualified Small Business Stock Exclusion.

We don’t recommend throwing in the towel though. IRS compliance is a must. But just like your vehicle’s air conditioning concerns can be solved by someone with know-how, so can your tax concerns.

Please speak with your tax professional or reach out to us if you have questions about this major opportunity to protect your wealth.

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