Operating your small business as a Qualified Small Business Corporation (QSBC) could be a smart idea, tax-wise that is.
Under Section 1202 of the Internal Revenue Code, operating as a Qualified Small Business Corporation (QSBC) offers unique tax benefits. QSBCs are essentially treated the same as a regular C corporation for tax and legal purposes, with an exception regarding its shareholders. Shareholders of QSBCs can potentially exclude 100% of their gains from the sale of QSBC stock from federal income tax yielding to a 0% federal income tax rate on profits from the sale of the QSBC stock.
To qualify for this tax benefit, shareholders must meet several requirements outlined in Section 1202 of the Internal Revenue Code. These requirements involve factors such as the size and nature of the business, the duration of ownership of the stock, and other specific criteria. To be eligible for the 100% stock sale gain exclusion deal, you must hold your QSBC shares for over five years. For shares that haven’t yet been issued, the 100% gain exclusion break will only be available for sales that occur sometime in 2029 or beyond.
Additionally, the 100% federal income tax gain exclusion is only available for sales of QSBC shares that were acquired on or after September 28, 2010. Do note, the tax benefit isn’t available for QSBC shares owned by another C corporation. However, QSBC shares held by individuals, LLCs, partnerships, and S corporations are potentially eligible.
If you currently operate as a sole proprietorship, single-member LLC treated as a sole proprietorship, partnership or multi-member LLC treated as a partnership, you’ll have to incorporate the business and issue yourself shares to attain QSBC status - a process in which your VAAS Pro Consultant can help you with.
Lastly, the corporation’s gross assets can’t exceed $50 million immediately after your shares are issued. If after the stock is issued, the corporation grows and exceeds the $50 million threshold, it won’t lose its QSBC status for that reason.
Businesses that Aren't Eligible
Health Services
Law Services
Engineering
Architecture
Accounting Services
Actuarial Science
Performing Arts
Consulting
Athletics
Financial Services
Brokerage Services
Banking
Insurance
Leasing
Financing
Investing
Farming
Oil Production or Extraction
Hotel or Motel Business
Restaurant
Natural Gas or other Minerals in which percentage depletion deductions are allowed
Businesses where the principal asset is the reputation or skill of its employees
Other Key Things to Note
The Tax Cuts and Jobs Act made a flat 21% corporate federal income tax rate permanent. So, if you own shares in a profitable QSBC and you eventually sell them when you’re eligible for the 100% gain exclusion break, the 21% corporate rate could be all the income tax that’s ever owed to the IRS.
The 100% federal income tax stock sale gain exclusion break and the flat 21% corporate federal income tax rate are two strong incentives for eligible small businesses to operate as QSBCs. We’ve summarized the most important eligibility rules here, but there are more. So before making your decision to operate your business as a QSBC, schedule an appointment to consult with us.