Investments in qualified small business stock.

• Author: Veniskey, David P.

The Internal Revenue Code contains several provisions that encourage investment in small businesses. These include certain advantages for investing in qualified small business stock (QSBS), as discussed below. But first, what is QSBS?

To qualify as QSBS, the stock must be:

* Issued by a domestic C corporation with no more than $50 million of gross assets at the time of issuance;

* Issued by a corporation that uses at least 80% of its assets (by value) in an active trade or business, other than in certain personal services and other types of businesses (described in Sec. 1202(e)(3));

* Issued after Aug. 10, 1993;

* Held by a noncorporate taxpayer (meaning any taxpayer other than a corporation);

* Acquired by the taxpayer on original issuance (there are exceptions to this rule); and

* Held for more than six months to be eligible for a tax-free rollover under Sec. 1045 and more than five years to qualify for gain exclusion.

3 Code sections that come into play

Sec. 1202. Partial exclusion for gains from certain small business stock: The Code provides favorable treatment for gains from investing in small business stock under Sec. 1202.

For stock acquired after Sept. 27, 2010, individual investors may exclude 100% of the gain they realize on the disposition of QSBS if it is held for more than five years. However, for stock acquired after Feb. 17, 2009, and on or before Sept. 27, 2010, the exclusion from gain is 75%, and for stock acquired after Aug. 10, 1993, and on or before Feb. 17, 2009, the exclusion from gain is 50%.

The amount considered under this exclusion is limited to the greater of $10 million or 10 times the taxpayer's basis in the stock. The amount of gain eligible for the full or partial exclusion is subject to these limits computed on a per-issuer basis. Special rules can also apply for businesses located within an empowerment zone. Note, however, that a 28% rate applies to gains that remain subject to tax after the 50% or 75% exclusions.

Sec. 1244. Losses on small business stock: The sale of stock at a loss usually generates a capital loss, which can be deducted in any year only to the extent of capital gains, plus $3,000 ($1,500 for married taxpayers who file separate returns). Fortunately, Congress recognized that investors in small corporations often run more of a risk of loss. As a result, the Code permits an individual to deduct, as an ordinary loss, a loss from the sale or exchange, or from worthlessness, of small business...