January 9, 2024

Understanding Qualified Small Business Stock (QSBS)

A Qualified Small Business (QSB) is an active domestic C corporation with assets not surpassing $50 million upon or after issuing stock, as stipulated by Section 1202 of the Internal Revenue Code (IRC). This classification allows individuals to invest in these businesses, unlocking potential tax benefits.

For a business to meet QSB criteria, it must satisfy the following:

  1. Type of Business: It should be a domestic C-Corporation engaged in a qualified trade or business.
  2. Size Limitation: Gross assets must not exceed $50 million before or immediately after stock issuance.
  3. Business Activities: At least 80% of assets must actively engage in qualified trades or businesses, with specific exceptions.
  4. Stock Issuance: The stock should meet specific qualifications, including original issuance and a holding period of at least five years, among others.

QSBS can be particularly advantageous, especially in businesses like software, where reinvesting profits for growth is a priority. When selling the software business after 5+ years, up to the first $10 million in gains may be exempt from capital gains tax.

PZM, for example, aligns well with this strategy. With rapid growth and strategic acquisition offers in recent years, moving into new verticals in 2024, we're poised for increased valuation.

To be eligible for QSBS treatment, a business needs to adhere to specific requirements, including, but not limited to, being a domestic C-Corporation engaged in active trade or business, maintaining assets within the stipulated limit, primarily using assets in qualified trades or businesses, and having stockholders hold qualified stock for over five years for potential exclusion of capital gains upon sale.