Qualified Small Business Stock
Fusion Farms is a Qualified Small Business Stock and here’s why that matters to prospective investors…
In addition to being a Qualified Opportunity Zone Investment, Fusion Farms is a Qualified Small Business Stock, which offers all kinds of tax benefits and protections to prospective investors. If you are interested in becoming an investor in Fusion Farms and would like more information, we encourage you to contact us at firstname.lastname@example.org or call +1-866-347-3321.
What is a Qualified Small Business Stock?
The term qualified small business stock (QSBS) refers to shares of a qualified small business (QSB) as defined by the Internal Revenue Code (IRC). A qualified small business, like Fusion Farms, is an active domestic C corporation whose gross assets—valued at the original cost—do not exceed $50 million on and immediately after its stock issuance. Individuals are able to receive tax benefits if they hold QSBS as long as they meet certain criteria.
The key takeaways here are that:
- QSBS is treated favorably for capital gains purposes if both the investor and the company meet certain requirements.
- How much of a tax break the investor will receive depends on when they purchased the stock and how long they held it.
Investors who sell their QSBS before the end of the required holding period can defer capital gains by investing the proceeds in another company’s QSBS.
Tax Implications for Qualified Small Business Stocks
A qualified small business stock is any stock acquired from a qualified small business after Aug. 10, 1993. Under Section 1202, the capital gains from qualified small businesses are exempt from federal taxes. To claim the tax benefits of the stock being qualified, the following must apply:
- The investor must not be a corporation.
- The investor must have acquired the stock at its original issue and not on the secondary market.
- The investor must have purchased the stock with cash or property, or accepted it as payment for a service.
- The investor must have held the stock for at least five years.
- At least 80% of the issuing corporation’s assets must be used in the operations of one or more of its qualified trades or businesses.
Tax treatment for a QSB stock depends on when the stock was acquired and the length of its holding. The Protecting Americans from Tax Hikes Act (PATH Act), allows investors to exclude 100% of capital gains on qualified small business stock (QSBS) if the stock qualifies under Section 1202 of the IRC. The exclusion has a cap of $10 million, or 10 times the adjusted basis of the stock, whichever is greater.
Again, this is separate and apart from the benefits an investor might get from Fusion Farms being a Qualified Opportunity Zone Investment.
The Benefits of 1244 Stock
Section 1244 of the Internal Revenue Code is the small business stock provision enacted to allow shareholders of domestic small business corporations to deduct a loss on the disposal of such stock as an ordinary loss rather than as a capital loss, which is limited to only $3,000 annually.
Normally, stock is treated as a capital asset and if disposed of at a loss, the loss is deducted as a capital loss. The general rule for net capital losses (losses that exceed gains) is that they are subject to an annual deduction limit of only $3,000. Any excess over $3,000 must be carried over to the next year.
A loss on Section 1244 stock, on the other hand, is deductible as an ordinary loss up to $50,000 ($100,000 on a joint return, even if only one spouse has a Section 1244 loss). A big difference! What this means is that in the unlikely – but possible – scenario that Fusion Farms doesn’t succeed (and create tax-free profits for them upon sale, or greatly reduced taxes as an Act 22 investor), investors can deduct their losses from ordinary income (for mainland investors).
Note that ordinary losses are normally 100% deductible; however, while a loss on Section 1244 stock is treated as an ordinary loss, the deduction is limited to the amounts stated above.