Congress Proposes Limiting Qualified Small Business Stock (QSBS) Tax Break

On Monday, September 13, the House Ways and Means Committee released the budget reconciliation bill known as the “Build America Back Better” act. The proposal would raise tax rates for corporations and individuals and make many other changes to the Internal Revenue Code.

One major proposed change is that to retroactively end the tax break for Qualified Small Business Stock (QSBS).

• The new proposal would revert the QSBS tax exemption to 50% for those earning more than $400,000, effective for all sales taking place at or after Sept. 13, 2021.

Current QSBS Rules

Section 1202(a) of the Code allows non-corporate taxpayers to exclude from gross income a percentage of capital gain recognized on the sale of QSBS that is held for more than five years.

• QSBS issued on or after September 28, 2010, is eligible for 100 percent exclusion from U.S. federal capital gains tax,3 up to a specified cap, while QSBS issued between February 18, 2009, and September 27, 2010, is eligible for 75 percent exclusion and QSBS issued on or after August 11, 1993, and prior to February 18, 2009, is eligible for 50 percent exclusion.
• The 50 percent and 75 percent gain exclusions are based on a 28 percent capital gains rate. Entrepreneurs and investors who have formed or made investments in corporations that are qualified small businesses as defined in Section 1202(d) of the Code often take advantage of this exclusion.

How the Proposed Changes Matter

As currently written, the bill would mean that for any capital gain earned after September 12, 2021, the QSBS exemption would be limited to 50% of the gain in the event that the taxpayer recognizes an annual adjusted gross income greater than or equal to $400,000. This change would also apply to a taxpayer which is a trust or an estate.

This could negatively impact many startup founders and early employees, who have made major financial decisions based on the current QSBS tax exemption.

It is worth noting that this bill is still under discussion and the committee plans to mark up the bill and make changes. However, if you are in the process of selling QSBS under circumstances where you could be impacted by this proposal, you should contact your ALL tax advisor or call us at 617-738-5200 to discuss the best options to proceed.