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Qualified Small Business Stock Provides Tax Advantages for Angel Investors

03/11/2016  |  By: Cindy Anderson, CPA, Senior Manager, Tax

The Protecting Americans from Tax Hikes (PATH) Act of 2015, which was signed into law in December 2015, made permanent the exclusion of 100 percent of the gain on the sale or exchange of Qualified Small Business Stock (QSBS) meeting certain requirements and subject to taxpayer limitations.

Specifically, Section 126 of the PATH Act made permanent what is commonly known as Section 1202.  This exclusion of gain applies to the computation and payment of all federal income taxes including the 3.8% “Medicare” tax on net investment income and the alternative minimum tax.

These changes should excite angel investors because they make it possible to improve the overall after-tax returns on their investment portfolios.  

Before the passing of the PATH Act, the §1202 exclusion percentage for QSBS acquired after December 31, 2014, reverted to the reduced exclusion amount of 50 percent and the AMT tax preference add back had been reinstated.

What is a Qualified Small Business Company?

A Qualified Small Business Company (QSBC) is generally a domestic C corporation with less than $50 million in assets at any time (including when the stock is issued) and uses at least 80 percent of the assets in an active conduct of one or more qualified trades or businesses (which excludes health, law, accounting, banking services as well as other specific business activities.)

Section 1202’s 100 Percent Gain Exclusion Made Permanent

For the 100 percent gain exclusion to apply, the QSBS investment must have been acquired after September 27, 2010. Certain lower exclusions may apply for QSBS investments acquired in earlier periods.

The stock must be issued directly by the issuer or through an underwriter to the taxpayer, and in exchange for money or other property other than stock, or as compensation for services provided to the corporation, other than for underwriting services.

The gain exclusion applies only to appreciation in stock value. If an investor transfers property other than cash to a QSBC in exchange for stock issued by the QSBC, the §1202 exclusion will not shield the appreciation on that property from tax, but the payment of tax could be deferred.  If the transfer is not taxed because of §351, the tax on the appreciation will be assessed when the QSBS is sold.

Tax Benefits for Angel Investors

QSBS is now even more attractive from a tax perspective. By purchasing stock in certain small businesses, angel investors can not only diversify their portfolio, but also enjoy preferential tax treatment, as long as such investments meet the requirements for exclusion under §1202.

This exclusion may also apply at the state level.  Of course tax consequences are only one of the many factors that should be considered before making an investment.

Please contact the LBMC Tax team at for additional information. We would be happy to work with you. For more information, visit our tax services page.