How to Work with Tax Haven Jurisdictions
The Qualified Small Business Stock (“QSBS”) tax exclusion is set forth under Section 1202 of the Internal Revenue Code. It was enacted in order to incentivize investment in certain small businesses by permitting gain exclusion upon the sale of QSBS. When shareholders sell or exchange their qualified stock, they can exclude up to 100% in capital gains tax, as long as the stock was held for at least 5 years.
In order to be eligible for QSBS, the following requirements must be met:
The company is a US C-Corp.
The company must have had gross assets of $50 million or less at all times before and immediately after the equity was issued.
At least 80% of a company’s assets must be actively used in a qualified trade or business. The IRS has a list of excluded business types. If your business is not specifically excluded, it is considered qualified. Excluded business types are businesses which offer services in certain fields: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business in which the principal asset is the reputation or skill of one or more of its employees.
If you are considering transitioning from an LLC or an S-Corporation to a C-Corporation, QSBS tax benefits are something to keep in mind. Taking advantage of QSBS can result in substantial tax savings, lessening the burden of the double taxation that comes with C-Corporation status.
The IRS has a liberal approach to accepting stock as QSBS, holding in recent private letter rulings that businesses with service components can still qualify for QSBS treatment. In a June 25 ruling, Letter Ruling 202125004, the IRS concluded that a manufacturer of products prescribed by third-party health care providers was eligible for QSBS treatment. The IRS reasoned that although the taxpayer's products were associated with the health care industry, it did not perform health services. Moreover, even though it employed specialists, its principal asset did not involve the reputation or skill of its employees.
In the letter ruling, the IRS reasoned that the taxpayer provides value to its customers primarily in the form of tangible products (rather than services). Moreover, the health care providers who prescribed the products were not employed by the taxpayer, and any interaction with customers regarding their diagnoses was incidental to providing the products. As a result, the taxpayer was more like a custom manufacturer than a service provider.
Thus, if your business produces tangible products, but there are also service components to the business, QSBS eligibility should not necessarily be ruled out. I recommend consulting with a tax advisor for an evaluation of your business activities in order to determine your eligibility for QSBS treatment.
