Qualified Small Business Stock

QSBS was first enacted in August 1993.[6] Expansion and modification of these original aspects of QSBS legislations have occurred over the years to further motivate taxpayers to invest in, or even create, certain types of small businesses to boost job creation and to prevent economic recession.[7]

Over the decades, several legislative events have contributed to investor interest in the QSBS Section 1202 capital gains tax exclusion:

QSBS eligibility and tax exemption benefits aim to fuel job growth on a national level by incentivizing investments in C-corporations located in the United States. However, QSBS eligibility excludes companies where individuals or groups of employees are considered the "product," such as healthcare workers, accountants, or lawyers.[15] Additionally, specific requirements must be met at the corporate level, security level, and individual taxpayer level for a company or investor to qualify and remain QSBS eligible.[16] Some of these requirements are at issuance of the stock, and others are during the shareholder's holding period.[17]

On a national level, each state has a specific treatment of QSBS gains at the state income tax level.[24] There are three ways states typically address the exclusion:

Some states fully conform to the Federal QSBS guidelines and allow full exemption if the stock meets the Section 1202 QSBS criteria. These states conform to the federal tax code on either a "static" or "rolling" basis. "Static" conformity means the state starts complying with the Internal Revenue Code as of a specific date. "Rolling" conformity means that the state adopts IRC changes as they occur.[25]

Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.[26]

Certain states do not have state income taxes, and therefore there is no QSBS implication at the state level. Additionally, select states do not allow any capital gains exclusions for QSBS.

States that Conform to Federal QSBS (IRC Section 1202)[27]

• Arkansas
• Arizona
• Colorado
• Connecticut
• Delaware
• Georgia
• Idaho
• Illinois
• Indiana
• Iowa
• Kansas
• Kentucky
• Louisiana
• Maine
• Maryland
• Michigan
• Minnesota
• Missouri
• Montana
• Nebraska
• New Mexico
• New York
• North Carolina
• North Dakota
• Ohio
• Oklahoma
• Oregon
• Rhode Island
• South Carolina
• Utah
• Vermont
• Virginia
• West Virginia
• Wisconsin

States that do not conform to Federal QSBS (IRC Section 1202)[28]

• Alabama
• California
• Mississippi
• New Jersey
• Pennsylvania
• Puerto Rico

States that Partially Conform to Federal QSBS (IRC Section 1202)[28]

• Hawaii
• Massachusetts

States Without State Income Tax (conform with IRC Section 1202)[28]

• Alaska
• Florida
• Nevada
• South Dakota
• Texas
• Washington
• Wyoming

States Without State Capital Gains Tax (conform with IRC Section 1202)[28]

• New Hampshire
• Tennessee

Due to practices that multiply the tax benefit, there are some criticisms over the uses of the QSBS tax exemption. Majority of these practices being used to multiply the tax benefit are not initially intended within the tax code. Originally, the enactment of the QSBS tax exemption legislation worked to incentivize investments in certain types of small businesses within the United States. However, as the popularity of the tax benefit began to grow, some investors found ways to make the most of the tax benefit by multiplying their personal tax savings and, in some cases, to family, friends, and acquaintances.[29]