Are we still eligible for the Qualified Small Business Stock Exemption (Section 1202)?

[luludeyang]

My husband joined a startup company (a qualified small business) and early exercised stock options. After 3 years, the startup company was acquired by a bigger startup company (which was not a qualified small business at that time) and the stock options from the first startup company were substituted by the second startup company's stock options.  We hold the substituted stock options for 3 more years and sold them this year.  Not sure whether we are still eligible for the Qualified Small Business Stock Exemption.  Can anyone advise? Thanks a lot!

[DianeW777 · Accepted solution]

It depends.  If the stock in the new company is qualified small business stock (QSBS) then under Section 351 it would still have the same special exemption.  However, when the newly issued stock of the acquiring company is non-QSBS any gains after the issuance of the stock would not qualify for the QSBS tax exclusion.  Sale of the new stock would be taxed as usual.

In the case of a taxpayer other than a corporation, gross income shall not include 50 percent of any gain from the sale or exchange of QSBS held for more than 5 years.

Qualified small business stock (QSBS):

To be QSB stock, the stock must meet all of the following tests.  (IRS Instructions Schedule D)

1. It must be stock in a C corporation (that is, not S corporation stock).

2. It must have been originally issued after August 10, 1993.

3. As of the date the stock was issued, the corporation was a domestic C corporation with total gross assets of $50 million or less (a) at all times after August 9, 1993, and before the stock was issued, and (b) immediately after the stock was issued. Gross assets include those of any predecessor of the corporation. All corporations that are members of the same parent-subsidiary controlled group are treated as one corporation.

4. You must have acquired the stock at its original issue (either directly or through an underwriter), either in exchange for money or other property (other than stock) or as pay for services (other than as an underwriter) to the corporation. In certain cases, you may meet this test if you acquired the stock from another person who met the test (such as by gift or inheritance) or through a conversion or exchange of QSB stock you held.

5. During substantially all the time you held the stock:

   1. The corporation was a C corporation;

   2. At least 80% of the value of the corporation's assets were used in the active conduct of one or more qualified businesses (defined next); and

   3. The corporation wasn't a foreign corporation, DISC, former DISC, regulated investment company, real estate investment trust, REMIC, FASIT, cooperative, or a corporation that has made (or that has a subsidiary that has made) a section 936 election.

[luludeyang]

Thank you for your detailed response! It's very helpful.  

[dongdong2022]

https://www.wealthspire.com/blog/tax-savings-quali[product key removed]ess-stock-qsbs