The federal tax treatment of QSBS for individual (non-corporate) taxpayers is outlined below:
- How are QSBS Shares Taxed?
The tax treatment differs according to when the shares were acquired (Eligible Gain is defined in the section below):
Shares acquired before 2/17/2009:
- 50% of your Eligible Gain qualifies for a Capital Gain Exclusion.
- A 28% tax rate applies to your remaining Eligible Gain.
- For AMT purposes, 7% of your Capital Gain Exclusion will be added to your Alternative Minimum Taxable Income (line 2h of form 6251).
Shares acquired after 2/17/2009 and before 9/28/2010:
- 75% of your Eligible Gain qualifies for a Capital Gain Exclusion.
- A 28% tax rate applies to your remaining Eligible Gain (i.e. an amount equal to 1/3 of your Capital Gain Exclusion).
- For AMT purposes, 7% of your Capital Gain Exclusion will be added to your Alternative Minimum Taxable Income (line 2h of form 6251).
Shares acquired after 9/27/2010:
- 100% of your Eligible Gain qualifies for a Capital Gain Exclusion.
- No portion of the sale will be subject to 28% rate or treated as an AMT preference item.
- Eligible Gain
The maximum Eligible Gain that may be taken into account for a given year is the greater of:
- $10,000,000, minus the aggregate amount of Eligible Gain used in previous years for sales of the same company’s stock; or
- Ten times the cost basis of the shares sold during the given year.
Any excess gains are taxed at regular capital gains rates. For example, if someone realizes $12,000,000 of QSBS gain, $10,000,000 will be considered eligible gain and $2,000,000 will be taxed like any other capital gain.
Note that the $10,000,000 limit described above is per issuer, not per taxpayer. For example, if someone sold shares of QSBS company A in a previous year, this will not affect her Eligible Gain for her shares of QSBS company B. She will be entitled to an Eligible Gain of $10,000,000 (or 10x the basis) for each stock.
- Net Investment Income Tax (NIIT)
Generally speaking, the Net Investment Income Tax (NIIT) is a 3.8% surcharge on capital gains, dividends and interest for taxpayers with a Modified Adjusted Gross Income over $200,000 (or $250,000 for joint filers). The gain from the sale of QSBS shares, minus the Capital Gain Exclusion, is subject to NIIT for taxpayers above the MAGI threshold.
In other words, if you pay regular capital gains or the 28% rate on a portion of your QSBS sale, you’ll owe NIIT on that amount as well. However, NIIT does not apply to your Capital Gain Exclusion.
- State Income Taxes
Most states follow the federal rules. However, some states do not recognize QSBS, such as California and Pennsylvania. Be sure to check the rules in your own state.
For California taxpayers contemplating moving out of state to sell their shares, important information can be found here: Can I move out of CA, sell my QSBS and return?
Tax Examples
The examples below illustrate some of the tax mechanics in action.
Example 1
Jill sells QSBS shares worth $14,500,000 that were acquired before 2/17/2009. The shares have a cost basis of $500,000, resulting in a gain of $14,000,000. She has not sold shares in previous years.
Jill’s Eligible Gain is $10,000,000, since this exceeds ten times the cost basis. Based upon the date of acquisition, she is eligible for a Capital Gain Exclusion of 50% of the eligible gain. Therefore, her $14,000,000 gain will be taxed as follows:
$5,000,000 excluded from federal taxes
$5,000,000 taxed at 28% (plus NIIT)
$4,000,000 taxed as regular capital gains (plus NIIT)
$14,000,000 total gain
In addition, $350,000 (7% of the Capital Gain Exclusion) will be added to her Alternative Minimum Taxable Income.
Example 2
John sells QSBS shares worth $15,100,000 that were acquired after 2/17/2009 and before 9/28/2010. The shares have a cost basis of $100,000, resulting in a gain of $15,000,000. In previous years he claimed an Eligible Gain on $2,000,000 of shares of the same stock.
John’s Eligible Gain is reduced to $8,000,000. Based upon the date of acquisition, he is eligible for a Capital Gain Exclusion of 75% of the Eligible Gain. Therefore, his $15,000,000 gain will be taxed as follows:
$6,000,000 excluded from federal taxes
$2,000,000 taxed at 28% (plus NIIT)
$7,000,000 taxed as regular capital gains (plus NIIT)
$15,000,000 total gain
In addition, $420,000 (7% of the Capital Gain Exclusion) will be added to his Alternative Minimum Taxable Income.
Example 3
Pat sells QSBS shares worth $23,000,000 that were acquired after 9/27/2010. The shares have a cost basis of $2,000,000, resulting in a gain of $21,000,000. In previous years he claimed an Eligible Gain on $5,000,000 of shares of the same stock.
Pat’s Eligible Gain is ten times the cost basis of the shares sold during the year, or $20,000,000, since that exceeds $10,000,000 less prior year sales. Based upon the date of acquisition, he is eligible for a Capital Gain Exclusion of 100% of the Eligible Gain. Therefore, his $21,000,000 gain will be taxed as follows:
$20,000,000 excluded from federal taxes
$1,000,000 taxed as regular capital gains (plus NIIT)
$21,000,000 total gain
Pat does not need to add any of the sale to his Alternative Minimum Taxable Income.