Tax break No. 1: Under the rules in effect before the new law, you can exclude up to 50% of the gain from the sale of QSBS from federal income tax if you meet certain requirements. For starters, you must hold the stock for at least five years. Also, the stock must have been issued directly to you or given to you by someone who received the original shares. 

This sounds pretty good, but there’s a catch: The capital gains tax on the taxable portion of the gain from QSBS is 28%. Because you’re usually paying tax on half the gain, the effective tax rate is 14% (50% of 28%). In contrast, the normal tax rate for long-term capital gain (i.e., gain on stock held for more than a year) is 15%—or just 1% higher. 

Tax break No. 2: No current tax is due on a gain from selling QSBS if you roll over the proceeds into new shares of the same company or other QSBS within 60 days. This tax break is available for QSBS held more than six months. If you reinvest less than 100% of the proceeds, you’re taxed on gains up to the difference between the sales proceeds and the amount reinvested. 

The holding period for the new stock dates back to the purchase of the original stock. Therefore, you can cash in the QSBS without paying any current tax while you keep the tax exclusion in your hip pocket. You must elect the rollover break by your tax return due date for the year of the sale (plus any extensions). 

Now the new tax law boosts the tax-free payoff at some future date. For sales of QSBS acquired after Feb. 17, 2009, and before Jan. 1, 2011, the tax exclusion increases from 50% to 75%. This lowers the effective tax bite to only 7% (25% of 28%), less than half the regular capital gains tax rate (this assumes you’re not subject to the AMT). 

To qualify for either tax break for QSBS, you must meet these requirements:

• The stock must have been issued after Aug. 10, 1993.
• The stock can’t be acquired in exchange for other stock (except in a QSBS rollover transaction).
• The issuing corporation must be a C corporation.
• At least 80% of the corporation’s assets must be used in the active conduct of a qualified trade or business.
• Certain businesses, such as those involving real estate or personal services (e.g., law, health, financial services, etc.), are excluded.
• The corporation can’t have more than $50 million in assets at the time the stock is issued.

Tip: Report any QSBS gain or rollover on Schedule D (Capital Gains and Losses) of Form 1040. The rules are complex, so follow the instructions (D-4) carefully at www.irs.gov/pub/irs-pdf/i1040sd.pdf

Example: Get the best of 2 tax worlds