Zero Percent Federal Income Tax on QSBC Sales: Too Good to Be True?

If you're constantly looking for the best way to shield your investment gains from federal income taxes, you were likely heartened by the Tax Cuts and Jobs Act's (TCJA) double-digit corporate tax rate reduction.

But even better than a 21 percent corporate tax rate is a zero percent tax rate on gains from selling stock, and that's exactly what qualified small business corporations (QSBCs) can provide for owners and investors. Learn more about the unique tax treatment of QSBC gains to determine whether this is a viable option for your portfolio. 

A 100 Percent Exclusion for Post-2010 Acquisitions

QSBCs are essentially C Corporations, but are further defined as businesses with less than $50 million in gross assets that do not count as a "principal asset" the "reputation or skill of employees." This means that most QSBCs are production-based companies (rather than law, accounting, or consulting firms, brokerage services, hospitality businesses like hotels, motels, and restaurants) that generate profits by producing products.

Individuals who acquire shares of a QSBC after September 28, 2010, may be able to exclude 100 percent of their stock sale gains from federal income tax. (Those who acquired shares between early 2009 through September 27, 2010, can exclude up to 75 percent of the taxable gain, while shares acquired from 1993 through 2009 are subject to a 50 percent exclusion.) To utilize this exclusion, you'll have to hold the QSBC shares for more than five years and meet a laundry list of other requirements. 

How the Tax Cuts and Jobs Act Helps

Although much was made about the beneficial changes the TCJA wrought to S Corps and other pass-through entities, the 21 percent corporate tax rate can provide even more benefits to QSBC holders. If you own (or own shares in) a QSBC that meets all the IRS's requirements, you'll be able to take advantage of this 21 percent tax rate every year, reinvest your profits, and exclude all your gains after you sell stock. There are few other legal investments that can provide this level of tax efficiency.

Whether you're planning to use this information to boost your own investment portfolio or to assist high-net-worth clients, boning up on the post-Tax Cuts and Jobs Act QSBC requirements and qualifications can reap enormous dividends—literally—for anyone who invests in a profitable small business.