By purchasing stock in certain small businesses, you can diversify your portfolio. You also may enjoy preferential tax treatment, such as:
Conversion of capital loss to ordinary loss. If you sell qualifying Section 1244 small business stock at a loss, you can treat up to $50,000 ($100,000, if married filing jointly) as an ordinary, rather than a capital, loss — regardless of your holding period. This means you can use it to offset ordinary income, reducing your tax by as much as 35% of this portion of the loss. Sec. 1244 applies only if total capital invested isn’t more than $1 million.
Tax-free gain rollovers. If within 60 days of selling qualified small business (QSB) stock you buy other QSB stock with the proceeds, you can defer the tax on your gain until you dispose of the new stock. The rolled-over gain reduces your basis in the new stock. For determining long-term capital gains treatment, the new stock’s holding period includes the holding period of the stock you sold.
To be a QSB, a business must be engaged in an active trade or business and must not have assets that exceed $50 million.
Exclusion of gain. Generally, taxpayers selling QSB stock are allowed to exclude up to 50% of their gain as long as they’ve held the stock for at least five years. But, depending on the acquisition date, the exclusion may be greater: The exclusion is 75% for stock acquired after Feb. 17, 2009, and before Sept. 28, 2010, and 100% for stock acquired after Sept. 27, 2010, and before Jan. 1, 2015. (The latter acquisition deadline had been Dec. 31, 2013, but Congress retroactively extended it.) This can be a powerful tax-saving tool, especially for higher-income taxpayers.
The taxable portion of any QSB gain will be subject to the lesser of your ordinary-income rate or 28%, rather than the normal long-term gains rate. (See the Chart “What’s the maximum capital gains tax rate?”) Thus, if the 28% rate and the 50% exclusion apply, the effective rate on the QSB gain will be 14% (28% × 50%).
Keep in mind that all three of these tax benefits are subject to specific requirements and limits. Consult a tax and financial advisor at LGT to be sure an investment in small business stock is right for you by calling (214)-871-7500 or visiting www.lgt-cpa.com.
Seek the services of a legal or tax adviser before implementing any ideas contained in this blog. To reach a financial advisor at Lane Gorman Trubitt PLLC, call (214) 871.7500 or email firstname.lastname@example.org.