Qualified Small Business Stock Points from a Recent Case

A recent United States Court of Federal Claims ruling on Qualified Small Business Stock (QSBS) under Internal Revenue Code § 1202 highlights critical concepts for obtaining gain exclusion. Here are five takeaways:

1. Holding Period:
   The five-year holding requirement is not flexible. Ownership begins at actual acquisition, not when rights are promised. Tracking the type and timing of issuance and transfer dates is important.
2. Original Issuance:
   QSBS requires acquisition at “original issue” directly from the issuer. Secondary transfers, even if pre-arranged, do not qualify except in limited circumstances.
3. Burden of Proof:
   Since this was a tax refund case, the taxpayers had the burden of proof to disprove the IRS determinations. This highlights the importance of good record keeping.
4. Asset Threshold:
   To establish that the $50 million asset cap requirement is satisfied, it is very helpful to have proof from the issuance period rather than having only later financial statements.
5. Clarity in Ownership Timing:
   Uncertainty about when and how stock was acquired can make QSBS determinations difficult. Section 1202 ties benefits to precise ownership history/timing. Avoid having a third party hold stock for the taxpayer’s benefit.

QSBS eligibility relies on the details of timing, source, proof, assets, and documentation. Proactive contemporaneous compliance activities are helpful for holders who are intending to pursue a QSBS strategy for an exit or other sale transaction.