Wealth Management Group Newsletter – Fall 2019
Dan Newman

QSBS Offers Remarkable Tax Breaks

Section 1202 offers investors a remarkable tax break: The ability to exclude up to 100% of the gain on the sale of qualified small business stock (QSBS). What’s the catch? For one thing, you must hold the stock for more than five years to enjoy the benefits. And the types of stock that are eligible are limited. However, under the right circumstances, you (or your heirs) can sell these securities federally income-tax-free.

Brief history

Sec. 1202 was enacted in 1993. Initially, it allowed non-corporate taxpayers to exclude from income 50% of their gain on the sale or exchange of QSBS. The remaining 50% was taxed at 28%. In 2003, the tax break fell out of favor when the regular long-term capital gains tax rate was cut to 15% (20% for high-income taxpayers).

However, Congress breathed new life into QSBS when it temporarily increased the exclusion to 75% in 2009 and then to 100% in 2010. In 2015, Congress made the 100% exclusion permanent for stock acquired after September 27, 2010.

How to qualify

To qualify as QSBS, stock generally must be issued by a U.S. C corporation to an individual or an entity other than a C corporation. It also must meet the following requirements:

  • Gross Assets
    The issuing corporation’s aggregate gross assets must not have exceeded $50 million at any time after August 10, 1993, or immediately after issuance of the stock. If the corporation’s aggregate gross assets grow beyond this threshold at a later date, the QSBS maintains its favorable treatment.
  • Original Issuance
    You must acquire the stock as part of an original issuance — directly from the corporation or through an underwriter, not from another shareholder — in exchange for money or property other than stock. Stock received as compensation for services, or as a gift or inheritance, also qualifies.
  • Active Business
    The corporation typically must use at least 80% of its assets (by value) in the conduct of one or more qualified active businesses. Several types of businesses do not qualify, including:

    • Farming;
    • Certain oil, gas and mining;
    • Banking, insurance, financing, leasing and investing;
    • Hotels, motels and restaurants; and
    • Service businesses in the health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage service fields.

In addition, no more than 10% of the corporation’s assets may consist of real estate that is not used in conducting a qualified active business.

  • Holding Period
    You must hold QSBS stock for at least five years after it is issued. If the stock is transferred by gift or inheritance, the transferor’s holding period is added to the recipient’s. Suppose, for example, that Ken purchases QSBS on January 1, 2014, and dies on January 1, 2017. His daughter, Kate, inherits the stock and sells it on February 1, 2019. Even though Kate has held the stock for only two years, she qualifies for 100% gain exclusion because Ken’s three-year holding period is added to hers.

    If your QSBS is converted into different stock of the same corporation, your holding period for the original stock is added to the holding period for the new stock. Also, if you sell the stock before you have satisfied the five-year holding period, it is possible to preserve the benefits of Sec. 1202 by rolling over your gain into another QSBS within 60 days. The original stock’s holding period is added to the replacement stock’s holding period. Note that rollover treatment is available only if you held the original stock for more than six months.

    Finally, be warned that Sec. 1202 limits the amount of QSBS gain you can exclude with respect to a particular corporate issuer in a given tax year. The maximum exclusion is the greater of $10 million or 10 times your aggregate adjusted tax basis in the stock sold during the tax year.

Plan carefully

Before investing in QSBS, weigh the benefits against the potential tax costs and investment risks. For example, if you anticipate that the corporation will pay significant dividends, double taxation may erase some of the benefits of tax-free gains.

If you decide to invest in QSBS, monitor your investment to ensure that the stock does not become disqualified. This could happen if the corporation ceases to satisfy the active business requirement or redeems your stock. Talk with a financial advisor about managing the risks associated with QSBS and how this investment fits into your larger investment portfolio.

Sidebar: Watch out for corporate redemptions

When Congress enacted Section 1202 of the tax code, it was concerned that existing qualified small business stock (QSBS) shareholders would cash in their holdings and then buy new stock with a higher tax basis to take advantage of tax-free gains. To discourage this, Sec. 1202 disqualifies new stock if the company redeems stock from you or a related person within two years before or after the new stock is issued. The latter requirement is designed to prevent you from acquiring new stock first and then cashing in the old stock.

For more information, contact David Bowman at 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

© 2019

New Rules Make 401(k) Hardship Withdrawals Easier


If you experience financial difficulties, it may be tempting to tap into the savings you have accumulated in a 401(k) or similar retirement plan. Many plans permit hardship withdrawals, and the Bipartisan Budget Act of 2018 relaxed some of the rules surrounding these withdrawals. But, even if it is easier for you to access your retirement savings in a pinch, doing so comes at a steep price.

How do you qualify?

Retirement plans may, but are not required to, provide for hardship withdrawals. Typically, these withdrawals are allowed for:

  • Unexpected medical expenses;
  • Tuition and related fees and expenses;
  • Costs related to purchasing a principal residence;
  • Payments necessary to avoid eviction from, or foreclosure on, a principal residence;
  • Certain expenses for repairing damage to a principal residence; and
  • Burial or funeral expenses.

The Budget Act has eased certain requirements for plan participants seeking hardship withdrawals. Notably, it has eliminated the requirement that participants take all available plan loans before receiving a hardship distribution.

In addition, the Budget Act has eliminated the six-month period that previously prohibited participants from making new contributions following a hardship withdrawal. And, it has expanded the types of funds available for hardship withdrawals. Now, participants can withdraw not only elective deferral contributions, but also qualified non-elective contributions, qualified matching contributions and earnings on these contributions.

Plans have some discretion in designing hardship withdrawal provisions. For example, a plan may allow withdrawals only from elective deferrals and earnings, even though it is permitted to allow withdrawals from other sources.

What are the consequences?

Most hardship withdrawals are subject to taxes and, if you are under age 59-½, a 10% penalty. Suppose, for instance, that a 50-year-old taxpayer takes a $10,000 hardship withdrawal from a 401(k) plan. Assuming the taxpayer is in the 32% tax bracket, the amount left after federal taxes and penalties is only $5,800 ($10,000 – $3,200 tax – $1,000 penalty).

You may be able to avoid a 10% penalty if:

  • You are disabled;
  • Your unreimbursed medical expenses exceed 10% (for tax years 2019 through 2025) of your adjusted gross income; or
  • A court order requires you to give the money to your former spouse, a child or another dependent in connection with a divorce.

In addition to the impact of taxes and penalties, consider how permanently removing funds from your account will affect your retirement savings. Also keep in mind that, unlike most assets, the money in a 401(k) or similar tax-advantaged plan is protected from creditors. Think twice before relinquishing the opportunity to shield assets and obtain tax-deferred growth.

Are there other options?

Given the costs of hardship withdrawals, they should be viewed as a last resort. If obtainable, a traditional bank loan would be a better option. If a bank loan is not possible, find out if your 401(k) plan allows loans. Not only will you avoid taxes and penalties, but these loans offer competitive interest rates and the interest payments go back into your account.  There are loan payment rules that must be adhered to, however. 

While these new provisions relax the rules on hardship withdrawals, it may not be the best route to take.  Careful analysis should be undertaken before deciding on this course of action. 

For more information, contact Dan Newman at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

© 2019

Forward Thinking