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In a merger, the QSBS qualification and holding period will be maintained if the merger is considered a tax-free stock transfer as (1) a section 351 stock exchange or (2) a section 368 reorganization.
The entity or individual receiving QSBS in a tax-free transfer will keep the prior holders’ holding period. For example, if an investor purchased QSBS in ABC Corporation 3 years ago then decided to gift the stock to his grandchild, his holding period passes to his grandchild. Therefore, if the grandchild holds the QSBS stock for another 2 years, they will receive the section 1202 tax exclusion.
Under Section 1202(h)(4) the holder of QSBS can exchange their stock for other QSBS or non-QSBS stock when electing Section 351(a). Section 351(a) allows the holder to conduct a tax-free transaction, exchanging either corporate stock or property.
Immediately after the exchange, the company issuing new stock in exchange for the QSBS has to have control of the QSBS corporation in terms of Section 368. Under Section 368 control means at least 80% of the voting power and at least 80% of the number of shares of other issued stock.
If the QSBS is exchanged for newly issued QSBS the stock will (i) maintain its holding period, (ii) defer any existing gains, and (iii) accumulate more Section 1202 QSBS tax gains to be included in the exclusion when the second QSBS is sold. Under Section 351(a) the QSBS can be exchanged for non-QSBS as stock and still maintain the first two caveats above, but it will not accumulate any new Section 1202 QSBS gains. When the non-QSBS is sold the built-in QSBS gain will be excluded but any new gains will be taxed at the taxpayer’s corporate tax rate.
If a company was acquired in a tax-free stock transaction the company acquiring the QSBS company would issue new stock in exchange for controlling ownership of the QSBS company. When the newly issued stock in the acquiring company qualifies as QSBS then nothing would change in terms of tax exclusion or holding period for the QSBS holder. The only caveat when the newly issued stock of the acquiring company is non-QSBS is that any gains after the issuance of the stock would not qualify for the QSBS tax exclusion; therefore, the only gain on allowed on the sale of the new stock would be the built-in gain from the original QSBS.
More on the QSBS holding period
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.
