The aggregate gain from sales of QSBS eligible stock issued by any corporation is subject to limits specified in IRC Section 1202(b).
Each year that a shareholder sells QSBS, the total gain that may be taken into account for each issuing corporation is limited to the greater of:
- $10 million less the total amount of gain previously excluded from such QSBS (the “cumulative limitation”), or
- Ten times the adjusted basis of the QSBS issued by the corporation and disposed of by the shareholder during the taxable year (the annual limitation).
Capital Gains Tax Rates
The long-term (assets held over 12 months) capital gains tax rates during 2020 are:
Capital Gains Tax Bracket
- 0%: Income between $0 – $39,375
- 15% : Income between $39,376 – $434,550
- 20%: Income over $434,550
- 28%: Maximum Tax Rate on Section 1202 QSBS Gains that are not excludable
Net Investment Income Tax (NIIT)
In addition to capital gains taxes, if an individual’s income exceeds a certain threshold they will also be subject to a Net Investment Income (NIIT).
NIIT is an additional 3.8% tax on certain net investment income of individuals and certain trusts or estates who meet a Modified Adjusted Gross Income (MAGI) threshold.
The tax was imposed under Section 1411 back on January 1, 2013. The trust or estate may qualify if they have undistributed net investment income and adjusted gross income over $12,150. Generally, net investment income includes interest, dividends, capital gains, rental and royalty income, and non-qualified annuities. It does not include gains on the sale of a personal residence. Below are the MAGI thresholds.
If you believe you owe NIIT you will need to fill out Form 8960 on your taxes.
The Net Investment Income Tax is applied for taxpayers above the following Modified Adjusted Gross Income levels:
- Married filing jointly $250,000
- Married filing separately $125,000
- Single $200,000
- Head of household (with qualifying person) $200,000
- Qualifying widow(er) with dependent child $250,000
Real World Ex
What if my QSBS gain exceeds the limitations?
If a taxpayer’s capital gains exceed the QSBS limitations, the gain above the limitation will be subject to capital gains taxes at a maximum rate of 28%.
Additionally, the additional gains could be subject to Net Investment Income Tax (NIIT) of 3.8% for high earning taxpayers.
As an example, ABC, Inc. issued $2 million of QSBS eligible stock to an investor. After holding the stock for at least five years, ABC was acquired. The investor sold their stock during the transaction for sale proceeds of $25 million, for a $23 million capital gain.
The limitation is $20 million, based on the greater of $10 million and 10x the investor’s basis. Therefore, the first $20 million of the gain is excluded and the additional $3 million gain is subject to capital gains taxes.