Managing QSBS status and working capital
Recent failures of prominent banks have left many startup portfolio companies eager to diversify their cash holdings into other forms of deposit instruments, including Treasury bills, money market funds, commercial paper, certificates of deposits, and corporate stock or debt.
For corporations that intend for their stock to meet the definition of “qualified small business stock” (QSBS) under the meaning of Section 1202 of the IRS Code, however, any reorganization of the balance sheet may leave the CFO concerned that the corporation is jeopardizing its stock’s status as QSBS.
As a reminder, a noncorporate shareholder of QSBS that has been held for more than 5 years can exclude from federal taxable income the greater of $10 million or 10 times the shareholder’s basis of the stock sold. For its stock to meet the definition of QSBS, however, a number of tests must be satisfied by the corporation, including two that are dependent on the nature of the corporation’s assets.
As this article will illustrate, however, there is typically no cause for concern. Provided the corporation accurately projects its working capital needs and refrains from investing in long-term positions in certain corporate stock or securities, the redeployment of cash into other types of deposit instruments should not pose a problem from a Section 1202 perspective. To understand why, let’s look at the two aforementioned tests that reference the nature of the corporation’s assets, the active trade or business test and the corporate securities limitation.