The QSBS Tax Exemption: A Valuable Benefit for Startup Founders and Builders(brownadvisory.com)
brownadvisory.com
The QSBS Tax Exemption: A Valuable Benefit for Startup Founders and Builders
https://www.brownadvisory.com/us/theadvisory/qsbs-tax-exemption-valuable-benefit-startup-founders-and-builders
55 comments
A map that shows color coded QSBS conformity per U.S. state: https://www.qsbsexpert.com/how-does-my-state-treat-qsbs/
> QSBS is not applicable in California and a few others, and some states only partially conform
I also believe this is based on the state of residence. So a New Yorker working for a Delaware corporation headquartered in California is fine. (California's weird retroactive tax policies make moving to get this benefit tricky, however.)
I also believe this is based on the state of residence. So a New Yorker working for a Delaware corporation headquartered in California is fine. (California's weird retroactive tax policies make moving to get this benefit tricky, however.)
[deleted]
There are a lot of exclusions based on the type of business. No farming, banking, finance, insurance, hotels, restaurants, "or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees" such as doctors, accountants, consultants, etc.
https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim...
https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim...
I'm considering a opening / franchising a new type of gaming-cafe - I wonder if that would be deemed a 'restaurant'.
Does it matter for this purpose? I have a hard time imagining that your business raises capital and has an exit, where QSBS will come into play.
Franchising is mostly IP and distribution depending ??
You might want to consider separating the businesses, with the core IP you franchise held in a parent company. Any company-operated restaurants would be separate entities.
Not a lawyer/accountant though, so as always, you should seek professional counsel.
Not a lawyer/accountant though, so as always, you should seek professional counsel.
I would like to add that this exclusion is per person per company and can be multiplied with the use of irrevocable trusts.
For example, you can set up trusts for your wife and two kids, put in shares, and all receive the qsbs exclusion. Definitely speak to accountants and lawyers before trying this at home.
For example, you can set up trusts for your wife and two kids, put in shares, and all receive the qsbs exclusion. Definitely speak to accountants and lawyers before trying this at home.
It is exceedingly difficult to spread the QSBS love like that. Not worth considering. You are venturing into theoretical territory.
Other resources I’ve found informative include this write-up about QSBS [1] and this deep dive into Section 1045 deferrals [2].
[1]: https://www.wsgr.com/en/insights/understanding-section-1202-...
[2]: https://frostbrowntodd.com/advanced-section-1045-planning/
[1]: https://www.wsgr.com/en/insights/understanding-section-1202-...
[2]: https://frostbrowntodd.com/advanced-section-1045-planning/
In my opinion, an outrageous tax-giveaway to the rich. Very sad that this was expanded to 100% (from 50%) during the Obama administration.
Some people will say it doesn't apply to California, but this misses the point: you still avoid federal income taxation (and AMT). California is simply smart enough (IMO) to not follow the federal government's lead on this. So yeah, you'll still have to pay some tax to California. Big whoop you just saved 28% of federal tax.
The QSBS exemption is an excellent reason to remain a C corporation. Please don't ask how I know.
If you are a founder, you should definitely study/inquire about the benefits of this exemption.
Some people will say it doesn't apply to California, but this misses the point: you still avoid federal income taxation (and AMT). California is simply smart enough (IMO) to not follow the federal government's lead on this. So yeah, you'll still have to pay some tax to California. Big whoop you just saved 28% of federal tax.
The QSBS exemption is an excellent reason to remain a C corporation. Please don't ask how I know.
If you are a founder, you should definitely study/inquire about the benefits of this exemption.
As someone who stands to make a bunch of money from this exemption if things work out (I have a pile of qualifying stock from a YC top 50 unicorn), I agree. I think I would end up paying literally $0 in tax for no good reason (my state has no income tax).
There is a good reason. The government wants to incentivize people to make long term investments into certain types of small businesses. You are very free to disagree with that, but the government often uses the tax code to encourage/discourage certain types of investment.
Also given that you have an investment that qualifies, it seems like it is an easy thing, but it’s a pretty narrow exception. It is a giveaway to the rich in the sense that any stock based tax incentive is a giveaway to the rich, but there are a lot of giveaways to a lot of people in the tax code.
Also given that you have an investment that qualifies, it seems like it is an easy thing, but it’s a pretty narrow exception. It is a giveaway to the rich in the sense that any stock based tax incentive is a giveaway to the rich, but there are a lot of giveaways to a lot of people in the tax code.
Exactly. If the tax rate on capital gains is excessive, what's my incentive to invest in a small startup? Its extremely risky as it is, but without this, parking my cash in my brokerage account becomes all the more likely.
Is there a big problem with investors not being incentivized to invest in startups? I’m not really hooked into things these days but pre-pandemic seemed like probably the best time in history to raise money as an early stage startup and I can’t imagine that reducing or taking away QSBS would meaningfully affect that. VC firms seem to be doing just fine.
If you're investing in startups because its your hobby, as many do, no tax break is going to change that.
As for others, if you're looking for returns and have the option to be an LP in a VC, make angel investments, or just park your money in the S&P500, a few of those options look more promising. While everything does have inherent risk, it is an added benefit to angel investing that you get QSBS, while being an LP or investing in the S&P necessarily don't have the same tax benefits. Incentivizing investment in small & new businesses is probably a better thing than just having the ultra wealthy invest in AT&T.
As for others, if you're looking for returns and have the option to be an LP in a VC, make angel investments, or just park your money in the S&P500, a few of those options look more promising. While everything does have inherent risk, it is an added benefit to angel investing that you get QSBS, while being an LP or investing in the S&P necessarily don't have the same tax benefits. Incentivizing investment in small & new businesses is probably a better thing than just having the ultra wealthy invest in AT&T.
Just be aware that if you invested via a convertible note, that the QSBS holding period may not start until that note converted into stock - particularly if the note had any debt-like features like interest payments.
Very few employees end up taking advantage of QSBS, its really only investors & the founders, as you actually have to purchase and hold your shares. For early employees who are typically given options, buying your options, even early, can be an expensive and costly bet to take advantage of a tax break many years down the line.
I got lucky as an early employee (first engineering hire) who got stock rather than options. I’m not sure how typical it is but I think they didn’t switch to option grants until about a year after I started, though granted they we’re still quite small probably sub-20 employees at that time.
I’m very relieved not to be holding options. I got kind of burned by them on my first job. I was forced to sell on the secondary market as they were expiring and I wasn’t willing to take that bet (which was the right choice given the information I had at the time IMO) but they IPO’d a year or so later and are currently sitting at ~4x the price I got. Still, I’m lucky to have walked away with anything.
I’m very relieved not to be holding options. I got kind of burned by them on my first job. I was forced to sell on the secondary market as they were expiring and I wasn’t willing to take that bet (which was the right choice given the information I had at the time IMO) but they IPO’d a year or so later and are currently sitting at ~4x the price I got. Still, I’m lucky to have walked away with anything.
Is this true though? In my cohort of early-ish employees that went through a modest IPO, there was definitely some discussion of QSBS in an ex-employee group. That's where I even found out about it, in fact. Buying options (years after company was formed, mind you) was a bet on the company, not on some tax breaks down the line. Holding on to the shares for multiple years after the IPO, now that's definitely a QSBS bet (and still unclear whether a good one, given stock market volatility).
Out if curiosity, how did you invest in a YC company so early? Did you have a personal connection to that particular company or were looking to invest in startups?
I got them as grants as an early employee. I think they switched to option grants maybe around 20 employees.
Yeah qsbs is totally nuts but I'm not complaining.
I mean you can also move to Puerto Rico for the majority of the year you sell and also have 0% capital gains for federal income tax (and PR tax) purposes, under act 60. It’s got to be your only US address though.
I live abroad. Can I move to Puerto Rico so that it becomes my in-USA home and then go back abroad and live outside the US almost all of the year, and then pay 0% capital gains in the USA because my US tax home is Puerto Rico?
I have some friends in PR for Act 60 that say yes to that
Based on what their Act 60 specialists say
As this matches my plan as well
But you should consult the specialists
Based on what their Act 60 specialists say
As this matches my plan as well
But you should consult the specialists
I primarily have a different perspective on taxes, which adds to the consensus making in this country.
To me, the goal of taxes is not for everyone to resent their neighbors because the levies are not even. The goal of taxes is not to stuff the state’s coffers, as no amount of taxes will balance its budget and what it does collect only pay interest on the stuff it already built. So there is no roads and schools argument to paying an arbitrary “fair share”. The goal of taxes - and this seems to match reality - is to incentivize certain kinds of transactions. If certain kinds of transactions are done throughout the year, the government leaves the remaining earnings that year alone, if they aren't it acts as the steward for a portion of the remaining.
The primary goal of macroeconomic policy for the last decade has been to convince people to move money into shares of more founders, with the hope that the founders spend heavily on goods and services to make their thing work. Velocity of money is more important for the economy’s growth, than the idea of taxes. This entropy of spending is far greater than individual consumers or the monolithic ideas of a government entity spending. This has also been largely unsuccessful, as people simply dont want to give random founders money. So the governments desperate attempt to further incentivize making it happen anyway via a tax exemption is congruent with the idea.
To me, the goal of taxes is not for everyone to resent their neighbors because the levies are not even. The goal of taxes is not to stuff the state’s coffers, as no amount of taxes will balance its budget and what it does collect only pay interest on the stuff it already built. So there is no roads and schools argument to paying an arbitrary “fair share”. The goal of taxes - and this seems to match reality - is to incentivize certain kinds of transactions. If certain kinds of transactions are done throughout the year, the government leaves the remaining earnings that year alone, if they aren't it acts as the steward for a portion of the remaining.
The primary goal of macroeconomic policy for the last decade has been to convince people to move money into shares of more founders, with the hope that the founders spend heavily on goods and services to make their thing work. Velocity of money is more important for the economy’s growth, than the idea of taxes. This entropy of spending is far greater than individual consumers or the monolithic ideas of a government entity spending. This has also been largely unsuccessful, as people simply dont want to give random founders money. So the governments desperate attempt to further incentivize making it happen anyway via a tax exemption is congruent with the idea.
> The goal of taxes - and this seems to match reality - is to incentivize certain kinds of transactions.
unfortunately the kinds of transactions it incentivizes are available and profitable mostly for the rich.
>The primary goal of macroeconomic policy for the last decade has been to convince people to move money into shares of more founders [....] This has also been largely unsuccessful, as people simply dont want to give random founders money.
Huh? how about qualified investor rule which denies most people the chance to give money to founders? I.e. the same as above - the transactions available only to the rich.
unfortunately the kinds of transactions it incentivizes are available and profitable mostly for the rich.
>The primary goal of macroeconomic policy for the last decade has been to convince people to move money into shares of more founders [....] This has also been largely unsuccessful, as people simply dont want to give random founders money.
Huh? how about qualified investor rule which denies most people the chance to give money to founders? I.e. the same as above - the transactions available only to the rich.
Its not an egalitarian society and there is a caste system. That has nothing to do with the utility of the tax policy and velocity of money.
Not sure what answer you wanted.
Not sure what answer you wanted.
Looking at it in hindsight it looks like a giveaway, but since most startup investments fail and return absolutely nothing, this just changes the odds to make investing in startups less risky. There would be much less startup capital around and people would just buy mutual funds in mega corps if it wasn't for this tax break.
I upvoted you and would agree that encouraging creativity, new enterprise formation and investment in new ideas are all positives that the policy is chasing.
I think this policy is not a very effective means to that end. QSBS does not reduce the probability of startup failure. You can increase the financial rewards of startup success, but at a certain point this becomes less-and-less effective, because of risk aversion, and because of the declining utility of money.
This is why I say it is a give-away. Because in most cases it won't change the calculus of starting/investing in a startup from "not worth it" to "worth it." It just changes how rich the founder/investors are in the case that the startup succeeds.
I reflect on my own experience: the existence or non-existence of QSBS did not and would not have any bearing on starting my own business. This is of course N=1, so take it with a grain of salt.
I would just conclude by saying: QSBS is not a give-away only if it changing behavior. I'm not sure I believe that it actually changes startup or investing behavior.
I will grant that my experience is as a founder, and not an investor. It's more plausible that investors, who can diversify their investments, would have their behavior affected by QSBS. QSBS changes expected value of investment, though I have no idea how much early-stage investors can calculate that.
I also don't subscribe to the theory that more investment entails more creativity and innovation. I suppose that's a founder-biased point of view.
I think this policy is not a very effective means to that end. QSBS does not reduce the probability of startup failure. You can increase the financial rewards of startup success, but at a certain point this becomes less-and-less effective, because of risk aversion, and because of the declining utility of money.
This is why I say it is a give-away. Because in most cases it won't change the calculus of starting/investing in a startup from "not worth it" to "worth it." It just changes how rich the founder/investors are in the case that the startup succeeds.
I reflect on my own experience: the existence or non-existence of QSBS did not and would not have any bearing on starting my own business. This is of course N=1, so take it with a grain of salt.
I would just conclude by saying: QSBS is not a give-away only if it changing behavior. I'm not sure I believe that it actually changes startup or investing behavior.
I will grant that my experience is as a founder, and not an investor. It's more plausible that investors, who can diversify their investments, would have their behavior affected by QSBS. QSBS changes expected value of investment, though I have no idea how much early-stage investors can calculate that.
I also don't subscribe to the theory that more investment entails more creativity and innovation. I suppose that's a founder-biased point of view.
How does this compare to funding a company by buying its stock inside a Roth IRA? (Not withdrawing, treating the company as an investment.)
Yes, there are penalties to withdrawing from a Roth before 55, so the profits are locked up for a while, but 0 state and federal income tax can be worth it.
Many Roth custodians (Schwab) only allow public company stock, so it does require some work.
Yes, there are penalties to withdrawing from a Roth before 55, so the profits are locked up for a while, but 0 state and federal income tax can be worth it.
Many Roth custodians (Schwab) only allow public company stock, so it does require some work.
you go tax free after 5 years of ownership for up to 10 or 50 million or something. so you can ball out as a young person (without paying taxes)
The "over 55" restrictions on Roth withdrawals isn't a problem for me.
You can’t own 50% of more of a company you invest in using your self directed Roth IRA. So, QSBS is great for founders who own 50% or more.
Just be your own custodian. Dont conflate the limitations of third party custodians with the actual law, which is way more flexible. You can move Roth Ira funds around willy nilly. You can have a literal stack of cash on your desk labeled Roth Ira and invest in almost anything. Its just the consumptive purchases that would be a problem.
To your question, it is always better to have free and clear money with no restrictions, which means 0% tax now is better than locked up funds that you also wont have to pay taxes on in the future. Retirement products and trusts are judgement proof though sometimes even against ex spouses, not IRAs though), so if you have or expect to have creditors, better not to have assets in your name. Even better is to only have debt in your name so you can just tell people to get in line, or discourage them from ever bothering with the courts at all. Stuffing Roth IRAs are good for that.
To your question, it is always better to have free and clear money with no restrictions, which means 0% tax now is better than locked up funds that you also wont have to pay taxes on in the future. Retirement products and trusts are judgement proof though sometimes even against ex spouses, not IRAs though), so if you have or expect to have creditors, better not to have assets in your name. Even better is to only have debt in your name so you can just tell people to get in line, or discourage them from ever bothering with the courts at all. Stuffing Roth IRAs are good for that.
Is there a write up of how do be your own custodian? I'm paying a trust company annual fees to basically file irs form 5498 for multiple iras that only own an llc. I would pay money for information on how to do this.
I tried to look into this and as far as I can tell you cannot actually be your own custodian for IRAs. There are of course self-directed IRAs where you can hold non-traditional investments, but they still require a third-party custodian.
Many people here are grabbing their pitchforks about QSBS and how it makes the rich richer. QSBS has a maximum per year rule of $10M. That means you save 20% (Federal LTCG rate) on $10M/year --> $2M.
That is not "making the rich richer", the person has to buy in a company worth less than $50M in value and hold it for 5+ years. This is a pretty rare case and helps people get into the single digit millions, not billions...
That is not "making the rich richer", the person has to buy in a company worth less than $50M in value and hold it for 5+ years. This is a pretty rare case and helps people get into the single digit millions, not billions...
> That is not "making the rich richer" [...] This is a pretty rare case and helps people get into the single digit millions, not billions
There are two different categories. Those who have "single digit millions" are "rich" by any reasonable scale. In the us, a net worth of $1 million would put one at around the 89th percentile while a net worth of $10 million would be around the 99th percentile.
Those who have "billions" are an entirely different category which presents its own problems -- perhaps we need a different term for it. Maybe "Super-rich"?
At any rate, you might want to be careful with the language you use. QSBS does appear to make the rich richer. It probably does not make a big difference in making the super-rich become richer. I would suggest making an effort to use language that makes it clear which you are talking about and one that does not suggest that people with "single digit millions" are not rich. Because we ARE rich, and we need to recognize that fact and behave accordingly as members of society.
There are two different categories. Those who have "single digit millions" are "rich" by any reasonable scale. In the us, a net worth of $1 million would put one at around the 89th percentile while a net worth of $10 million would be around the 99th percentile.
Those who have "billions" are an entirely different category which presents its own problems -- perhaps we need a different term for it. Maybe "Super-rich"?
At any rate, you might want to be careful with the language you use. QSBS does appear to make the rich richer. It probably does not make a big difference in making the super-rich become richer. I would suggest making an effort to use language that makes it clear which you are talking about and one that does not suggest that people with "single digit millions" are not rich. Because we ARE rich, and we need to recognize that fact and behave accordingly as members of society.
LOL @ someone saving $2m on their taxes as "not rich."
QSBS allows way more than $2M/year of tax deduction.
- 10M cap applies to per entity per year per transaction. so if 10 of my investments every year have gain of $10M each - I pay exactly ZERO DOLLARS in state and federal taxes on this $100 million income every year.
- On top of it, If I make more than $10 million in a year on one transaction - there are ways to split this gain over multiple years (via deferred transactions) or over multiple entities (via trusts and LLCs)
I know on good authority that most GPs in venture funds pay very little capital gains tax due to QSBS “loophole”.
- 10M cap applies to per entity per year per transaction. so if 10 of my investments every year have gain of $10M each - I pay exactly ZERO DOLLARS in state and federal taxes on this $100 million income every year.
- On top of it, If I make more than $10 million in a year on one transaction - there are ways to split this gain over multiple years (via deferred transactions) or over multiple entities (via trusts and LLCs)
I know on good authority that most GPs in venture funds pay very little capital gains tax due to QSBS “loophole”.
Important to note that QSBS doesn’t necessarily make sense for some “indiehacker” type businesses.
You have to be a C-corp to benefit, which means either double taxation (paying both corporate tax and personal capital gains tax on all distributions) or paying yourself all in salary with payroll/income tax on all of it.
If you don’t intended to take on investors (or don’t intend to sell), an LLC or pass through type of arrangement may make more sense in the long run from a tax perspective. Under this arrangement you pay no corporate tax, and can elect to be treated as an S Corp for tax purposes. This way you can receive some of your comp as a dividend which would be at lower capital gains tax rates.
Of course, if at any point you plan on chasing investment, Delaware C Corp from the beginning (and QSBS qualification) is generally the best advice. This is complicated stuff, so consult a professional.
You have to be a C-corp to benefit, which means either double taxation (paying both corporate tax and personal capital gains tax on all distributions) or paying yourself all in salary with payroll/income tax on all of it.
If you don’t intended to take on investors (or don’t intend to sell), an LLC or pass through type of arrangement may make more sense in the long run from a tax perspective. Under this arrangement you pay no corporate tax, and can elect to be treated as an S Corp for tax purposes. This way you can receive some of your comp as a dividend which would be at lower capital gains tax rates.
Of course, if at any point you plan on chasing investment, Delaware C Corp from the beginning (and QSBS qualification) is generally the best advice. This is complicated stuff, so consult a professional.
What if you choose to live outside the US (FEIE)?
The C corp pays taxes IF there is income. After your salary payment there won't be any income.
Important detail is to be sure to claim losses personally if you are investing personally. So if you fail, then at least you've got some capital losses to milk off over the years.
Of course with a c-corp you've got a PITA factor... but the PITA factor seems unavoidable when trying to manage IRS complexity.
The C corp pays taxes IF there is income. After your salary payment there won't be any income.
Important detail is to be sure to claim losses personally if you are investing personally. So if you fail, then at least you've got some capital losses to milk off over the years.
Of course with a c-corp you've got a PITA factor... but the PITA factor seems unavoidable when trying to manage IRS complexity.
Very few desirable countries (other than say Singapore, etc) have lower taxes than the US, so FEIE might be irrelevant if your local country has high income or capital gains taxes.
If you’re doing the digital nomad thing to avoid paying taxes anywhere (except to the US, which you can’t avoid) that might make QSBS more desirable, but under the specific scenario that:
- you live in a low tax country like singapore (or you intend to stay a traveling digital nomad for years to dodge any non-US taxes)
AND
- your business doesn’t pay you a salary significantly higher than the FEIE cap of roughly 100k/yr
If you make $500k/yr living in Singapore, the FEIE is irrelevant (since as a victim of American global tax you’ll pay US income tax wherever you are) and it’d be better to convert as much of your salary into dividends/distributions as possible to pay lower cap gains rates.
If you’re doing the digital nomad thing to avoid paying taxes anywhere (except to the US, which you can’t avoid) that might make QSBS more desirable, but under the specific scenario that:
- you live in a low tax country like singapore (or you intend to stay a traveling digital nomad for years to dodge any non-US taxes)
AND
- your business doesn’t pay you a salary significantly higher than the FEIE cap of roughly 100k/yr
If you make $500k/yr living in Singapore, the FEIE is irrelevant (since as a victim of American global tax you’ll pay US income tax wherever you are) and it’d be better to convert as much of your salary into dividends/distributions as possible to pay lower cap gains rates.
QSBS is not applicable in California and a few others, and some states only partially conform:
https://www.mossadams.com/articles/2021/04/qualified-small-b....