If you're in the startup tech world, you've definitely heard the term, QSBS. It's what every startup founder dreams (or stresses) about and lately it's been making some headlines.
QSBS stands for Qualified Small Business Stock and it is referring to Section 1202 of the Internal Revenue Code that allows taxpayers who invest in startups to exclude up to $10 million of their gain once shares have been sold.
Now, it's not that easy. It's the IRS we're talking about, so there are some finer details you should know. In order for the exclusion to apply, both the shareholder and the company must satisfy a number of requirements:
the shareholder must have held the shares for 5 years (aka, if you're a founder, your C Corporation is at least 5 years old)
the gain is limited to the greater of $10 million, or 10 times their basis in the stock
the shareholder must receive the shares directly from the company in exchange for cash or as compensation for services.
these shares must be acquired before the company has more than $50MM in gross assets (so basically less than $50MM of funding)
the business must be structured as a C corporation for the 5 year period
no more than 10% of the company's value can come from real estate or securities
the business type cannot be:
services in the fields of law, health, financial services, brokerage services
banking, insurance, financing, leasing, investing, or similar business
farming, or any business of operating a hotel, motel, restaurant, or similar business
There is a way to stack the QSBS exclusion in excess of $10 million. The law states that each, "taxpayer" can exclude the gain, so startup founders can gift their children shares of their company, that way both can exclude their respective $10 million on the sale of the shares. Startup founders can also establish certain types of trusts for the benefit of their family, and each of the trusts can hold its own $10 million exclusion after the founder transfers the shares.
Will This Last?
Startup founders found out recently, that their beloved QSBS exclusion may be coming to an end.
House Democrats have proposed to retroactively eliminate the tax break for QSBS. Their proposal decreases the current 100% exemption to 50% for those earning more than $400,000.
Which, if you're in the boat where this exemption really matters, your taxable income will 100% exceed $400,000.
Now, this is not law, but it's something you should be aware of if you've been planning for the exemption.
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