The QSBS Tax Exemption: A Valuable Benefit for Startup Founders and Builders
brownadvisory.com
brownadvisory.com
https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim...
Not a lawyer/accountant though, so as always, you should seek professional counsel.
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.
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....
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.)
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.
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.
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.
[1]: https://www.wsgr.com/en/insights/understanding-section-1202-...
[2]: https://frostbrowntodd.com/advanced-section-1045-planning/
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.
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.
So people generally like a paper trail for that
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.
Based on what their Act 60 specialists say
As this matches my plan as well
But you should consult the specialists
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.
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.
The parent wants equitable tax policies that apply to everyone.
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.
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.
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.
Not sure what answer you wanted.
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.
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...
- 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”.
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.