For almost anyone, $10 million is a lot of money. Now, think about earning that much without having to pay federal taxes.
Sound like a pipe dream? It's not. Countless founders and early-stage employees at fast-growing companies around the country have done it, taking advantage of a little-known section of the tax code — the qualified small-business stock (QSBS) capital gain exclusion.
First enacted as part of a 1993 budget bill and made permanent in 2015, the exclusion applies to any business, though it's especially relevant to high-net-worth investors associated with tech startups.
And while it has undergone several evolutions, the upshot is it allows anyone to avoid federal capital gains taxes on the first $10 million in gains derived from qualified company stock.
The problem is that not every advisor fully understands how the exclusion works. Let's start with the basics because, as with anything, there are a few conditions.
First, the issuing company must be an operating C-Corp with fewer than $50 million in assets. Second, shares acquired from a secondary sale are ineligible. Third, the owner is required to hold the shares for at least five years.
Beyond that, here's a comprehensive checklist for advisors with clients who own QSBS-eligible stock:
Can a client exercise their stock options early to get the holding period started?
Yes. Many startups will allow their employees to take advantage of IRS rule 83(b), enabling them to exercise stock options early. Along with getting a jump on the holding period, such a move has the added benefit of potentially minimizing their tax burden even further.
Indeed, because options are taxed based on a company's valuation at the time of exercise, early movers can realize significant savings if the firm secures more funding at higher valuations.
Under what conditions should you counsel your client to sell their QSBS-eligible stock?
