Case Study: QSBS benefits with a Charitable Remainder Trust • Learn with Valur

We’ve covered some important aspects of QSBS over the past few months, including the basics of the QSBS exemption, its history, and how you can increase your QSBS exemption benefits.

In this article, we’ll answer a question we hear a lot: “How does Valur optimize its QSBS stacking trusts to maximize returns?” Our team has spent countless hours analyzing the use of various types of trust, and we have identified a Charitable Remainder Unitrust (CRUT) as a great vehicle for stacking/increasing your QSBS benefits.

CRUTs and QSBS Exemptions

What is a CRUT? Simply put, a Charitable Remainder Trust, or CRUT, is an irrevocable trust typically used by individuals looking to defer capital gains taxes on an appreciated asset sale. They’re also a tool of choice for QSBS stacking, because they qualify as an individual shareholder and, therefore, receive their own $10 million QSBS exemption.

What is the point of QSBS stacking?

Any individual using a Charitable Remainder Trust for QSBS stacking likely has a few simple goals:

(1) Maximizing returns by minimizing taxes. Using a CRUT to gain an additional $10 million QSBS exemption — that is, an additional $10 million tax free — which can be reinvested for the long term.

(2) Accessing those returns as soon as possible. CRUTs operate on a set distribution schedule — dictated by the IRS — with a percentage of assets being distributed every year to you or your named beneficiaries. Your money is safe in the trust and you can invest it how you’d like, but some people prefer to get their proceeds out of the trust as soon as possible so they have additional flexibility.

How does Valur help you achieve these goals?

With those goals in mind — minimizing taxes, maximizing returns, and doing so on the shortest timeline possible — here is the structure we have designed for QSBS Stacking:

(1) Length – We set our QSBS stacking trusts to run for 4 years. The shorter the CRUT’s length, the higher the distribution rate. For a 4 year trust, the distribution rate is 44%, which means that you would withdraw 44% of the trust’s current value every year.

(2) Payment Methodology – Our QSBS stacking trusts are built as Standard CRUTs, which means you get a guaranteed payout of 44% of trust asset every single year until the trust term ends.

(3) Investment Methodology – Although the trust will only run for 4 years, it still usually makes sense to reinvest your funds while the trust is running. You will owe some tax on any investment gains during that time, but we can help you understand the impact of various investment strategies.

An Example

Take Tommy, a successful entrepreneur living in Oregon. Tommy has $20 million of QSBS-eligible shares from his business, and he is expecting an exit imminently. He’s narrowed down his tax planning options to two scenarios, and he’s trying to evaluate the pros and cons of each.

An important note before we dig in: Regardless of the planning choices Tommy makes, his first $10 million of gains will be tax free — that’s why we call QSBS the best tax break around. The question is what he should do with the next $10 million of QSBS-eligible equity.

Option 1: Do nothing. Imagine that Tommy does no planning for the remaining $10 million. When he sells, he’ll owe 35% taxes (federal and state capital gains tax and the federal net investment income tax). That means he’d keep $6.5 million of after-tax proceeds to spend or invest as he sees fit.

Pros – No planning required and immediate access to the entire $6.5 million of proceeds
Cons – Taxes owed on the exit and, as a result, smaller returns in the short and long run

Option 2: QSBS stacking with a CRUT. Now consider what happens if Tommy places the remaining $10 million into a CRUT prior to selling. When he sells, the trust keeps $10 million because the trust gets it’s own QSBS exemption. Oregon conforms to federal QSBS standards, so this amount is entirely free of federal and state taxes. (Note, though, that five states, including California, do charge state tax on QSBS-eligible gains.)

Pros – Keep 100% of the proceeds tax free, in an asset-protected trust
Cons – Minor liquidity constraints; the money is distributed to Tommy over the course of four years, with almost half — $4.55 million — coming out to him in year 1

The Math behind the Numbers

Let’s break down the math so you can understand the assumptions, the outcomes, and the real value.

The assumptions:

Oregon Taxes – 35% all-in federal and state taxes
QSBS Eligible – 0% up-front tax rate on sale
Exit Amount – $10 million (excludes the additional amount taken as a personal exemption)
Investment Growth Rate (both inside and outside of trust) – 8% per year
Annual Trust Distribution Rate – 44%

Trust math

Over 4 years, assuming Tommy reinvested his earnings at 8% growth, the trust would distribute $11.28 million of after-tax proceeds, while only incurring a tax bill of $1.2 million. (Why is there a tax bill if the assets are QSBS eligible? Because Tommy will be taxed on the investment gains of the QSBS exit proceeds as they are reinvested inside the trust — here, about $2.5 million of gains over 4 years.) Additionally the charity of Tommy’s choice would receive approximately $1.35 million. (This amount could go to his private foundation or donor-advised fund, so he retains significant control over those proceeds.)

No-trust math

After 4 years, assuming Tommy invested the total after-tax sale proceeds of $6.5 million for 4 years at an 8% annual return and didn’t take distributions (ensuring an apples-to-apples comparison to the trust), he would have $8.0 million of after-tax proceeds, while incurring a tax bill of $4.3 million! That’s $3.5 million of taxes on the initial sale and an additional $800K of taxes on the after-exit growth.

Next Steps

By using a Charitable Remainder Trust to stack his QSBS exemption, Tommy ends up with an additional $3.25 million (or 40%) above where he would otherwise have been if he had done no planning at all. These numbers — and the short time horizon — make the QSBS-stacking CRUT a no-brainer for almost anyone who expects more than $10 million in capital gains from the sale of QSBS-eligible assets.

Access our blog to know more about QSBS stacking trusts to maximize your returns, or try out our helpful calculator!

About Valur

We built a platform to give everyone access to the tax and wealth building tools of the ultra-rich like Mark Zuckerberg and Phil Knight. We make it simple and seamless for our customers to take advantage of these hard to access tax advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make it easy and have helped create more than $500m in wealth for our customers.