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QSBS Stacking: How to Stack Up the Benefits?

✅ Key Takeaway: The Qualified Small Business Stock exemption is the best tax break available to startup founders, early employees and investors: $10 million of capital gains tax free. But with a “QSBS stacking” strategy, you can achieve even greater protection. As an example below demonstrates, gifting shares to a CRT can allow you to multiple the QSBS exemption, protecting $20 million, $30 million, or more.

In our QSBS overview, we covered the basics of what the QSBS exemption is and how it impacts individuals in the 2021 tax environment. In this article we’ll cover QSBS stacking and packing, and everything you should know on how you can multiply (or “stack”) your Qualified Small Business Stock (QSBS) exemption to protect $20 million, $30 million, or up to $500 million of your capital gains with proper planning.

How QSBS Stacking Works

The QSBS exemption’s requirements are fairly straightforward: Every person (or qualified trust) who owns qualifying shares gets to pay 0% federal taxes (and 0% state taxes everywhere except California, Pennsylvania, and a couple of other states) on their first $10 million of capital gains or 10X their investment from the sale of each company’s stock.

The key to QSBS stacking strategy is right there in the requirements: There’s a new $10 million exemption for every person who owns stock, and for every company whose stock the person owns. In other words, if two people each own qualifying shares, they both get a $10 million exemption, and if one person owns qualifying shares in two (or more) companies, that person gets a separate $10 million exemption on the sale of each company’s shares.

How can you take advantage of these rules? By giving some of your qualifying shares to a Charitable Remainder Trust (or another qualified trust). If a taxpayer gifts or bequeaths QSBS shares to a trust (or someone else), the recipient of the shares will be allowed its own exemption, effectively uncapping the amount of gains that are tax free.

What’s more, if you give qualifying shares to a trust, they get to inherit your eligibility—if the shares were eligible for the exemption when you received them, they remain eligible, and the recipient gets to take over your eligibility clock. (Recall that you have to hold your shares for at least five years to get the exemption).

Strategies to Increase QSBS Exemptions

With the above definition in mind, founders and investors with large stakes in qualifying companies may consider the following strategies to multiply their QSBS exemptions:

  • Gift to a charitable remainder trust: This strategy should track if you’ve been keeping up with our materials. The extra virtue of this approach is that you get to take advantage of the special rules of CRTs, including controlling the payouts and continued tax-free growth after you sell your shares and diversify your investments. Typically the investment strategy is different than other CRTs but the goal is to distribute as much tax free dollars as possible over a shorter term.
  • Outright gift: A simple gift of shares—to your child, parent, or another individual—is perhaps the simplest way to access additional QSBS exemptions. If you give your qualifying shares away, the recipient could pay no taxes on the first $10 million of gains.
  • Gift to a simple trust: This is probably the second most straightforward (and, therefore, the second most common) strategy. If you would rather not give your shares away outright—for example, if you would like to put conditions on a gift to your children so they don’t receive too much before they reach a certain age, or so they can only use the money for certain purposes—you can put the shares in a trust and impose those rules. Note: You can use the simple trust strategy to set aside shares for anyone, even unborn children.
Increase your QSBS Exemption with this stacking

QSBS Stacking Example

Take the New York founder, Jenn, who owns and plans to sell all of her $25 million of equity follow her company’s IPO. Jenn early exercised all of her shares at incorporation and her cost basis is ~$100. She has one son and she and her husband plan to have another kid in the next couple of years. Without QSBS protection, she’d have to pay taxes on the full $25 million of gains, so she’d owe about $8.5m in federal, state, and local taxes. With her own QSBS exemption, however, she can pay zero taxes on the first $10 million of gains. And with QSBS stacking, the entire $25 million can be tax free.

The first $10 million: Jenn keeps $10 million of equity in her name and is able to avoid federal and state taxes on these gains as a New York resident. This is the simple baseline QSBS exemption.

Option 1 for the remaining $15 million: Jenn wants extend tax-free treatment to her remaining gains if possible, but she prefers to maintain control and have access to the capital. She can do that by splitting those those remaining gains between two CRTs. (Up to $10MM in a single CRT.)

Option 2 for the remaining $15 million: Jenn wants extend tax-free treatment to her remaining gains if possible, but instead is fine giving up some control and access to the funds. So she decides to split the remaining gains between her son and her unborn second child. To do that, Jenn sets up two separate “non-grantor trusts,” and she names her son and her planned child as beneficiaries. She gifts $7.5 million of equity to each trust, and, after her company’s IPO, the trusts sell the equity, realize those gains, and claim their own QSBS exemption. (What happens next depends on how Jenn organizes these trusts; in most cases, someone in her situation would establish certain conditions to ensure that the money is invested wisely and remains available for her children’s use as they grow up.)

As a result of this simple (if clever) planning, Jenn’s family will collectively pay zero taxes on her entire $25 million equity stake!

How To Maximize Your QSBS Exemption For $500 Million Tax Free?

You could receive up to $500m tax free in capital gains without transferring any equity to anyone else with a lot of planning. (As an important note, this won’t be applicable for most founders, investors or employees but is something multi-time founders often look at and plan around.) To help understand how this works let’s revisit the applicable rules on QSBS.

Relevant QSBS Stock Rules

  1. A taxpayer’s aggregate per-issuer gain exclusion for a given taxable year is generally limited to the greater of (a) $10 million (the “$10 Million Cap”), minus the aggregate prior Section 1202 gain excluded with respect to such issuer, or (b) 10 times the taxpayer’s original adjusted tax basis in the issuer’s QSBS sold during such taxable year (the “10X Basis Cap”). More simply put, you can claim QSBS exemptions on the greater of $10m or 10x your basis in the stock (this does ignore QSBS stacking and packing). In most scenarios $10m is larger than 10x your basis but with planning you can use the 10x rule to claim up to $500m in exemptions
  2. Only domestic entities subject to federal income tax as C corporations are eligible to issue QSBS. Only if the company is a C Corp are you eligible for QSBS but you don’t have to start the company as a C Corp, the company could start as an LLC, S Corp etc. and become a C Corp and the ownership shares can then become eligible for QSBS.
  3. The issuing C corporation cannot have more than $50 million in aggregate gross assets before or up until immediately after the issuance of the stock. In other words, only equity received before the C Corp had $50m in assets are eligible which means you could transform the company from an S Corp to C Corp and as long as the company’s assets are worth less than $50m your shares would be eligible for QSBS at 10x their basis.

In most cases because founders are issued shares at a value of fractions of a penny so claiming QSBS at 10x the basis is significantly less valuable than claiming $10m in exemptions (founders, investors and employees can claim more exemptions with QSBS stacking). But how can they use these stock rules to avoid taxes on $500m of taxes?

  • They create their company as an LLC (currently not eligible for QSBS since it isn’t a C Corp)
  • Build their business until it has a fair market value of $49.9m and then convert it to a C Corp. At this point, they are contributing shares which are worth $49.9m to the company
  • Once they meet the other QSBS requirements, their QSBS exemption will be the greater of $10m or 10 times the basis of your basis – which in simpler words is the value you contributed to the company or $49.9m
  • Now you are eligible for QSBS exemptions that are the greater of $10 or 10x$49.9m or $499m in QSBS exemptions.

This is obviously hard to accomplish, least of all building a world changing company. But as taxes continue to increase, upfront tax planning like this can potentially help you save more than $150m in taxes.

Next Steps

Timing is key to the QSBS stacking and packing strategy:

  • The more you know about the ultimate value of your shares, the better, since you may want to gift only enough shares so that each recipient can claim the full $10 million exemption. Accordingly, most people wait until they have at least some sense of the likely acquisition value of their shares.
  • In short, getting started early–even if it’s only the planning phase, and you don’t actually move any assets today–will help you avoid missing out on these potentially life-changing tax savings.

Read more in our introduction to the QSBS exemption if you haven’t already. Schedule a time to chat with our team or get started at no cost and with no commitment!

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.