News & Press

Lido Insights featured image

LIDO INSIGHTS | The Recent Rise in Popularity of the Qualified Small Business Stock | January 2022

Published 01-20-2022

Share

By: Stu Katz and Olivia Zaiya


First, what is Qualified Small Business Stock and why is it important?

The IRS allows taxpayers who have stock in qualified small business companies to avoid up to $10 million in capital gains taxes, the 3.8% net investment tax, and the alternative minimum tax on the sale of those shares. A taxpayer with QSBS can sell $10 million of that stock and pay zero federal taxes on that sale, potentially saving millions. Many states also allow a full state tax exemption but notably CA, PA, AL, and MS do not.

For the gain on the sale of stock to be eligible for this substantial tax exclusion, the following requirements must be met:

The Date Requirement. The taxpayer acquired the stock after Sept. 27, 2010, for the 100% deduction. Stock held before this time may qualify for a smaller deduction (50%-75%).

The Small Business Requirement. At all times before and immediately after the issuance of the taxpayer’s stock, the corporation’s adjusted basis in its assets must not exceed $50 million.

The Original Issuance Requirement. The taxpayer’s stock must be original issuance, received directly from the company—it cannot be purchased through a secondary market.

The Holding Requirement. The taxpayer must hold the stock for at least five years.  For stock options the five-year period starts once the option is exercised. There is the ability to exchange one QSB stock for another QSB stock before the five year holding period.

The Qualified Business Requirement. At all times during the taxpayer’s holding period, the issuing company must be actively engaged in a qualified trade or business. Generally, most professional service businesses such as finance and investment management businesses and hospitality businesses are disqualified.

The C-Corp Requirement. The company must be a U.S. C corporation.

Until recently, the last requirement has been the most prohibitive for start-ups to use QSBS as a tax strategy. Businesses structured as C-corps are subject to double taxation, first at the corporate level then again at the individual level when distributions are made to the taxpayer. Unless a business had to be a C-corporation for other reasons, it was typically not advised for a start-up to structure as a C-corp when more favorable tax structures existed. S-corps, partnerships and LLCs are all pass-through entities, meaning they do not pay the corporate tax—they are taxed at the taxpayer level only. However, the passage of the Tax Cuts and Jobs Act significantly reduced the corporate tax rate from 35% to 21%.

This changed the game. Now, if earnings can be retained and reinvested in the business and the individual tax can be avoided by using the QSBS provisions, the choice of entity for founders and other investors has fundamentally shifted. Structuring a start-up as a C-corp for the purposes of taking advantage of the QSBS exemption is becoming increasingly more popular. QSB stock can also be very appealing to early-stage investors, which may help start-ups businesses acquire capital. QSB stock can save entrepreneurs, executives, and investors millions of dollars in taxes. This, combined with creative estate planning strategies can actually increase the $10 million dollar cap on the exclusion exponentially since the $10 million dollar cap is per person.

As an innovative wealth management firm, Lido Advisors strives to add value in the areas of estate planning, tax considerations and investment management. We dedicate our resources to the development of innovative, creative, and cutting-edge solutions for executives and entrepreneurs. If you are interested in discussing this strategy or others with our team of advisors and affiliated professionals, contact us here.

Lido Advisors, LLC is an SEC-registered investment adviser. Please note that SEC registration does not denote any particular competence or ability and no inference to the contrary should be made. For complete information on the services we provide and our fees, please review our Form ADV at adviserinfo.sec.gov, call (310) 278-8232, or mail us at 1875 Century Park East Suite 950, Los Angeles, CA 90067.

Past performance is not indicative of future performance. The information in this report is for informational purposes only and should not be relied upon as the basis of an investment or liquidation decision. Nothing in this report shall be construed to be a solicitation to buy or offer to sell any security, product or service to any non-U.S. investor, nor shall any such security, product or service be solicited, offered or sold in any jurisdiction where such activity would be contrary to the securities laws or other local laws and regulations or would subject Lido to any registration requirement within such jurisdiction. All content herein has been obtained from sources deemed to be reliable, but is subject to unintentional errors, omissions and changes without notice, and is not warranted as to its accuracy or completeness. You should not rely on the information contained herein, and should rely solely on, and carefully read, the appropriate offering and related subscription materials relating to any specific investment product before making any investment decision.

Not all investments are suitable for all clients. It should not be assumed that any security listed or any recommendations made in the future will be profitable or without loss, including risk of loss of principal, or will equal any prior performance. All investments involve the risk of potential investment losses including the potential risk of loss of principal as well as the potential for investment gain. Further, the prior performance figures indicated herein represent portfolio performance for only a short time period and may not be indicative of the returns or volatility each portfolio will generate over a long time period. The performance of the portfolios should also be viewed in the context of the broad market and general economic conditions prevailing during the periods covered by the performance information. Any references to future returns/risk are not promises of the actual return the client portfolio may achieve. Before investing, investors should seek financial advice regarding the appropriateness of investing in any securities of investment strategies discussed. Not all investments are suitable for all investors.

Lido specifically disclaims any and all liability arising from the information or illustrations presented in these materials and is not responsible for the consequences of any decisions or actions taken as a result.

LA21BG0010

Lido Advisors, LLC is an investment advisor registered with the Securities & Exchange Commission. SEC registration does not denote competence, ability, or expertise.  As an SEC-registered advisor, we are required to publicly file certain information with the SEC as well as furnish or provide you with the opportunity to obtain information about our principals, employees, products, services, and fee schedules.  Please review our Form ADV, which provides this information, at adviserinfo.sec.gov, call us at (310) 278-8232, or mail us at 1875 Century Park East, Suite 950, Los Angeles, CA 90067 for a copy of our Form ADV.

The future is uncertain and cannot be predicted.  Past performance is not indicative of future performance. These materials are provided for informational and illustrative purposes only and should not be relied upon as the basis of an investment decision. You should not construe this as investment advice or an offer to buy or sell securities.  All content herein has been obtained from sources deemed to be reliable, but is subject to unintentional errors, omissions and changes without notice, and is not warranted as to its accuracy or completeness. You should not rely on the information contained herein, and should rely solely on, and carefully read, the appropriate offering and related subscription materials relating to any specific investment before making a decision to invest.

Not all investments are suitable for all clients. Investing carries a risk of loss, including the complete loss of principal. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will be profitable or suitable for your financial situation or risk tolerance.  Any references to projected or future expected returns or risk are not guarantees, promises, or assurances that these outcomes will be achieved.  Before investing, you should seek financial advice regarding the appropriateness and suitability of the contemplated investment as not all investments are suitable for all investors.

We do not provide legal or tax advice.  Any investment has tax and legal consequences.  You should consult with a licensed professional prior to making any investment.