Tax

Advanced Tax Strategies for Company Founders

June 1, 2021 by eric

This article was originally published on TechCrunch.com on May 13, 2021. Written by Peyton Carr.

As an entrepreneur, you started your business to create value—both in what you deliver to your customers and what you build for yourself. You have a lot going on, but if building personal wealth matters to you, the assets you’re creating deserve your attention.

There are numerous advanced planning strategies available that you can implement to minimize capital gains tax, minimize future estate tax, and increase asset protection from creditors and lawsuits. Capital Gains tax can reduce your gains by up to 35%+, and estate taxes can cost up to 50%+ on assets you leave to your heirs. Careful proactive planning can minimize your exposure and actually save you millions.

Smart founders and early employees should closely examine their equity ownership, even in the early stages of their company’s life cycle. Different strategies should be used at different times and for different reasons. The following are a few key considerations when determining what, if any, advanced strategies you might consider:

Your company’s life cycle – early, mid, or late stage.
The value of your shares – What are they worth now, what do you expect them to be worth in the future, and when?
Your own circumstances and goals – What do you need now, and what will you need in the future?

Some additional items to consider include issues related to Qualified Small Business Stock (QSBS), gift and estate taxes, state and local income taxes, liquidity, asset protection, and whether you and your family will retain control and manage the assets over time.

Here are some advanced planning strategies for your equity to implement at different stages of your company life cycle to reduce tax and optimize wealth for you and your family.

Irrevocable Non-Grantor Trust

QSBS allows you to exclude tax on $10mn of capital gains (tax of up to 35%+) upon an exit/sale. This is a benefit every individual and some trusts have. There is a significant opportunity to multiply the QSBS tax exclusion well beyond $10mn.

The founder can gift QSBS eligible stock to an irrevocable non-grantor trust, let’s say for the benefit of a child, so that the trust will qualify for its own $10mn exclusion. The founder owning the shares would be the grantor in this case. Typically, these trusts are set up for children or unborn children. It is important to note that the founder/grantor will have to gift the shares to accomplish this because gifted shares will retain the QSBS eligibility. If the shares are sold into the trust, the shares lose QSBS status.

In addition to the savings on federal taxes, founders may also save on state taxes. State tax can be avoided if the trust is structured properly and in a tax-exempt state like Delaware or Nevada. Otherwise, even if the trust is subject to state tax, some states, like New York, conform and follow the federal tax treatment of the QSBS rules, while others, like California, do not. For example, if you are a New York State resident, you will also avoid the 8.82% state tax, which amounts to another $2.6mn in tax savings if applied to the example above. This brings the total tax savings to almost $10mn, a material savings in the context of a $40mn gain. Notably, California does not conform, but California residents can still capture the state tax savings if their trust is structured properly, and in a state like Delaware or Nevada.

Currently, each person has a limited lifetime gift tax exemption, and any gifted amount beyond this will generate up to a 40% gift tax that has to be paid. Because of this, there is a tradeoff between gifting the shares early while the company valuation is low and using less of your gift tax exemption vs. gifting the shares later and using more of the lifetime gift exemption. The reason to wait is that it takes time, energy, and money to set up these trusts, so ideally, you are using your lifetime gift exemption and trust creation costs to capture a benefit that will be realized. However, not every company has a successful exit; therefore, it is sometimes better to wait until there is a certain degree of confidence that the benefit will be realized.

Parent-Seeded Trust

One way for the founder to plan for future generations while minimizing estate taxes and high state taxes, such as California or New York, is through a parent-seeded trust. This trust is created by the founder’s parents, with the founder as the beneficiary. Then the founder can sell the shares to this trust. This does not involve the use of any lifetime gift exemption and eliminates any gift tax, but it also disqualifies the ability to claim QSBS. The benefit is that all the future appreciation of the asset is transferred out of the founder’s and the parent’s estate and is not subject to potential estate taxes in the future.

The trust can be located in a tax-exempt state such as Delaware or Nevada to also eliminate home state-level taxes. This can translate up to 10%+ in state-level tax savings. The trustee, an individual selected by the founder, can make distributions to the founder as a beneficiary if desired.

Further, this trust can be used for the benefit of multiple generations. Distributions can be made at the discretion of the trustee, and this skips the estate tax liability as assets are passed from generation to generation.

Grantor Retained Annuity Trust (GRAT)

This strategy enables the founder to minimize their estate tax exposure by transferring wealth outside of their estate, specifically without using any lifetime gift exemption or being subject to gift tax. It’s particularly helpful when an individual has used up all their lifetime gift tax exemption. This is a powerful strategy for very large “unicorn” position sizes to reduce a founder’s future gift/estate tax exposure.

For the GRAT, the founder (grantor) transfers assets into the GRAT and receives back a stream of annuity payments. The IRS 7520 rate, which is currently very low, is a factor in calculating these annuity payments. If the assets transferred into the trust grow faster than the IRS 7520 rate, there will be an excess remainder amount in GRAT after all the annuity payments are paid back to the founder (grantor.) This remainder amount will be excluded from the founder’s estate and can transfer to beneficiaries or remain in the trust estate tax-free. Over time this remainder amount can be multiples of the initial contributed value. If you have company stock that you expect will pop in value, it can be very beneficial to transfer those shares into a GRAT and have the pop in value occur inside the trust. This way you can transfer all the upside gift and estate tax-free out of your estate and to your beneficiaries.

Additionally, because this trust is structured as a grantor trust, the founder can pay the taxes incurred by the trust, making the strategy even more powerful.

One thing to note is that the grantor must survive the GRAT’s term for the strategy to work. If the grantor dies before the end of the term, the strategy unravels and some or all the assets remain in his estate as if the strategy never existed.

Intentionally Defective Grantor Trust (IDGT)

This is similar to the GRAT in that it also enables the Founder to minimize their estate tax exposure by transferring wealth outside of their estate, but has some key differences. The grantor must ‘seed’ the trust by gifting 10% of the asset value intended to be transferred, so this approach requires the use of some lifetime gift exemption or gift tax. The remaining 90% of the value to be transferred is sold to the trust in exchange for a promissory note. This sale is not taxable for income tax or QSBS purposes. The main benefits are that, instead of receiving annuity payments back, which requires larger payments, the grantor transfers assets into the trust and can receive back an interest-only note. The payments received back are far lower because it is interest-only (rather than an annuity).

Another key distinction is that the IDGT strategy has more flexibility than the GRAT and can be generation-skipping.

If the goal is to avoid generation-skipping transfer tax (GSTT) the IDGT also is superior to the GRAT because assets are measured for GSTT purposes when they are contributed to the trust prior to appreciation rather than being measured at the end of the term for a GRAT after the assets have appreciated.

The Bottom Line

Depending on each founder’s situation, we may use some combination of the above strategies or others depending on the circumstances and goals. Every founder, their company life cycle, and their personal situation is different. Many of these strategies are most effective when planning in advance; waiting until after the fact will limit the benefits you can extract. When considering advanced strategies for protecting wealth and minimizing taxes as it relates to your company stock, there’s a lot to take into account—the above is only a summary. We recommend you seek proper counsel and choose wealth transfer and tax savings strategies based on your unique situation and individual appetite for complexity.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

What You Need to Know About Selling Your Company Stock

July 31, 2020 by eric

What You Need to Know About Selling Your Company Stock

Part 3: The Founder’s Guide to Managing Your IPO Stock

This article was originally published on TECHCRUNCH.COM on July 22, 2020. Written By: Peyton Carr

In a recent article, I covered all of the reasons you might be tempted to hold a highly-concentrated position in your company stock as a tech founder and how it fits into your portfolio. I then followed up with a rundown on why resisting diversification is generally a bad idea and the subconscious biases that hold us back from selling.

So now that you understand the benefits of diversification and have taken inventory of your portfolio, what is the most effective way for you to move forward? I will share with you what to keep in mind before selling, how to decide when to sell, and strategies to execute sales such as options, exchange funds, prepaid variable forward contracts, qualified small business stock, and tax considerations. Now, let’s take a deep dive into strategic approaches to take as a shareholder and important tax implications to consider.

Keep in Mind: Lockups and Blackout Periods

Most tech companies that IPO have a 180-day lockup period that prevents insiders, employees, and VC funds from selling immediately. There is usually language that also prohibits hedging with derivatives (options) during that period. Lockups are intended to help prevent insider trading and provide the company with additional post-IPO price stability.

It is also important to abide by the company’s blackout periods, which prohibit transactions during more share-price-sensitive times, such as earnings or material non-public information releases.

Concentrated Stock Strategies

Ad-hoc Selling – This is the most straightforward and involves the outright sale of your shares. However, this can be difficult for various reasons such as selling restrictions, the perception by others that you are unloading stock, and many psychological biases that act as internal mental obstacles.

Scheduled Selling – Selling all your stock at once could be both emotionally challenging and tax-inefficient. Scheduled selling involves the selling of a set number of shares over a specific period. This selling strategy can help by spreading the tax impact over a few years. It also provides an advantage from a psychological standpoint since the plan is determined upfront, then mechanically executed.

As an example, a founder might plan to sell 500,000 shares over 18 months. The founder is comfortable selling quarterly, which equals six selling periods of 83,333 shares per quarter. In a scenario where a founder is subject to blackout periods, a 10b5-1 trading plan can be implemented and set on autopilot. The company may even allow you to sell your shares during blackout periods with a 10b5-1 trading plan. See the example of scheduled selling below.

Hedging with Options – Multiple hedging strategies can be implemented to protect your downside; however, some of the more common approaches used are the protective put and the protective collar. Below are basic examples of how these strategies are executed, for illustrative purposes.

Protective Put– Buying protection against the downside
Collar – Give up some upside, to limit some downside

Each strategy allows the owner to continue holding the stock while providing some downside protection against a stock’s decline. However, these strategies are not tax-efficient and are complicated, so working with an expert is essential. Both puts and certain types of collars would have been extremely expensive to implement during the recent market crisis because market volatility is a factor in options prices. See the below chart of the VIX (volatility index) during peak crisis. However, in some instances, these strategies can make sense.

Exchange Funds –This strategy allows an investor to contribute their concentrated stock position into an exchange fund partnership alongside other investors who also contribute their stock positions. In return, each investor receives a diversified stock portfolio, selected by an investment manager. This strategy allows the investor to achieve immediate diversification while deferring the taxes that they would have otherwise paid in most situations.

At the end, usually seven or more years out, each investor receives a basket of stocks. They pay zero tax if they hold the stocks forever, but if you sell, your aggregate cost basis is equal to the cost basis of the original shares contributed. Some downsides of using exchange funds to consider are lockups, expenses, and sometimes not achieving the desired level of diversification. Below I detail some high-level positives and considerations.

Prepaid Variable Forward Contract – This strategy enables a shareholder to synthetically diversify their equity exposure by entering into an agreement (contract) with a bank or brokerage firm to receive a loan now, and sell their stock at a future date. The reason it is ‘variable’ is because the amount of stock the shareholder delivers in the future depends on share value upon expiration. The shareholder can also decide in the future to cash-settle (deliver cash) instead of delivering (selling) stock.

This strategy is essentially a combination of a type of equity collar, described in the options section above, and a loan. Because this is an option, pricing varies based on market conditions and the stock involved. If structured correctly, the shareholder does not pay tax until the future sale date.

Fun fact is, recently, it was disclosed in an SEC filing that Vince McMahon had entered one of these covering approximately 3.5 million shares, or $80 million of WWE stock. Many perceived this as him effectively selling about 15% of his shares and questioned whether he was ready to “tap out” for good.

Below is a hypothetical example of a prepaid variable forward.

When Should You Sell IPO Stock?

Based on an analysis of 258 IPOs, it is usually the most beneficial for shareholders to sell their stock as soon as possible after the lockup period expires. If you look at the performance of holding IPO stocks for the long term versus selling immediately and diversifying, the results may surprise you.

This chart shows a sample of 258 IPOs from 1990 to 2012, and the four years following their lockup expiration. The data illustrates that the median tech IPO underperforms the S&P 500 index by around 20% after the first year following lockup expiration. Even the best IPOs that fall into the top quartile, still barely keep up with the S&P 500. You must be very confident that your company is an exception to this.

These findings are also consistent with the underperformance of IPO stocks relative to the S&P 500, as reported by Professor Jay Ritter, an academic authority on IPOs. If you’d like to dig deeper like I do, you can download his full data set here.

Consider Taxes Before You Sell

When deciding to sell, it’s important to consider taxes. We realize that concentrated stock often comes with a very low cost basis, which can be another obstacle for investors to overcome before selling.

How you own your stock and how long you have owned it will ultimately determine how you are taxed. Below is a chart showing the different types of taxation on various forms of equity compensation.

Two important things to consider are whether you will be taxed at long-term or short-term capital gains rates and whether you qualify for the qualified small business stock (QSBS) exclusion. Your income will impact the rates at which you are taxed. Please consult with your advisor before making any decisions.

Generally, we suggest making investment decisions and then optimizing for tax. I always tell my clients not to let the tax tail wag the investment dog. However, there are scenarios where it can make sense to hold your stock for slightly longer to minimize taxes owed.

For example, short-term capital gains (holding period < 1 year) can be far more expensive than paying taxes on a long-term capital gain (holding period > 1 year).

Let’s say you own $1 million of XYZ, a $100 stock, with one month to go before it qualifies for long-term capital gains treatment. In the example below, if the stock maintains the same price for the next month, you can net 27% more in after-tax profits; you get to keep an extra $170,000. Even if the stock price drops 21%, you would still net the same profits as if you had sold it at the previous higher price but subject to the higher short-term capital gains rate. See the example below.

Careful planning is required, as IPOs can have very volatile share prices. If XYZ sells off significantly over the next month, it is possible you can be in a far worse scenario than having just sold it outright and paying the short-term capital gains. Nobody has a crystal ball, but understanding the tradeoffs is helpful in the decision-making process.

Qualified Small Business Stock (QSBS)

If your shares qualify for the QSBS exclusion, you could potentially sidestep up to 100% of your capital gains taxes upon sale. That is not a typo, this is arguably one of the most significant tax opportunities out there. If you are a founder or early employee and you have held your shares for over five years, this is something you should look into.

You can reference the table below to determine the QSBS qualification holding period for different types of equity. This is one of the most valuable and significant tax incentives for founders and early employees, but not everyone will qualify.

Some further clarification on determining whether or not your shares qualify is below. For a more in-depth discussion on QSBS, you can reference the guide I wrote.

Your company is a Domestic C Corporation.
Stock is acquired directly from the company.
Stock has been held for over five years.
Stock was issued after August 10th, 1993, and ideally, after September 27th, 2010, for a full 100% exclusion.
Aggregate gross assets of the company must have been $50 million or less when the stock was acquired.
The business must be active, with 80% of its assets being used to run the business. It cannot be an investment entity.
The business cannot be an excluded business type such as, but not limited to: finance, professional services, mining/natural resources, hotels/restaurants, farming, or any other business where the business reputation is a skill of one or more of the employees.

Deciding whether or not to sell your company stock or when to sell it, is not a decision to enter into lightly. Rather than simply cashing in your stock for a quick payday or holding it in a highly concentrated position, dreaming of a potentially huge payday in the future, I encourage you to look deeper — at your big-picture financial goals, your overall investment portfolio, details and strategies specific to employee shareholders, and important tax implications. A rational, evidence-based approach will produce the best path forward.

Want to learn how to handle your stake in company stock with a sharp focus on achieving your personal financial goals? Download our In-Depth Guide, The Founder’s Guide to Managing Your IPO Stock.

Information in this article does not constitute personalized financial or legal advice. The contents of this article are for informational purposes only and should not be relied upon without specific professional legal or financial advice.

2020 Tax Code Changes: What You Need to Know

June 18, 2020 by eric

WRITTEN BY: CALVIN LO
Tax season is officially in full swing and while you’re probably focused on filing your 2019 tax return by the recently extended deadline of July 15, 2020, it’s never too early to begin preparing for next year.¹

There are some cases in which the deduction amounts remain the same as 2019. For instance, medical and dental expenses, as well as state and local sales, are not changing in the new year.

However, standard deductions, income thresholds for tax brackets, certain tax credits and retirement savings limits have increased and may be important for you to keep in mind.

Brackets & Rates

For individual taxpayers filing as single and with income greater than $518,400, the top tax rate remains 37 percent for the 2020 tax year. This is an increase from $510,300 in 2019. For MFJ, or married couples filing jointly, this rate will be $622,050 and for MFS, or married individuals filing separately, it will now be $311,025 per person.² Income ranges of other rates are as follows:

35% for single and MFS incomes over $207,350 ($414,700 for MFJ)
32% for single and MFS incomes over $163,300 ($326,600 for MFJ)
24% for single and MFS incomes over $85,525 ($171,050 for MFJ)
22% for single and MFS incomes over $40,125 ($80,250 for MFJ)
12% for single and MFS incomes over $9,875 ($19,750 for MFJ)²

The lowest rate is 10 percent for single individuals and MFS, whose income is $9,875 or less. Alternatively, married individuals filing jointly, or MFJ, can expect this rate if their combined income does not exceed $19,750.²

You may be filing as head of household, or HOH, in which case the income thresholds are the same as the rates for singles in the 37, 35 and 32 percent brackets. In alternative head of household brackets, the income thresholds are now:

$85,501 – $163,300 in the 24 percent bracket
$53,701 – $85,500 in the 22 percent bracket
$14,101 – $53,700 in the 12 percent bracket
Up to $14,100 in the 10 percent bracket³

Capital Gains

The 2020 tax year also includes increases in long-term capital gains rates for particular income thresholds including:

Zero percent for single and married individuals, filing separately, with incomes up to $40,000; up to $80,000 for married couples, filing jointly; and up to $53,600 for heads of households.
15 percent for single income $40,001 to $441,450; $80,001 to $496,600 for married couples, filing jointly; $40,001 to $248,300 for married individuals, filing separately; and $53,601 to $469,050 for heads of households.
20 percent for single income exceeding $441,450; exceeding $496,600 for married couples, filing jointly; exceeding $248,300 for married individuals, filing separately; and exceeding $469,050 for heads of households.⁴

Standard Deductions

When it comes to standard deductions a few differences apply. Married couples filing jointly can expect an increase to $24,800 for the 2020 tax year, which is up $400 from 2019. Single taxpayers and married individuals filing separately will notice the standard deduction rise to $12,400 for 2020 (up $200 from 2019). Lastly, heads of households can expect an increase to $18,650 for the 2020 tax year, which is up $300 from 2019.²

For single individuals, the alternative minimum tax, or AMT, exemption amount for 2020 is $72,900 and begins phasing out at $518,400. Married couples filing jointly can expect the AMT exemption amount to be $113,400, which begins to phase out at $1,036,800.²

Retirement Plans

For employees participating in employer retirement plans including 401(k)s, 403(b)s, most 457 plans and the federal government’s Thrift Savings Plan (TSP), the contribution limit has increased to $19,500.⁵ The catch-up contribution limit, which is geared towards employees age 50 and older, has increased to $6,500 and the limit for SIMPLE retirement accounts has been raised to $13,500 for the 2020 tax year.⁶

If taxpayers meet certain conditions, they can deduct contributions to a traditional IRA. For instance, if either the taxpayer or their spouse was covered by an employer’s retirement plan, the deduction may be reduced or phased out. If neither the taxpayer or their spouse is covered, the phase-out of the deduction does not apply.⁷ These ranges for 2020 are as follows:

For single taxpayers covered by a workplace retirement plan, the phase-out range is $65,000 to $75,000.
For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $104,000 to $124,000.
For an IRA contributor who is not covered by a workplace retirement plan, but who is married to someone who is covered, the deduction is phased out if the couple’s income is between $196,000 and $206,000.⁷

Health Spending

The dollar limit for employee salary reductions for contributions to a health flexible spending account, or FSA, has increased $50 from 2019 to $2,750. Also in 2020, participants who have self-only coverage in an HSA, or health savings account, must have a plan in which the annual deductible is not less than $2,350 and no more than $3,550. Additionally, for self-only coverage, the maximum out-of-pocket expense amount of $4,750, which is an increase of $100 from 2019.²

For participants with family health coverage, the base for the annual deductible is now $4,750 for the year 2020. The deductible cannot exceed $7,100 and the out-of-pocket expense limit is $8,650, which is an increase of $100 from 2019.²

Estates & Gifts

Inheritances are also experiencing changes in the coming tax year. For instance, estates of descendants who pass during 2020 have a basic exclusion amount of $11.58 million, which is up from $11.4 million for estates in 2019. The annual exclusion for individual gifts is $15,000 for the 2020 tax year, the same as it was for 2019.²

Regardless of your circumstances, the inflation adjustments of the IRS are meant to ease taxes, which means it pays to be aware of changes and the latest amounts. With preparedness in mind, you’ll be able to thoughtfully plan for the 2020 tax year ahead.

¹https://www.thune.senate.gov/public/index.cfm/2020/3/thune-daines-and-king-introduce-bill-to-extend-the-tax-filing-deadline-provide-additional-relief-to-middle-income-americans
²https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2020
³https://www.debt.org/tax/brackets/
⁴https://www.forbes.com/sites/davidrae/2020/01/13/new-capital-gains-rates-for-2020/#5144871143eb
⁵https://www.tsp.gov/PlanParticipation/EligibilityAndContributions/contributionLimits.html
⁶https://www.irs.gov/pub/irs-pdf/p560.pdf
⁷https://www.irs.gov/retirement-plans/ira-deduction-limits

This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

The Paycheck Protection Program: A Guide for Business Owners and Startup Companies

April 1, 2020 by eric

WRITTEN BY: CALVIN LO

Quick Take

There has been a tremendous amount of data regarding the stimulus, but I wanted to highlight the following information on the Paycheck Protection Program (PPP) available for business owners and self-employed since it may be very valuable to you or others you know. This is a government package to support all employers (and the self-employed) in retaining staff by offering a loan that may be forgiven if used on payroll, rent, or utilities. Details are still developing on the program, but we recommend that if you are eligible to apply as soon as you are able. Although this package is for $349bn, we believe there will likely not be enough capacity to adequately serve all eligible businesses. There are 30mn+ small businesses alone in the US and loan amounts will be granted on a first-come, first-serve basis. Treasury also urged those in need of funding to apply quickly, noting that the program has a cap and demand is likely to be high.

Application Start Dates

April 3, 2020, small businesses and sole proprietorships
April 10, 2020, independent contractors and self-employed individuals

Who can apply? All businesses with 500 or fewer employees can apply. This includes nonprofits, sole proprietorships, self-employed individuals, and independent contractors.

How large can my loan be? Loans can be for up to 2.5x of your average monthly payroll costs from the last year ($100k/employee cap). Subject to an overall $10 million cap.

How much of my loan will be forgiven? The loan amount you use for payroll costs, mortgage interest, rent, and utility payments over the eight weeks after getting the loan.

Do I need to pledge any collateral for these loans? No. No collateral is required.

Do I need to personally guarantee this loan? No. There is no personal guarantee requirement.

Background Info

Small businesses, startups, and self-employed individuals account for a significant portion of our country’s economy. During a global pandemic, like the one we’re experiencing now, this group suffer some of the hardest hits. On March 27, 2020, President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law, allocating funding to support the U.S. economy and workers through the coronavirus outbreak. The legislation includes a number of proposals aimed at supporting small businesses. For those hit hard due to forced closures and a sharp downturn in foot traffic, this bill may provide some relief.

Bear in mind this is a $2 trillion dollar stimulus program, equal to 10% of GDP, that was compiled and passed in the government in the matter of a few weeks. Broad guidelines were provided but more specific clarifications are being released every couple days. The Treasury has announced one thing then pivoted and revised their statement 48 hours later. It is a fluid situation and banks are doing their best to be compliant yet approve applications under the program. We recommend operating under the most current rules from the official websites in the links below and the guidance of your bank.

In times of concern, it’s important to know your options, including what the recently passed stimulus package includes and how to protect your assets moving forward.

What Does the Package Include?

American small businesses are supported by the recently passed CARES Act in the following ways:

A $350 billion forgivable loan program (The Paycheck Protection Program) designed to encourage small businesses from laying off employees.
A delay in employer-side payroll taxes for Social Security until 2021 and 2022.
50 percent refundable payroll tax credit on worker wages to incentivize businesses, including those with fewer than 500 employees, to retain their current workforce.
Sole proprietors and other self-employed workers may be eligible for the expanded unemployment insurance benefits the bill provides.
A portion of the $425 billion in funds appropriated for the Federal Reserve’s credit facilities will target small businesses.

How Does the $350 Billion Paycheck Protection Program Work?

Under the stimulus package, the Small Business Administration (SBA) will oversee the Paycheck Protection Program. This program will distribute $350 billion to small businesses that meet certain requirements, and the loans will be made available to companies with 500 or fewer employees.

Businesses can receive loans up to $10 million, and these loans will be administered by banks and other lenders. Additionally, the Paycheck Protection loans will carry a 1% interest rate.

Currently, the SBA guarantees small business loans that are distributed by a network of more than 800 lenders across the country. The program creates a form of emergency loan that has the potential to be forgiven when used to maintain payroll through June of 2020. In order for the above amounts to be forgiven, the business must maintain the same number of employees (equivalents) in the eight weeks following the date of origination of the loan as it did from either February 15, 2019 through June 30, 2019, or from January 1, 2020 through February 29, 2020.¹ The program also expands the network beyond the SBA so that more banks, credit unions and lenders can issue the appropriate loans.

If your business uses the loan funds for the approved purposes and maintains the average size of your full-time workforce based on when you received the loan, the principal loan will be forgiven, meaning you will only need to pay back the interest accrued.² The primary purpose of these loans is to incentivize small businesses to refrain from laying off workers and ultimately rehire laid-off employees that have already lost jobs due to COVID-19.

What Types of Businesses Are Eligible For The Paycheck Protection Program?

The Paycheck Protection Program offers loans for small businesses with fewer than 500 employees, 501(c)(3) nonprofits with fewer than 500 workers and some 501(c)(19) veteran organizations. Food service businesses are also eligible if they employ fewer than 500 people per physical location.

Self-employed individuals, sole proprietors and freelance or gig economy workers are also eligible to apply for financial assistance during this time. Even without a personal guarantee or collateral, businesses that are struggling can receive a loan as long as they were operational on February 15, 2020.

Eligible borrowers are required to make a good-faith certification that the loan is necessary due to the uncertainty of current economic conditions caused by COVID-19.

How Do I Get a Payroll Protection Loan?

The loan program will provide loans through SBA-approved private lenders. As banks are currently working on implementing this program, it’s important to check with your current banking relationship to see where they’re at in the process. Those that are already approved by the Small Business Association may be quicker to put the loan program into place.

As a small business owner or self-employed individual, it’s always important to be aware of your options in prosperous times and those of hardship. With some assistance and the promise of keeping your workers employed, your small business can continue to thrive.

https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program-ppp
https://home.treasury.gov/policy-issues/top-priorities/cares-act/assistance-for-small-businesses

Happily Ever After: Financial Planning For Newlyweds

February 24, 2020 by eric

WRITTEN BY: CALVIN LO

The wedding is over, and it’s time for the happily ever after. But once you have unpacked the wedding gifts and written the thank you notes, you probably need to sit down for a thoughtful financial discussion to establish common goals. While you probably discussed finances to some extent before tying the knot, now it’s time to get into the nitty-gritty details. Here are a few financial housekeeping strategies to start your marriage off on the right foot.

Have the “State of the Union” Talk about Money

Have an honest conversation with each other covering items such as net worth, salary, company benefits such as health insurance, investments, retirement savings, future liquidity events, inheritance, credit scores, and debt or student loans.

Honesty is parament when it comes to finances. I also suggest discussing “what money means to you” and “what was money like for you growing up.” There is a lot you can learn about someone from those two questions.

Tweak Your Tax Withholdings

One of the first financial tasks you may want to do as a married couple is adjust the tax withholdings that you and your spouse claim on your W-4. Remember that you don’t want to over-withhold (receiving a large tax refund) or under-withhold (having to pay the IRS taxes in April). The IRS website is a good place to start if you need help in deciding what withholdings you should take to balance the numbers (of course, your financial planner can also help!).

Yours, Mine, and Ours

Next, you’ll want to take some time to discuss how you’ll handle banking matters moving forward. This is a good time to understand the legal differences between joint (what’s ours) or separate property (what’s mine and what’s yours), which can vary by state.

You might consider adding one another to your existing bank accounts or opening a new joint account. You’ll also need to decide how much you’ll deposit from each of your paychecks into these accounts to pay the bills. You may want to keep separate bank accounts for your own personal spending, but having at least one shared account is often a good idea. That way, in the case of an emergency, your spouse can pay bills and manage money as needed.

It also might be a good idea to decide which bank accounts and credit cards have the best benefits then close any other accounts that are charging annual fees and you will no longer be using. Check into how closing credit card accounts can impact your FICO score before you close them out. Just keep in mind that opening joint credit card accounts means that both spouses are responsible for whatever financial mistakes the other one might make, so be wise before opening joint accounts.

Set Financial Goals

You and your spouse should have a serious discussion about the financial goals you both have for the future. This should include things like planning for debt reduction, saving for retirement, creating an emergency fund, kids, real estate purchase(s), and any other large upcoming financial purchases. Outline a one-, five-, and ten-year plan, but remember to keep these goals flexible as things will almost certainly change. Meeting with a financial advisor who specializes in working with families to establish long-term financial plans can significantly help you and your spouse ask the right questions, get on the same page, and consider your options.

Plan a Budget

Budgets can help you and your spouse avoid money arguments by planning where every dollar will go in advance. Don’t forget to plan for expenses, savings, and possibly a little discretionary cash for each partner to enjoy. Plan for how you would handle unexpected expenses that pop up now and then. Also discuss how each partner will be contributing. Is it equally, based on a percentage of your salary, or some other setup? Make sure both partners have an equal say in the discussion and be willing to compromise. That’s what marriage is about, after all!

Have a Monthly Budget Meeting

Early in a marriage is the best time to start having a monthly budget meeting. During the first year, schedule a discussion with a financial planner to help you both solidify the best ways of handling finances. At this meeting, you both can discuss which bills need to be paid next, where the budget needs to be tweaked, tax implications, and how future plans need to change. This is a great habit to get into so that both spouses are aware of how much money is available and what needs to be paid for in the near future.

While there is no one “right” way to handle your finances in marriage, one thing is for sure – you need to have open communication and an overall plan that both parties are aware of and happy with. These two factors will greatly reduce financial stress on your marriage.

Tax

As a newly married couple, you must decide whether to file joint or separate tax returns. For most scenarios, filing joint returns makes the most sense.

Each spouse should also adjust the tax withholdings that you each claim on your W-4. Remember that you don’t want to over-withhold (receiving a large tax refund) or under-withhold (having to pay the IRS taxes in April). The IRS website is a good place to start if you need help in deciding what withholdings you should take to balance the numbers (of course, your financial planner can also help!).

Life Insurance

Life insurance is often overlooked and usually not a priority for newly married couples. However, this is an important consideration and a way to protect the other spouse should something happy to you. This is particularly important if you are in a single income household or are planning for a child. Many mistakenly think it is too costly, but options like Term insurance can be good.

Next Steps

Have the money conversations upfront and on a regular basis. A healthy relationship is paramount. Being on the same page about your finances will foster a healthy financial life together.

Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

Founders’ and Entrepreneurs’ Guide to QSBS

December 11, 2019 by eric

This article was originally published on TECHCRUNCH.COM on December 4, 2019. Written By: Peyton Carr

Founders, entrepreneurs, and tech executives in the know realize they may be able to avoid paying tax on all or part of the gain from the sale of stock in their companies — assuming they qualify.

If you’re a founder who’s interested in exploring this opportunity, put careful consideration put into the formation, operation and selling of your company.

Qualified Small Business Stock (QSBS) presents a significant tax savings opportunity for people who create and invest in small businesses. It allows you to potentially exclude up to $10 million, or 10 times your tax basis, whichever is greater, from taxation. For example, if you invested $2 million in QSBS in 2012, and sell that stock after five years for $20 million (10x basis) you could pay zero federal capital gains tax on that gain.

What is QSBS, and why is it important?

These tax savings can be so significant, that it’s one of a handful of high-priority items we’ll first discuss, when working with a founder or tech executive client. Surprisingly, most people in general either:

Know a few basics about QSBS;
Know they may have it, but don’t explore ways to leverage or protect it;
Don’t know about it at all.

Founders who are scaling their companies usually have a lot on their minds, and tax savings and personal finance usually falls to the bottom of the list. For example, I recently met with someone who will walk away from their upcoming liquidity event with between $30-40 million. He qualifies for QSBS, but until our conversation, he hadn’t even considered leveraging it.

Instead of paying long-term capital gains taxes, how does 0% sound? That’s right — you may be able to exclude up to 100% of your federal capital gains taxes from selling the stake in your company. If your company is a venture-backed tech startup (or was at one point), there’s a good chance you could qualify.

In this guide I speak specifically to QSBS on a federal tax level, however it’s important to note that many states such as New York follow the federal treatment of QSBS, while states such as California and Pennsylvania completely disallow the exclusion. There is a third group of states, including Massachusetts and New Jersey, that have their own modifications to the exclusion. Like everything else I speak about here, this should be reviewed with your legal and tax advisors.

My team and I recently spoke with a founder whose company was being acquired. She wanted to do some financial planning to understand how her personal balance sheet would look post-acquisition, which is a savvy move.

We worked with her corporate counsel and accountant to obtain a QSBS representation from the company and modeled out the founder’s effective tax rate. She owned equity in the form of company shares, which met the criteria for qualifying as Section 1202 stock (QSBS). When she acquired the shares in 2012, her cost basis was basically zero.

A few months after satisfying the five-year holding period, a public company acquired her business. Her company shares, first acquired for basically zero, were now worth $15 million. When she was able to sell her shares, the first $10 million of her capital gains were completely excluded from federal taxation — the remainder of her gain was taxed at long-term capital gains.

This founder saved millions of dollars in capital gains taxes after her liquidity event, and she’s not the exception! Most founders who run a venture-backed C Corporation tech company can qualify for QSBS if they acquire their stock early on. There are some exceptions.

Do I have QSBS?

A frequently asked question as we start to discuss QSBS with our clients is: how do I know if I qualify? In general, you need to meet the following requirements:

Your company is a Domestic C Corporation.
Stock is acquired directly from the company.
Stock has been held for over 5 years.
Stock was issued after August 10th, 1993, and ideally, after September 27th, 2010 for a full 100% exclusion.
Aggregate gross assets of the company must have been $50 million or less when the stock was acquired.
The business must be active, with 80% of its assets being used to run the business. It cannot be an investment entity.
The business cannot be an excluded business type such as, but not limited to: finance, professional services, mining/natural resources, hotel/restaurants, farming or any other business where the business reputation is a skill of one or more of the employees.

When in doubt, follow this flowchart to see if you qualify:

When does the 5-year clock start ticking for QSBS?

One of the most important requirements for getting the QSBS exclusion is that you’ve held your stock for 5 or more years; the clock doesn’t start until you actually acquire the shares. We’ve run into examples where people think they’ve met the requirements, but unfortunately, they did not. Take a look at a few examples here:

Let’s look at original issuance in this real-life example. One of our clients was curious whether he had QSBS. He had invested early in his friend’s company, which had achieved unicorn status, making his investment a home run.

However, his investment was made via a SAFE note, which is not abnormal at that early stage in the company’s life. But when that SAFE note converted, the aggregate gross assets of the company were well in excess of the $50 million cut off. Although his holding period is greater than 5 years and everything else ticked the boxes, the $50 million aggregate gross assets test was not met and he did not qualify.

Actionable tip: If you are using a SAFE or Convertible Note, it’s important to know that the asset requirement and holding period does not start until you receive the actual shares from the C Corporation.

What happens if I sell my stock or it’s acquired before 5 years?

You may be able to leverage Section 1045 of the Internal Revenue Code. Section 1045 allows for QSBS holders to roll over gains received from the sale of qualifying QSBS, into QSBS of a different issuer(s). In this situation, you want to be mindful of two key timelines:

The original QSBS must be held for more than six months at the time of the disposition
The rollover must occur within 60 days

Actionable tip: It’s also important to note that a 1045 election needs to be filed on or before the tax return date for the tax year of the 1045 rollover.

Keep in mind that although 1045 rollovers are permitted in these situations, you don’t want to make a rushed investment decision just to meet the 60-day rollover deadline. In fact, I find more times than not, that the stars do not align here. It’s not realistic to roll all the gains from your exit, back into favorable early-stage venture investments, that you can source within 60 days!

However, if the stars do align and you have a favorable opportunity, you can take advantage of it in a tax advantaged way. For example, if you qualify to leverage a Section 1045 rollover, you could hypothetically roll the gain of your disposition QSBS into three new QSBS eligible companies – and potentially receive QSBS treatment from all three new companies later on. That’s a win!

Real-life QSBS situations you may encounter

You own QSBS that was acquired by a company whose stock is not QSBS

Even if your QSBS stock is acquired in a stock transaction by a company whose stock isn’t QSBS, the stock you receive would maintain its QSBS treatment, but only up to the price of the exchange. Example, your company is bought and now you own shares equal to $10 per share in the acquiring company. Assuming your five-year holding period is met, you only get to claim the exclusion up to the gain on the date of the acquisition, the $10 per share. If you hold the shares and they increase to $20 per share and then you sell, you still only get to claim $10 per share for QSBS purposes. The additional gain would be counted as regular capital gains.

Example:
A private company was acquired by a public company. An early employee had received restricted shares in the private company early on and filed her 83(b) upon receipt of the private company’s shares to start her holding period.

The private company was acquired, 4 years after she filed her 83(b), by a public company and she received new stock in the public company. She waited one more year (total 5 year holding period), then sold the new public company stock. During the last year, that public company stock had increased in value.

Her shares met QSBS requirements. She can claim the QSBS exclusion up to the gain on the date of acquisition. She pays capital gains tax on any stock appreciation over the price at which she received the public company stock.

Actionable tip: An 83(b) election allows you to pay taxes on restricted shares, based on fair market value of the shares at the time of granting rather than at the time of vesting. You have 30 days after being issued the shares to do this. This is particularly appealing during the early stages of a company’s life, when the tax due may be very little due to a lower company valuation.

You invest in venture capital and/or private equity

For those who are investing in private equity or venture capital, or those who are making co-investments, QSBS may also be in play. Typically, some of these investments will be made through LLCs taxed as partnerships.

Assuming the LLC taxed as a partnership is the original QSBS purchaser, the QSBS eligible gains may be able to be passed through to the underlying investors as long as the 5-year holding period has been satisfied. For venture capital firms, things can get more complicated at the general partner level, and you’ll need to speak with your legal and tax advisors.

And also remember that if the investment is done through a convertible note, the 5-year QSBS clock does not start ticking until that note is converted to equity.

This can get complicated with record-keeping but generally, we’d recommend asking for a QSBS representation from the company, to the extent possible, and making sure it is included in the stock purchase agreements.

How to not blow your shot at QSBS

You may be asking yourself: there are so many requirements, what do I need to watch out for so I don’t blow it? The truth is, there are multiple ways, but here are a few of the more common ones to look out for:

#1: S-Corporation trap

Only investments into a C Corporation will qualify as QSBS. If you start your company as an S Corporation, then later change the status to a C Corporation, the QSBS eligibility would be lost. However, there could be a workaround involving the starting of a newly formed C Corporation. Proper tax and legal guidance is very important here.

#2: Active business requirement

The “active business requirement” states that you need to ensure that 80% of the company’s assets are being used in the active conduct or business. Generally, most early stage C Corporation startups will qualify for this as long as they are not an excluded business or trade such as service businesses, hotels, investing, finance/insurance/banking, leasing, farming, mining, or oil and gas.

#3: Redemptions from the company

One of the biggest traps that founders face when it comes to QSBS is that they don’t pay close enough attention to the company’s redemptions of stock. My team and I have seen this several times unfortunately. Recently, we came across a situation while helping a group of early employees with some pre-sale planning.

Unfortunately, early in the company’s life, shares had been redeemed by the company from the brother of one of the founders. This redeemed stock, even though it was a small amount in the grand scheme of things, disqualified the QSBS for the rest of the company.

Yikes! This is a situation you definitely want to avoid. When it comes to redemptions, two types of redemptions can blow your QSBS:

Redemptions of over 5% of the stock by your company, within one-year (before or after) stock is issued by your company
Redemptions of stock by the company, from recipient or related person within two years (before or after) stock is issued by your company

#4: Don’t gift QSBS stock to charity

For those who are charitably inclined, gifting long-term appreciated low basis stock to charity can be a win-win situation. However, it’s better to gift long-term appreciated non-QSBS stock with low basis. Gifting QSBS stock is tax inefficient. Certain situations could make sense where there is a 50% or 75% exclusion percentage, when the holding period is less than five years, or if you’ve already taken your $10 million exclusion. This should be reviewed with a professional.

#5: Don’t contribute QSBS to a Family Limited Partnership (FLP)

Many affluent entrepreneurs and families will use Family Limited Partnerships (FLPs) for wealth transfer and to organize and consolidate the family’s investment activities. While the gifting of QSBS can be very beneficial, and making an investment directly from the FLP into the C Corporation is acceptable, it should be known that contributing QSBS directly to a partnership will disqualify the stock’s QSBS status, and should be avoided.

#6: Team familiar with QSBS

Many financial advisers, accountants and attorneys are only vaguely familiar with QSBS. It’s important to have the right team in place looking out for you. However, it is your responsibility to be aware, and document the requirements. I encourage all of my clients to post me if they are going to make any financial decision related to their company or QSBS stock so we can confirm with certainty that it will not have any adverse effects. Sometime this is an easy, yes or no, other times it will require a more thorough analysis and involve lawyers and accountants.

My team and I found an opportunity to get a client a tax refund of about $250,000. His company was acquired by a public company years ago. He received stock in the deal and sold the stock at a later date. The total stock holding period was 5 years (original stock holding period + public stock holding period) and his accountant had completely missed the opportunity, even after having been informed. The point here is that it’s easy for this to slip through the cracks if someone is not familiar with it. Needless to say, he found a new accountant shortly thereafter.

#7: Documentation

Protect yourself by documenting everything. There are many requirements so it is incredibly important to maintain good records. We always say document QSBS status early and often, and after every round of financing. Ask your company to help you with documentation if necessary. You can (and should) be documenting:

Date of purchase
Consideration paid
Representation that your company is below $50 million in aggregate gross assets
Certification that your company has 80%+ its’ assets being actively used in operating the business, and intends to continue to do so

Final thoughts

There are many resources available online to walk you through the intricacies of QSBS. However, beyond digging through tax code line by line, your best bet is to start by speaking with a professional. This is not something you want to DIY, and the appropriate advice is worth its weight in gold. Remember – QSBS may seem like a hassle, but it’s powerful. And if you qualify, it could be legitimately life-changing.

Tax

Irrevocable Non-Grantor Trust

Parent-Seeded Trust

Grantor Retained Annuity Trust (GRAT)

Intentionally Defective Grantor Trust (IDGT)

The Bottom Line

What You Need to Know About Selling Your Company Stock

Part 3: The Founder’s Guide to Managing Your IPO Stock

Keep in Mind: Lockups and Blackout Periods

Concentrated Stock Strategies

When Should You Sell IPO Stock?

Consider Taxes Before You Sell

Qualified Small Business Stock (QSBS)

Brackets & Rates

Capital Gains

Standard Deductions

Retirement Plans

Health Spending

Estates & Gifts

Quick Take

Background Info

What Does the Package Include?

How Does the $350 Billion Paycheck Protection Program Work?

What Types of Businesses Are Eligible For The Paycheck Protection Program?

How Do I Get a Payroll Protection Loan?

Have the “State of the Union” Talk about Money

Tweak Your Tax Withholdings

Yours, Mine, and Ours

Set Financial Goals

Plan a Budget

Have a Monthly Budget Meeting

Tax

Life Insurance

Next Steps

What is QSBS, and why is it important?

Do I have QSBS?

When does the 5-year clock start ticking for QSBS?

What happens if I sell my stock or it’s acquired before 5 years?

Real-life QSBS situations you may encounter

How to not blow your shot at QSBS

Final thoughts

Will you help me solve any and all financial problems I may encounter?

What types of clients do you specialize in?

What services do you provide?

How do you help clients implement their financial plans?

Are your recommendations truly in my best interest?

What are all the different ways you get paid?

Why would I choose you as my advisor and not do it myself?

What are the benefits of working with an independent advisor compared to a bank or large advisory firm?

Do you use proprietary funds?

Where do you keep my money and how can I see it?