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QSBS: Stock Guide for Founders and Entrepreneurs

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 — if they qualify. This can literally amount to millions in tax savings.
If you’re a founder who’s interested in this opportunity, put careful consideration into the formation, operation and selling of your company to meet its eligibility requirements.

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 stock 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. 

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What is QSBS and why is it important?

With QSBS stock, 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. Surprisingly, most people in general either:

  1. Know a few basics about QSBS rules;
  2. Know they may have it, but don’t understand how to leverage or protect it;
  3. 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 fall 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, rules work in his favor; but until our conversation, he hadn’t even considered leveraging it.

Instead of paying 20%+ long-term capital gains taxes, how does 0% sound? Leveraging the  QSBS exclusion you may be able to exclude up to 100% of your federal capital gains taxes from selling your stake in the company. If your company is a venture-backed tech startup (or was at one point), there’s a good chance you qualify.

In this guide I speak specifically to the QSBS rules on a federal tax level; however, it’s important to note that some states do not follow the federal tax treatment of the QSBS rules. For example, the QSBS New York rules follow the federal treatment, while QSBS California, Pennsylvania, and other states completely disallow the exclusion. There is a third group of states, including Massachusetts and New Jersey, that have their own modifications to the rules. Like everything else I speak about here, all QSBS rules should be reviewed with your financial, legal, and tax advisors.

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