Double Your QSBS Exemption (or More) with Trust Stacking

✅ 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 how you can multiply (or "stack") your Qualified Small Business Stock (QSBS) exemption to protect $20 million, $30 million, or more of your capital gains simply by gifting some of your equity to a CRT.

How stacking works

The QSBS exemption's requirements are fairly straightforward: Every person (or 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 from the sale of each company's stock.

The key to the 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. 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.)

The details

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.

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!

What to do now

Timing is key to the QSBS stacking 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.

Next Up

Tip

You can choose from different types of Charitable Remainder Trust, including Standard, NIMCRUT, and Flip CRUT.

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