If you’ve founded, worked for, or invested in a successful startup and you’re looking to sell your shares, chances are you’ve heard about the Qualified Small Business Stock (QSBS) exclusion. This tax break can allow you to exclude at least a portion of your capital gains on the sale of eligible stock from federal and most states’ taxes after holding the stock for at least five years. (That’s why we’ve called it the “best tax break around.”) Another tool in the tax-planning toolbox is a Charitable Remainder Unitrust (CRUT). Put these two together, and you get one version of what’s known as “QSBS stacking,” a strategy that can help you keep more of your wealth and support worthy causes you believe in at the same time.

Let’s break it down in simple terms, then walk through a real-life example. If you want to jump to running calculations, you can use the calculator here.

Key Takeaways

• The QSBS exclusion allows founders, early employees, and early investors to exclude from capital gains tax the greater of (a) $10 million of capital gain or (b) an amount of capital gain equal to 10x the shareholder’s basis in the stock, provided that the stock has been held for at least five years.
• Combining QSBS with a CRUT creates a powerful tax optimization strategy called “QSBS stacking” that allows you to avoid taxes on more than $10 million of capital gains.
• In the example scenario described below, using QSBS stacking with a CRUT results in $12 million after taxes (measured five years after the sale) versus $8.7 million without QSBS stacking!

Recap: What is the QSBS Exclusion?

QSBS stands for Qualified Small Business Stock. The sale of QSBS stock is exempt from federal tax (as well as state taxes in 45 states plus the District of Columbia) for up to the greater of (a) $10 million of capital gain or (b) an amount of capital gain equal to 10x the shareholder’s basis in the stock. When is stock eligible for QSBS treatment? There are a number of requirements, but the short answer is this: If you start, join, or invest in a young company (by putting in cash or working there in exchange for shares) that meets certain requirements (the company must be a C corp and must be the right type of business), and then hold your shares for at least five years, the company will qualify. Most tech startups qualify. This is huge: You could sell your startup shares and not pay capital gains taxes on the proceeds.

What is a Charitable Remainder Trust?

A Charitable Remainder Unitrust (CRUT) is a special type of tax-advantaged trust. Here’s the gist:

1. You fund the trust with an asset — For example, you might fund the trust with shares of your company’s stock.
2. The CRUT sells the asset — The sale goes just as it would if you still owned the shares, except that the shares are titled in the trust’s name and (this is important!) no immediate federal or state tax is paid on the sale.
3. You (or someone you choose) get annual distributions from the trust. These distributions could last for a terms of years or for your whole life, and they’re based on a fixed percentage of the trust’s assets each year. The distributions carry out tax liability incurred inside the trust to the beneficiary, but if the shares that were sold were QSBS shares, there won’t be much if any tax liability to carry out.
4. Charity gets the remainder interest. After the term ends, whatever is left goes to the charity of your choice.

In the non-QSBS context, the key benefit of a CRUT is that it allows you to defer taxes on the sale of appreciated assets, reinvest the money pre-tax, and compound it for a long time, ultimately creating more wealth for you all while supporting a charitable cause.

QSBS + CRUT = QSBS Stacking

The QSBS exclusion is great, and CRUTs are a valuable strategy for deferring capital gains tax on any appreciated asset. So what happens if you combine these two strategies? Enter QSBS stacking. As the name implies, QSBS stacking is a set of strategies for “stacking” multiple $10 million QSBS exclusions on top of each other. This move capitalizes on an important feature of QSBS: every taxpayer gets his, her, or its own exclusion. Since a CRUT is consider a separate taxpayer, the CRUT will get its own exclusion.

QSBS stacking, then, is about multiplying the number of QSBS exclusions you can utilize when selling your shares. This can take several forms: You can stack QSBS exclusions by gifting shares directly to family members, by gifting shares to non-grantor trusts, or by gifting shares to CRUTs. But our focus here is on the CRUT option, which is the best fit for most people who are looking to maximize the proceeds they receive (versus passing on assets to loved ones). Since QSBS-eligible shares are not taxed upon sale, the distribution of the sales proceeds of QSBS-eligible shares does not carry out any tax liability to the beneficiary.

The Key Mechanism: Four-Tier Accounting

Understanding the tax code’s “four-tier accounting” system is crucial for maximizing the tax benefits of QSBS stacking with CRUTs. When your CRUT makes its annual distributions, the IRS requires these payments to follow a specific order based on the type of income being distributed. This ordering system determines how much tax you’ll pay on your distributions— and, more importantly, how much of your QSBS gains can remain tax free.

Here’s how the tiers work, from first (highest taxed) to last (tax free):

1. Tier 1 – Ordinary Income: The trust must first distribute any ordinary income it generated from investments (like interest and non-qualified dividends). This gets taxed at your normal income tax rates.
2. Tier 2 – Capital Gains: Next comes any capital gains the trust generated from its post-QSBS investments.
3. Tier 3 – Other Income: This includes tax-exempt income.
4. Tier 4 – Return of Principal: The QSBS gains your CRUT realized when it sold your shares are classified as principal, not capital gains. Once the trust has distributed all its other income types, your distributions come from this principal tier — tax-free.

Why this Matters for QSBS Stacking: When you put QSBS in a CRUT, two powerful things happen. First, the initial sale inside the CRUT is tax free because CRUTs are tax-exempt entities. Second, when that money eventually comes back to you as principal (Tier 4), it remains tax-free. The four-tier system ensures you’ll eventually access these tax-free gains, though you may need to work through the higher-taxed tiers first.

Strategic Tip: To maximize the tax-free nature of your QSBS gains, consider investing the CRUT’s assets in tax-efficient vehicles that minimize Tier 1 and Tier 2 income. This allows more of your distributions to come from the tax-free principal tier sooner.

Case Study: Comparing Using a CRUT for QSBS Stacking vs. Not Using One

We are going to compare the benefits of using a CRUT for QSBS stacking versus not using one and see how much money you would end up with after five years. We’ll assume that all proceeds are invested in the market.

Scenario:

• You’re a New York City founder.
• You have already sold $10 million of QSBS assets and therefore have no remaining personal QSBS exclusion.
• You put the next $10 million of shares into a five-year CRUT.
• The CRUT pays you 37% of its value each year, but we measure that value at the end of the year, after accouting for the growth of the assets in the trust being reinvested.
• All investments (inside the CRUT and outside the CRUT) grow 10% per year (2% ordinary income and 8% capital gains).
• After the fifth year (and five payments from the trust to you), the remaining assets go to charity.

CRUT Step-by-Step Calculations

Here’s what the numbers would look like in Year 1:

• Start Value: $10,000,000
• Growth (10%):
  • Qualified Dividends (2% of $10,000,000) = $200,000
  • Capital Gains (8% of $10,000,000) = $800,000
  • Pre-Distribution Total: $10,000,000 + $200,000 + $800,000 = $11,000,000
• First Year Payout/Distribution (37% of $11,000,000): 0.37 × $11,000,000 = $4,070,000
• End-of-Year Trust Value: $11,000,000 – $4,070,000 = $6,930,000

Year-by-Year Details

Year 1

Distribution Breakdown (Year 1):

• Qualified Dividends: $200,000 (taxed at long-term capital gains rates)
• Long-Term Capital Gains: $800,000 (taxed at long-term capital gains rates)
• Principal: $4,070,000 – ($200,000 + $800,000) = $3,070,000 (QSBS principal, tax-free)

Year 2

Distribution Breakdown (Year 2):

• Qualified Dividends: $138,600
• Long-Term Capital Gains: $554,400
• Principal: $2,819,000 – ($138,600 + $554,400) ≈ $2,126,000

Year 3

Distribution Breakdown (Year 3):

• Qualified Dividends: $96,080
• Long-Term Capital Gains: $384,320
• Principal: $1,955,200 – ($96,080 + $384,320) ≈ $1,474,800

Year 4

Distribution Breakdown (Year 4):

• Qualified Dividends: $66,584
• Long-Term Capital Gains: $266,336
• Principal: $1,355,000 – ($66,584 + $266,336) ≈ $1,022,000

Year 5

Distribution Breakdown (Year 5):

• Qualified Dividends: $46,142
• Long-Term Capital Gains: $184,570
• Principal: $938,000 – ($46,142 + $184,570) ≈ $707,288

Summary of Distributions and Components

(Principal total is approximate; we summed each year’s principal portion.)

Approximate Tax Calculation (Federal + City + State)

• Qualified Dividends: ~$547,406 at ~37% ≈ $202,540 of tax
• Long-Term Capital Gains: ~$2,189,626 at ~37% ≈ $810,158 of tax
• Principal (QSBS): The rest ($8.4 million) is principal and tax-free due to the QSBS exclusion.

Total Tax ≈ $1,012,698

Post-Tax Distributions ≈ $11,137,200 – $723,000 ≈ $10,124,422 (importantly, this doesn’t account for investing the distributions each year through the end of five years)

If you do reinvest the distributions and pay the taxes, you will end up with $12,036,999 after taxes. On top of that, you would be able to donate $1,600,000 to the charities of your choice after five years.

Comparing using a CRUT vs. Not Using One

If you don’t use a CRUT and aren’t able to use an additional QSBS exclusion, you will pay 37% in federal and state taxes upfront on the $10,000,000 sale of your shares, leaving you with $6.7 million to start investing. After 5 years, you’d have $8,687,558, which is about 72% of what you would have had with a CRUT.

Conclusion

QSBS stacking with a CRUT represents a powerful tax-planning strategy for founders, early employees, and early investors in successful startups. By combining the tax advantages of QSBS with the charitable and tax deferral benefits of a CRUT, you can potentially:

• Create a significant charitable impact ($1,600,000 in the example above).
• Significantly increase your after-tax returns.

About Valur

We’ve built a platform to give everyone access to the tax and wealth-building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures. With Valur, 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 things simple. The results are real: We have helped create more than $3 billion in additional wealth for our customers. If you would like to learn more, please feel free to explore our Learning Center. You can also see your potential tax savings with our online calculators or schedule a time to chat with us!