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Key Takeaway:The Qualified Small Business Stock (QSBS) exemption is the best tax break available to startup founders, early employees, and investors: $10 million of capital gains tax-free. But you can achieve even greater protection with a “QSBS stacking” strategy. As the example below demonstrates, gifting shares to a CRT can allow you to multiply the QSBS exemption, protecting $20 million, $30 million, or more from tax.
In our QSBS overview, we covered the basics of what the QSBS exemption is and how it impacts individuals. In this article we’ll cover QSBS stacking and packing, and everything you should know on how you can multiply (or “stack”) your QSBS exemption to protect $20 million, $30 million, or up to $500 million of your capital gains with proper planning.
For visual learners: Check out this Video to learn about QSBS Stacking
How QSBS Stacking Works
The QSBS exemption’s requirements are fairly straightforward: Every taxpayer gets to pay 0% federal taxes (and 0% state taxes everywhere except California, Pennsylvania, New Jersey, Alabama, and Mississippi) on their first $10 million of capital gains or 10X their investment from the sale of a QSBS-eligible company’s stock.
The key to any QSBS stacking strategy is right there in the requirements: There’s a new $10 million exemption for every taxpayer, and for every company whose stock the taxpayer 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 (or another qualified trust). If a taxpayer gifts or bequeaths QSBS shares to a trust (or someone else), the recipient of the shares will be able to take advantage of its own exemption, effectively uncapping the amount of gains that are tax free.
What’s more, if you give qualifying shares to a trust, the trust will 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 holding period. (Recall that you have to hold your shares for at least five years to get the exemption.)
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:
Strategies to Increase Your QSBS Exemption
Want to learn if QSBS stacking can work for your stock?
Take Jenn, a New York City founder who plans to sell all of her $25 million of equity once her company IPOs. Jenn early exercised all of her shares at incorporation and her cost basis is ~$100. She has one son and plans 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 $8.5 million 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: If Jenn wants to maintain control over the shares and have access to the capital, she can split the remaining gains between two CRTs. (Up to $10 million in a single CRT.)
Option 2 for the remaining $15 million: If Jenn is fine giving up some control and access to the funds, so she sets up two separate “non-grantor trusts,” and she names her son and her future child as the respective 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 exemptions.
As a result of this simple (if clever) planning, Jenn’s family will collectively pay zero taxes on her entire $25 million equity stake!
Not bad results at all! And you can also play with our online calculator to customize it with your own numbers and see your potential savings here.
You can also read a more detailed QSBS stacking example here.
How does QSBS Packing Work?
There are two rules that are important to keep in mind when thinking about QSBS packing. First, a taxpayer’s aggregate per-issuer gain exclusion for a given taxable year is generally limited to the greater of (a) $10 million, minus the aggregate prior gain excluded with respect to such issuer, or (b) 10 times the taxpayer’s original adjusted tax basis in the issuer’s QSBS sold during that year. More simply put, you can claim QSBS exemptions on the greater of $10 million or 10x your basis in the stock. In most scenarios, $10 million is larger than 10x your basis, but it’s possible to use “packing” to take advantage of the 10x basis rule.
Second, only domestic C corporations with up to $50 million in assets are eligible to issue QSBS. But if the company starts as an LLC, S corporation, or some other type of entity and then becomes a C corporation, the ownership shares can become eligible for QSBS treatment five years after the conversion.
In theory, you could transform the company from an S corporation to C corporation when it has $49.9 million of assets and then claim $499 million in QSBS exemptions (10 * $49.9 million), potentially saving $150 million or more in taxes on the sale. You can see how strategies that maximize a taxpayer’s basis in QSBS-eligible shares can be extremely powerful.
Next Steps
Timing is key to the QSBS stacking and packing strategies. 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 maximum 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.
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!
Mani is the founder and CEO of Valur. He brings deep financial and strategic expertise from his prior roles at McKinsey & Company and Goldman Sachs. Mani earned his degree from the University of Michigan and launched Valur in 2020 to transform how individuals and advisors approach tax planning.
