Every year, countless small business start-ups hear about the Qualified Small Business Stock (QSBS) exclusion and lock in 🔒 on that being their ticket to a tax-free seven + figure exit. 💰

And for some, it is.

But a bigger percentage of others never make it there. Or worse, they get there and don't have a qualifying stock sale. 🫣

Today, we're talking about one way to bail out of a QSBS set-up without being double-taxed to death.

QSBS Background

For anyone not in the know, QSBS is an exclusion allowed for C-Corp stock sales subject to a few criteria:

• Stock held for 5 years (new OBBB rules grant partial exclusions at 3 years [50%] and 4 years [75%]) ✋
• Maximum gain excluded (not taxed) of $15 million PER SHAREHOLDER 👨‍👩‍👦‍👦 (or 10X basis)
• Asset size of business < $75 million 🏢 (under new OBBB rules - old rules were $50MM)
• Not a disqualified industry 🧑‍🏫 (professional services, finance and investment, farming and mining, hospitality and real estate)

It's an attractive exit plan for many tech start-ups or other businesses who will be able to sell their stock when they're ready to move on.

Stock Sale

But not every small business sale is a stock sale - or should be. 👈 Most buyers of small businesses prefer asset sales (or stock sales treated as asset sales) to get more favorable tax treatment.

When stock is purchased, the purchase price is non-recoverable until it is sold. It stays as basis.

When assets are purchased, however, the purchase price can be recovered through depreciation - accelerating the post-tax return on investment. 🔄

Full caveat here - many times a calculation can be done if a seller is set on a stock sale to take advantage of QSBS and the seller prefers an asset sale. In this calculation, the tax benefit foregone by the buyer can be adjusted against the sales price. 🧮

This make sense but can still be a shock to a lot of first time sellers.

Bailing on the C-Corp Altogether

But in cases where the seller realizes they won't be able to sell the stock at all, and will have to sell the assets, there is still a way out. Though it takes a bit longer. 📆

This strategy is done to avoid double taxation of a C-Corp asset sale which usually flows like this:

• C-Corp sells assets (think equipment, intangibles)
• C-Corp pays 21% tax on the gain of the sale of those assets (+ relevant state tax)
• C-Corp distributes remaining cash to shareholders as dividend
• Shareholders pay 20% capital gains tax (+ 3.8% net investment income tax + state tax) 😵

This is in contrast to a pass-through entity (partnership or S-Corp) that pays only one level of tax at the shareholder level. 1️⃣ And on an exit, much of the gain will be at the lower capital gains rates not subject to net investment income tax and more deductible via a Pass-through Entity Tax (PTET) election as a SALT Cap workaround. 🤑

For C-Corps that have all natural persons (people) as shareholders, an option is to make a S-election to convert to a S-Corp.

The hook is that the S-Corp needs to wait 5 years before selling the assets - otherwise the "built-in-gain" of the assets at the date of conversion will be taxed as if it were a C-Corp. The built-in-gain needs to burn off. 🔥

Yes, it takes a bit longer on the exit. But if you can see it coming and pivot to this early enough, it can save nearly half the taxes that would otherwise be paid and gone forever.

Obvious warnings on this one - always talk to a tax pro and legal counsel. Every situation is different.

The Takeaway

Going for the gold with QSBS can be a great call if it works out. But it doesn't always.

Know that there are other options and ways out of it if you act early enough and are real with yourself and your advisors.

🫡

Meme Cleanser 🧼

No memes or posts this week - looks like some emails are getting caught up by SPAM so trying out no links! They'll return if deliverability doesn't change!

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