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Has your company growth stalled? You may be in the 2nd Chasm.
You remember it like yesterday. Your company’s revenue had flatlined. Growth had stalled. Things that worked before just stopped. You…
“Imagine owning stock in a company where the price appreciates greatly, you sell it, and pay NO tax on your profit.”
This quote sounds like a late night informercial trying to sell you some get rich quick scheme. But would it surprise you that it’s the first line of an article written by the US Small Business Administration? LINK
What the SBA organization is referring to is ‘Qualified Small Business Stock’ or US Tax code 1202 – and it is the single best tax code for small businesses & small business investors.
Section 1202 was actually enacted over 25 years ago as an incentive for taxpayers to start and invest in small businesses. But at the time of initial inception – the code had a graduated amount of gains you could exclude from your taxes – making it only marginally beneficial to taxpayers.
But in 2010 – when the exclusion of gains went to 100% – the popularity of QSBS grew. And popularity skyrocketed when the capital gains rate went up in 2013.
This 100% exclusion was then made permanent by the Obama administration in the PATH Act in 2015.
What are the benefits?
In a nutshell – QSBS encourages investors to invest in small businesses under $50m in assets. After holding these qualified shares for 5 years – the gains from the shares are tax free (no capital gains, no AMT, no NIIT).
The amount the taxpayer can exclude is the GREATER of $10m or 10x basis. Meaning – on a small business that shoots through the roof – the investor could theoretically book up to $450m in tax free gains.
And for small business owners – the QSBS incentive adds several % to their IRR and encourages shareholders that have a long-term investment horizon.
What do small business owners need to do?
While the tax break is very generous – the definition to qualify has a bunch of restrictions:
Assuming your business qualifies – you do also have to consider the double taxation of a C Corp and ensure the QSBS tax exclusion is worth it.
What do investors need to do?
For investors – a few key elements need to be in place:
Many times, however, the small business owner may not be aware of QSBS. So ensuring the owner is structured properly (C Corp, etc) is really important. Also – since dividends are not tax-free – you’ll need to determine if you want to receive them or if you simply want to keep that money in the business for the full 5 years.
And if needed – there is also a ‘rollover’ clause (Section 1045) that enables you to move your QSBS gains under the 5-year mark into another QSBS within 60 days.
If the idea of ‘tax free gains’ is interesting to you – QSBS is an incredible opportunity – and arguably the most generous tax code of all time for small businesses & small business investors.
But ironically – QSBS is still largely unknown by most small businesses and investors.
The good news is that there are a lot of articles out there to spin up. But ensure you speak to your tax attorney to get all the details that are applicable to your situation. Here are some good articles/papers:
*Note – Ionic Partners does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Andy is a technology optimist and the co-founder & CEO of Ionic Partners. Formerly - he was the founder & CEO of Think3, Founder & CEO of Crossover, co-founder & CEO of RideAustin and the CEO of a variety of technology companies including Engine Yard, DNN Corp, Kayako, Bizness Apps, FogBugz, School Loop, Agemni, SLI Systems, and Sococo. Andy runs all of his companies with 100% remote talent – across all functions.