QSBS "Stacking" (Via Gifts and Trusts)

Gifting QSBS stock and/or utilizing irrevocable trusts can allow you to multiply the QSBS tax exclusion well beyond $10 million.

Strategy Overview

Per IRS rules, a taxpayer can exclude up to 100% of their capital gains from the sale of QSBS, subject to certain limits (e.g. greater of $10 million or 10 times the taxpayer's basis). If you have gains in excess of $10 million, a strategy to consider is multiplying the exemption via gifting stock and/or the utilization of trusts (as each trust with its own taxpayer ID is able to claim its own QSBS tax exclusion). This requires careful planning, however, to ensure you (i) gift correctly and/or that (ii) each trust is set up correctly, purposefully valid (in the eyes of the IRS), and meets your financial goals (given the irrevocable nature of the trusts).

Tax Details

Under the QSBS rules in Section 1202 of the Internal Revenue Code, a taxpayer can exclude up to 100% of their capital gains from the sale of QSBS, subject to certain limits. The primary limit is a cap on the total amount of gain that can be excluded; (i) the greater of $10 million or (ii) 10 times the taxpayer's basis in the stock.

That said, Section 1202 also specifies that the QSBS tax exclusion is per taxpayer ID. This provides a strategic opportunity to potentially multiply the QSBS limit through a number of avenues:

• For married couples, each individual may be able to claim a QSBS exclusion. However, this isn't always a given (e.g. when you were married and the state you live in can impact treatment).

• Gifting stock to another individual will allow the recipient to retain your tax basis and holding period. And because they are a separate taxpayer, they'll be able to utilize their own QSBS exemption. You lose ownership and control of the shares with this strategy, however, as the recipient will have full rights to the assets to do as they please.

• Utilizing trusts may offer the most flexibility. Irrevocable trusts have their own taxpayer ID, and thus if set up correctly are able to claim their own separate QSBS tax exclusion. There are a lot of things to consider with this approach, however, such as (i) what type of trust(s) to utilize (e.g. SLANT, ING, Irrevocable, CRUT), (ii) the pros/cons of each type of trust, (iii) beneficiaries, (iv) control over the asset, and (v) company stock transfer restrictions.

Setting up trusts for QSBS purposes is complex. One needs to ensure a large number of items are considered and done correctly (e.g. the tax basis and holding period transfer; funded with the appropriate number of shares; completed gift (or not); trust structure; purpose; valid in the eyes of the IRS). We highly recommend working with an advisor to strategize and structure correctly.

Key Benefits

• Save on taxes by multiplying the total QSBS tax exclusion amount. By using gifts and/or trusts, you can potentially claim multiple QSBS exclusions, thereby expanding the total QSBS exclusion amount.

Key Considerations/Flags

• Gift taxation. IRS rules only allow individuals to gift a certain amount to each person tax free each year (e.g. $17,000 in 2023). You may also utilize your lifetime gift and estate exemption if desired, but it will reduce your estate exemption.

• Trusts are complex to setup and require ongoing management. Setting up multiple trusts requires careful planning and legal guidance. Additionally, managing multiple trusts will likely involve ongoing administrative and tax prep costs.

• Cost to establish each trust. Each trust must be a separate legal entity with its own taxpayer identification number. The cost to setup a trust of this nature, with the help of an experienced professional, is frequently cited between $15,000 and $35,000 per trust.

• IRS scrutiny on purpose and structure of trusts. The IRS may scrutinize the purpose and structure of the trusts to ensure they serve legitimate non-tax purposes and are not purely tax-driven.

Strategy: When to Consider This and When to Avoid It

🟢 When to Consider This Strategy:

• You have QSBS gains in excess of $10 million. If your anticipated QSBS gains exceed the $10 million QSBS exclusion, a "stacking" strategy may help you save a large amount on tax.

🔴 When to Not Use This Strategy:

• If your gains will be under $10 million. For the vast majority of individuals with QSBS, the realized gains will be less than $10 million. In these circumstances, there is no need to multiply the exclusion.

• If you are not comfortable with the costs, complexity, and/or loss of control. Nearly all stacking strategies have tradeoffs. If you're not comfortable with one or more of the tradeoffs of a strategy, then it likely isn't the best choice.

• If your company doesn't permit the transfer of shares to certain trusts. If your company is not publicly traded, you will need to abide by their shareholder rules and transfer restrictions. Some companies may not permit shares to be transferred to a trust (or certain types of trusts).

🟡 Consider on a Case by Case Basis:

• You're very uncertain of the future value of your company. While planning for the future is highly desired, QSBS stacking strategies can make that challenging because the future price of company stock is unknown. Trust strategies further compound this challenge due to the varying benefits of when, and at what price, shares are transferred to certain trusts.

Example