Finance at work
I am an early employee at a startup. What do I need to know to save up to $10 million in future taxes?
To incentivize investment and growth in the private sector, lawmakers came up with a favorable tax treatment for employees and investors in small businesses called the QSBS exemption. Qualified small business stock, or QSBS, is a category of equity ownership defined by the IRS for companies below $50 million in assets.
The tax savings almost sounds too good to be true. However, not all companies and startups may receive beneficial tax treatment.
The first set of qualifications required for the QSBS exemption are listed below.
Business must be an active C corporation (no LLC or S Corporation)
The total assets of the business must be less than $50 million at the time the stock is received
Stock must be held for five years before it is sold
There are certain industries and businesses that cannot qualify for the QSBS exemption. These industries are largely service-based industries where consumers or customers are purchasing services rather than actual products.
The QSBS tax break
If all three criteria above are met and the industry exceptions do not apply, we are entitled to the following benefits:
Federal tax exemption of 10x our initial investment, or $10 million (whichever is greater)
State tax exemptions of capital gains unless we live in California and Pennsylvania Note: Massachusetts, New Jersey, and Hawaii offer QSBS exclusions on state tax for capital gains with modifications to federal requirements.
To take full advantage of the QSBS exemption, we need to early exercise. There are risks involved in early exercise and going after the tax exemption. Review the lesson on exercising early and the lesson on qualifying for QSBS to figure out if we qualify for QSBS.