One Little Secret Deduction for Tech Professionals in Early Stage Companies to Save Millions
For many technology professionals, having your company IPO is one of the ultimate goals and milestones during your tenure at the firm. All of the long hours and hard work finally come to fruition as, ideally, shares that you were granted have appreciated greatly and now have liquid, tangible value.
In these situations, you stare down a hefty tax bill for when you begin to sell shares of stock to capture your return. Among the myriad of strategies to minimize taxes on these gains, one strategy that can potentially save you the most goes largely unknown. Before we dive into the article, I suggest you look at our recent blog post on how tech Professionals can reduce taxes through donor advised funds.
Qualified Small Business Stock (QSBS)
The Section 1202 Qualified Small Business Stock (QSBS) Capital Gains provision allows for individuals who have originally invested in a company with a value under $50M to exclude up to $10M in capital gains or 10 times their initial investment on their taxes, whichever is higher. Though it seems too good to be true, the provision allows for employees of startups to participate in this great benefit.
There are a few rules regarding who is allowed to participate, including:
Investor must have held the stock for a minimum of five years
The value of the Company at original cost does exceed $50M
At least 80% of the issuing corporation's assets must be used in the operations of one or more of its qualified trades or businesses
The firm must produce a tangible product
If an investor’s gain exceeds the $10M cap or 10 times the adjusted basis of the stock threshold, gains above those limits are subject to a 28% capital gains tax.
There are also stipulations regarding when the investor acquired the stock, including:
100% capital gains exclusion for QSBS acquired after Sept. 27, 2010. A 100% exclusion on capital gain applies, which also includes exclusions from the AMT and NII tax.
75% capital gains exclusion for QSBS acquired between Feb. 18, 2009, and Sept. 27, 2010. However, 7% of the gain is subject to AMT.
50% capital gains exclusion for QSBS acquired between Aug. 11, 1993, and Feb. 17, 2009. However, 7% of the gain is subject to AMT.
Example
If an employee acquired or purchased $2M worth of stock after On Jan 1, 2014, and have held the stock until Jan 1 2019, they would be able to sell this QSBS for up to $22M (10 times original investment + original investment) they would have a capital gain of $20M. Under QSBS rules, they would not owe any capital gains tax.
If they sold their stock for $23M, they would only pay a capital gains tax of 28% on the $1M over the threshold = $280,000.
Conclusion
For employees of tech firms that have held company stock for over 5 years, QSBS offers tremendous opportunity to save on capital gains taxes and maximize the net profit on that stock when they look to sell.
Want to see if the QSBS deduction applies to you? Reach out to one of our advisors and we would be happy to assist.