Tax Planning with QSBS: Stacking Up the Benefits of 1202 March 2022
Capital gains taxes from the sale of a business can often run into several millions of dollars. A little-known but extremely useful tax planning strategy enables entrepreneurs to multiply the benefits of Section 1202 by restructuring how they hold their company stock. Section 1202, otherwise known as the Small Business Stock Gains Exclusion, generally provides for the full or partial exclusion of capital gain realized on the sale of qualified small business stock (QSBS). The rules are fairly nuanced, but taxpayers can exclude from capital gain either $10M or 10 times their basis in the stock sold if certain requirements are met. These limits are on a per taxpayer basis.
“Stacking” to multiply the $10M exclusion
While the tax savings from Section 1202 are beneficial, they are capped per “taxpayer”, thus exposing larger transactions to substantial taxes. A taxpayer for purposes of 1202 is an individual, trust, estate, partnership, or S corporation. Stacking involves increasing the number of taxpayers that can take advantage of an exclusion – entrepreneurs can effectively spread their company ownership amongst multiple individuals or entities. Each owner or “taxpayer” receives the same capital gains exclusion limit ($10M or 10x their basis), resulting in the potential for no Federal capital gains taxes being owed, even on much larger transactions.
$30M owner would owe ~$4M in Federal tax without “stacking”
The below diagram shows the tax savings and net proceeds that an individual selling their 1202 business for $30M would receive with no additional tax planning. The individual’s taxable gain is decreased by $10M, but they are still on the hook for $4M of Federal taxes.
“Stacking” saves the same owner $4M in Federal taxes
Compare this to the below example in which the business ownership is spread between three entities, including two carefully constructed irrevocable trusts. Each entity receives the full $10M exclusion, resulting in $0 Federal taxes.
Financial planning and tax strategies require careful consideration, expert advice, and are not without risk.
Disclosures: Miracle Mile Advisors LLC (“MMA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where MMA and its representatives are properly licensed or exempt from licensure. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. The principal risks of MMA’s strategies are disclosed in the publicly available Form ADV Part 2A. Values are approximate. The above example assumes a California resident, resulting in full realization of State capital gains tax.