Living in Silicon Valley, most of us might have heard the stories of your friends becoming millionaires after numerous years’ toil and hardworking in startups. The windfalls of their wealth may get taxed by the government at a big portion if a tax planning is not done in advance. With respect to the capital gain derived from the disposition of the stock issued by startups, there are some strategies to save a huge amount of taxes. The following elaborates the logistics.
The law allows taxpayers to exclude from gross income a certain amount of gain recognized on the sale of QSBS. Generally, a taxpayer may exclude 50 percent of gain upon the disposition of QSBS that was issued after August 10, 1993. The amount of the gain exclusion increases to 75 percent for QSBS issued between February 17, 2009 and the passage of the Creating Small Business Job’s Act (“Jobs Act”) on September 27, 2010. The Code provides for 100 percent gain exclusion if the taxpayer acquired the QSBS after the passage of the Jobs Act and before January 1, 2014. In 2016, the 100 percent gain exclusion was made permanent.
The Code limits the amount of gain a taxpayer may exclude on the disposition of QSBS by Issuer. The taxpayer may exclude the greater of $10 million (reduced by gain excluded in previous years) or ten times the aggregate adjusted basis of the QSBS issued by the corporation and disposed of by the taxpayer in the same taxable year.
In order to be qualified as QSBS, there are many criteria required such as the stock holding period, companies’ annual revenue and other factors. For a thorough planning regarding such issues, a tax advisor should be needed.