{"id":411780,"date":"2024-11-07T14:12:08","date_gmt":"2024-11-07T14:12:08","guid":{"rendered":"https:\/\/seedlegals.com\/?p=411780"},"modified":"2024-11-07T14:12:08","modified_gmt":"2024-11-07T15:12:08","slug":"qsbs-for-investors","status":"publish","type":"post","link":"https:\/\/seedlegals.com\/us\/resources\/qsbs-for-investors\/","title":{"rendered":"QSBS for investors: Save millions in capital gains taxes on your startup investments"},"content":{"rendered":"","protected":false},"excerpt":{"rendered":"<p>If you invest in startups, you need to know about Qualified Small Business Stock (QSBS). It\u2019s stock issued by early-stage companies that gives you the potential for a 100% exemption on federal capital gains taxes, up to $10 million or 10 times your original investment amount, whichever is greater.<\/p>\n","protected":false},"author":169,"featured_media":411781,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[141],"tags":[],"event_tags":[],"class_list":["post-411780","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-uncategorized-us"],"acf":{"blog_layout":"v2","v2":{"hero":{"image_background_color":"#E7F1FF","image_fit":"img--cover"},"adverts":[{"type":"selector","selected_advert":{"ID":412070,"post_author":"77","post_date":"2024-11-11 09:48:00","post_date_gmt":"2024-11-11 09:48:00","post_content":"","post_title":"US - Talk to the team","post_excerpt":"","post_status":"publish","comment_status":"closed","ping_status":"closed","post_password":"","post_name":"us-newsletter","to_ping":"","pinged":"","post_modified":"2024-11-13 16:19:20","post_modified_gmt":"2024-11-13 16:19:20","post_content_filtered":"","post_parent":0,"guid":"https:\/\/seedlegals.com\/?post_type=blog_advert&#038;p=412070","menu_order":0,"post_type":"blog_advert","post_mime_type":"","comment_count":"0","filter":"raw"},"custom_advert":{"advert_tracking_id":"","layout":"default","image":{"image":false,"link":""},"text":{"heading":"","content":"","button":null,"background_color":"#EEF4FF","text_color":"#000646"},"form":{"form":{"type":"none","hubspot_form":{"layout":"newsletter","hide_founderinvestor_toggle":false,"default_community":"founder","custom_form_id":"","gdpr_disclaimer":"By subscribing, you agree to receive information from SeedLegals. You can unsubscribe anytime. View our <a href=\"\/privacy-policy\/\" target=\"_blank\" rel=\"noopener noreferrer\">privacy policy<\/a>"},"custom":{"embed":""},"gtm_form_type":false,"gtm_form_location":false}},"cta_and_testimonials":{"heading":"","button":null,"bullet_points":false,"testimonials":false}}}],"related_sidebar_posts":false},"show_author_card":false,"revision_date":"","hero_image":411781,"has_custom_post_authors":true,"custom_post_authors":{"authors":[{"author":{"ID":169,"user_firstname":"Idin","user_lastname":"Sabahipour","nickname":"Idin Sabahipour","user_nicename":"idin-sabahipour","display_name":"Idin Sabahipour","user_email":"idin@seedlegals.com","user_url":"","user_registered":"2024-08-29 09:55:07","user_description":"","user_avatar":"<img alt='' src='https:\/\/secure.gravatar.com\/avatar\/45fe33a1de890806e7ec6d8ac105288d6228c292c65cf28e96818af3496fd572?s=96&#038;d=mm&#038;r=g' srcset='https:\/\/secure.gravatar.com\/avatar\/45fe33a1de890806e7ec6d8ac105288d6228c292c65cf28e96818af3496fd572?s=192&#038;d=mm&#038;r=g 2x' class='avatar avatar-96 photo' height='96' width='96' loading='lazy' decoding='async'\/>"},"role":"Writer"},{"author":{"ID":172,"user_firstname":"Drew","user_lastname":"Macklin","nickname":"drewmacklin","user_nicename":"drewmacklin","display_name":"Drew Macklin","user_email":"drewmacklin@seedlegals.com","user_url":"","user_registered":"2024-11-08 15:39:57","user_description":"","user_avatar":"<img alt='' src='https:\/\/secure.gravatar.com\/avatar\/8bc81ff5103857f65325d50bbf7a4019afbc9a7a1d4020c1c5993bb03035bccb?s=96&#038;d=mm&#038;r=g' srcset='https:\/\/secure.gravatar.com\/avatar\/8bc81ff5103857f65325d50bbf7a4019afbc9a7a1d4020c1c5993bb03035bccb?s=192&#038;d=mm&#038;r=g 2x' class='avatar avatar-96 photo' height='96' width='96' loading='lazy' decoding='async'\/>"},"role":"Legal review"}]},"is_expert_reviewed":true,"expert_reviewed":{"heading":"Expert reviewed","tooltip_message":"This article has been fact-checked by a SeedLegals subject matter expert.<br><br><a href=\"\/us\/authors-and-experts\/\" target=\"_blank\">Meet our experts<\/a> and learn more about our review process and quality assurance in our <a href=\"\/us\/editorial-policy\/\" target=\"_blank\">editorial policy<\/a>."},"post_content_width":"default","post_content":[{"acf_fc_layout":"text","text":"<p>If you invest in startups, you <em>need<\/em> to know about Qualified Small Business Stock (QSBS). It\u2019s stock issued by early-stage companies that gives you the potential for a 100% exemption on federal capital gains taxes, up to $15 million or 10 times your original investment amount, whichever is greater. You can find the QSBS rules in <a href=\"https:\/\/uscode.house.gov\/view.xhtml?path=\/prelim@title26\/subtitleA\/chapter1\/subchapterP\/part1&amp;edition=prelim\" target=\"_blank\" rel=\"noopener\">Section 1202 of the Internal Revenue Code<\/a>.<\/p>\n<p>If you\u2019re investing in companies that meet the criteria, QSBS can give you substantial tax benefits, which means higher after-tax returns. So check that the company is QSBS compliant so you can get the benefits.<\/p>\n<p>In this article, we&#8217;ll cover how QSBS can help you as an investor and what you need to do to claim the tax relief.<\/p>\n<h2>How QSBS helps investors save capital gains tax<\/h2>\n<p><strong>You could pay less federal capital gains tax when you sell your stock<\/strong><\/p>\n<p>For federal tax, you can exclude 100% of the gain up to $10 million, or 10 times your original investment amount, whichever is greater. For example, if you make an investment of $500,000 that qualifies as QSBS, and later sell the stock for $5.5 million, you can exclude the entire gain of $5 million when calculating your federal capital gains tax (effectively saving $1,190,000 based on current federal capital gains tax rates of 20% plus the 3.8% Medicare surtax for high earners).<\/p>\n<table class=\" aligncenter\" style=\"height: 152px; width: 83.9508%; border-collapse: collapse;\">\n<tbody>\n<tr style=\"height: 56px;\">\n<td style=\"width: 37.2517%; height: 56px; border-color: #a8a8a8; text-align: center;\"><\/td>\n<td style=\"width: 23.5893%; height: 56px; border-color: #a8a8a8; background-color: #ececff; text-align: center;\"><strong>Without QSBS benefit<\/strong><\/td>\n<td style=\"width: 24.6635%; height: 56px; border-color: #a8a8a8; background-color: #c8c8fa; text-align: center;\"><b>With QSBS benefit<\/b><\/td>\n<\/tr>\n<tr style=\"height: 24px;\">\n<td style=\"width: 37.2517%; height: 24px; text-align: left; border-color: #a8a8a8; padding-left: 40px;\"><strong>Investment amount<\/strong><\/td>\n<td style=\"width: 23.5893%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #ececff;\">$500,000<\/td>\n<td style=\"width: 24.6635%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #c8c8fa;\"><span style=\"font-weight: 400;\">$500,000<\/span><\/td>\n<\/tr>\n<tr style=\"height: 24px;\">\n<td style=\"width: 37.2517%; height: 24px; text-align: left; border-color: #a8a8a8; background-color: #f0f0f0; padding-left: 40px;\"><strong>Sale price<\/strong><\/td>\n<td style=\"width: 23.5893%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #ececff;\">$5.5 million<\/td>\n<td style=\"width: 24.6635%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #c8c8fa;\"><span style=\"font-weight: 400;\">$5.5 million<\/span><\/td>\n<\/tr>\n<tr style=\"height: 24px;\">\n<td style=\"width: 37.2517%; height: 24px; text-align: left; border-color: #a8a8a8; padding-left: 40px;\"><strong>Capital gains taxable amount<\/strong><\/td>\n<td style=\"width: 23.5893%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #ececff;\">$5 million<\/td>\n<td style=\"width: 24.6635%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #c8c8fa;\"><span style=\"font-weight: 400;\">$0<\/span><\/td>\n<\/tr>\n<tr style=\"height: 24px;\">\n<td style=\"width: 37.2517%; height: 24px; text-align: left; border-color: #a8a8a8; background-color: #f0f0f0; padding-left: 40px;\"><strong>Capital gains tax paid<\/strong><em> (based on federal capital gains tax rates of 20% plus 3.8% Medicare surtax for high earners)<\/em><\/td>\n<td style=\"width: 23.5893%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #ececff;\">$1.19 million<\/td>\n<td style=\"width: 24.6635%; height: 24px; text-align: center; border-color: #a8a8a8; background-color: #c8c8fa;\"><span style=\"font-weight: 400;\">$0<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n"},{"acf_fc_layout":"text","text":"<p><strong>You could pay less state capital gains tax when you sell your stock<\/strong><\/p>\n<p>Many U.S. states conform to the federal QSBS rules, offering the same tax benefits at state level. For example, Delaware, New York, Colorado, and Connecticut conform to QSBS. If you\u2019re in a state that conforms to QSBS, you can also benefit from state tax exemptions, making your investment even more tax efficient. Not all states conform to QSBS, though (for example, California doesn\u2019t).<\/p>\n<p><strong>You could defer paying capital gains tax<\/strong><\/p>\n<p>If you sell your QSBS in one company and reinvest the proceeds into QSBS in another company within 60 days, you can defer paying taxes on the capital gains. Generally, you have to hold QSBS for 5 years to get the full benefit (more on that below). But if you reinvest your QSBS proceeds in this way, the five-year holding period continues from the earlier investment. So, if you hold QSBS in Company A for 2 years and then roll over to Company B and hold it for 3 more years, you meet the 5-year requirement. This rollover allowance means you\u2019ll have the flexibility to make new investments without facing any immediate tax bills.<\/p>\n<p><strong>You could pass QSBS tax benefits to your heirs<\/strong><\/p>\n<p>In some situations, you can transfer the QSBS tax benefits into trusts or directly to your heirs. This means your family can inherit the stock with no immediate tax consequences and they\u2019ll benefit from the QSBS exemption on capital gains when they eventually sell the stock. This offers better tax savings in the long run.<\/p>\n<p><strong>You could benefit from ordinary loss treatment with QSBS<\/strong><\/p>\n<p>If you sell QSBS at a loss, it can be treated as an ordinary loss rather than a capital loss. This means you can deduct it from your regular income, potentially lowering your overall taxes more effectively than if it were considered a capital loss.<\/p>\n<p><strong>You could receive Alternative Minimum Tax (AMT) relief<\/strong><\/p>\n<p>AMT makes sure that individuals and companies pay a minimum amount of tax, even after deductions and exemptions. Normally, capital gains relief can impact AMT calculations, but the QSBS exclusion also applies to AMT. This can give you an extra tax relief.<\/p>\n"},{"acf_fc_layout":"content_highlight","highlight_type":"tip","background_colour":"blue","show_icon":true,"content":"Not sure if the companies you\u2019re investing in are set up to issue QSBS? Share our article on <a href=\"https:\/\/seedlegals.com\/us\/resources\/qsbs-for-founders\/\" target=\u201d_blank\u201d>QSBS for founders<\/a> with them \u2013 it covers what they need to do to qualify for QSBS.","link":null},{"acf_fc_layout":"text","text":"<h2><strong>How to qualify for QSBS tax relief<\/strong><\/h2>\n<p>There are a few requirements you (and the companies you\u2019re investing in) need to satisfy to qualify for QSBS. For most startup investments, these should be achievable.<\/p>\n<ol>\n<li><strong>The company must be a C-corporation<\/strong>: Only C-corporations are eligible to issue QSBS. S-corporations and LLCs do not qualify (foreign corporations are also not eligible). Most startups are set up as Delaware C-corporations, so this shouldn\u2019t be an issue. If the company\u2019s not set up as a C-corporation, check out the FAQs below where we explain what they need to do.<\/li>\n<li><strong>The company\u2019s assets must not exceed $75 million<\/strong>: The company\u2019s gross assets, including cash and other assets valued at their original cost (plus any investment that\u2019s being raised at the time) must not be more than $75 million at the time the stock is issued. Most companies at the start of their journey won\u2019t have more than $75 million in assets, so again, this should be okay.<\/li>\n<li><strong>The company must be an active business<\/strong>: At least 80% of the company\u2019s assets must be used in the operations of its qualified business, which excludes activities that generate passive income (like owning property and collecting rent). For startups raising investment to grow their business in a normal way, this requirement should usually be satisfied.<\/li>\n<li><strong>The company must not be in an excluded industry<\/strong>: Service businesses like healthcare, law, and financial services generally can\u2019t qualify for QSBS. A full list of excluded businesses can be found at <a href=\"https:\/\/uscode.house.gov\/view.xhtml?path=\/prelim@title26\/subtitleA\/chapter1\/subchapterP\/part1&amp;edition=prelim\" target=\"_blank\" rel=\"noopener\">Internal Revenue Code Section 1202(e)(3)<\/a>.<\/li>\n<li><strong>For stock issued after July 4, 2025, partial QSBS tax exclusions may be available after 3 or 4 years, with the full exclusion generally available after 5 years<\/strong>: If you\u2019re investing through SAFEs or convertible debt, check out the FAQs below where we explain how this impacts the five-year hold requirement.<\/li>\n<li><strong>You must receive the stock from the company<\/strong>: You must have been issued stock directly from the company (both common and preferred stock can qualify for the relief). This means you don\u2019t get any QSBS benefit if you acquire the stock through a secondary market transaction (for example, if you buy it from another investor\u200b).<\/li>\n<\/ol>\n<h2>FAQs for investors<\/h2>\n<p>Here are some questions you might be asking.<\/p>\n<p><strong>How can I be assured that my investment qualifies for QSBS?<\/strong><\/p>\n<p>It\u2019s important to check that the company qualifies to issue QSBS before receiving stock. You could request representations and warranties from the founders in the investment documents which state they comply with the QSBS requirements. We\u2019ve also written this article on <a href=\"https:\/\/seedlegals.com\/us\/resources\/qsbs-for-founders\/\" target=\"_blank\" rel=\"noopener\">QSBS for founders<\/a> which you can share with companies you\u2019re interested in investing in \u2013 it covers what they need to do to qualify.<\/p>\n<p><strong>Can QSBS be held by a company or does it have to be held by an individual?<\/strong><\/p>\n<p>QSBS is designed to be held by individuals. It can be owned by pass-through entities like trusts, partnerships, and S-corporations, but there are limitations and additional requirements. For example, for trusts, the tax benefit can only apply to the beneficiaries if they were beneficiaries at the time the stock was issued. You can find more about QSBS being held by entities at <a href=\"https:\/\/uscode.house.gov\/view.xhtml?path=\/prelim@title26\/subtitleA\/chapter1\/subchapterP\/part1&amp;edition=prelim\" target=\"_blank\" rel=\"noopener\">Internal Revenue Code Section 1202(g<\/a>).<\/p>\n<p><strong>Does a SAFE qualify as QSBS?<\/strong><\/p>\n<p>SAFEs can <em>potentially qualify<\/em> as QSBS, but there is some uncertainty around this. QSBS can only apply to &#8220;stock,&#8221; and it\u2019s not certain whether the Internal Revenue Service (IRS) classifies a SAFE as &#8220;stock&#8221;. This distinction is important because of the requirement to hold QSBS for five years to achieve the full benefit (only partial tax exclusions can be made available after 3 or 4 years). If a SAFE is considered &#8220;stock,&#8221; the five-year clock starts from the moment the investor enters into the SAFE. If not, the clock only starts from when the SAFE converts to equity in the company at the point it\u2019s issued to the investor. So, it depends on how the IRS classifies it. The Y Combinator SAFE, for instance, is intended to be treated as &#8220;stock,&#8221; but this characterization isn\u2019t binding on the IRS. If you\u2019re a SAFE investor and want to ensure you get QSBS relief sooner, you should consider converting the SAFEs into stock as soon as possible. This way, you reduce the uncertainty around whether the SAFE itself is treated as &#8220;stock\u201d. In any case, it\u2019s always worth consulting with your tax advisor for their view on the knock-on effects of treating SAFEs as \u201cstock\u201d for tax purposes.<\/p>\n<p><strong>Does convertible debt qualify as QSBS?<\/strong><\/p>\n<p>Convertible debt doesn\u2019t qualify as QSBS until it\u2019s converted into stock. The five-year holding period for QSBS starts only when the convertible debt is actually converted into stock. As with SAFEs, you could convert the debt into stock to trigger the five-year holding period required for QSBS.<\/p>\n<p><strong>I\u2019m a non-US resident. Can I benefit from QSBS as an investor?<\/strong><\/p>\n<p>Not unless you\u2019re subject to US capital gains tax (for example, this could happen if you have a permanent establishment in the US). So, if you\u2019re a foreign investor and aren\u2019t required to file a US federal income tax return, you can\u2019t take advantage of QSBS tax relief. You should consult a tax professional to understand your specific tax obligations.<\/p>\n<p><strong>The company I\u2019m investing in didn\u2019t initially set up as a C-corporation. Can it still benefit from QSBS?<\/strong><\/p>\n<p>Only C-corporations can issue QSBS, but a company can convert from another structure (such as an LLC or an S-corporation) to a C-corporation and issue QSBS (as long as the other criteria are met). <a href=\"https:\/\/seedlegals.com\/us\/resources\/how-to-get-up-to-500m-in-federal-tax-relief\/\" target=\"_blank\" rel=\"noopener\">There&#8217;s more on how it works in this article.<\/a><\/p>\n<p>Also, if you were issued stock before conversion to a C-corporation, you could still benefit from QSBS on that. The gains on that stock before the conversion won\u2019t qualify for QSBS. But gains on the stock after the conversion can qualify for QSBS (provided the company meets the other requirements).<\/p>\n<p>For example, say you own 100 units in an LLC, which grow in value to $5 million. Then, the LLC converts to a C-corporation. After the conversion, the company grows further and your stock is sold for $30 million. In this case, QSBS could apply to the $25 million gain that accrued after the conversion, but not to the initial $5 million from when the company was an LLC.<\/p>\n"},{"acf_fc_layout":"content_highlight","highlight_type":"tip","background_colour":"blue","show_icon":true,"content":"Most companies should keep it simple and start as a C-corp to qualify for QSBS. <br \/>\r\n<br \/>\r\nBut if the founders are experienced or have enough money to grow without VC investment, there may be some benefit for starting as an LLC and converting later.<br \/>\r\n<br \/>\r\nIt\u2019s a more complex path but it could unlock greater tax savings.<br \/>\r\n<br \/>\r\nHere\u2019s our article on the <a href=\"https:\/\/seedlegals.com\/us\/resources\/how-to-get-up-to-500m-in-federal-tax-relief\/\" target=\"_blank\">$500 million QSBS tax saving strategy<\/a> to see when it makes sense (and the trade-offs involved).","link":null},{"acf_fc_layout":"text","text":"<p><strong>If the company I\u2019m investing in is raising funds, does the $75 million limit for QSBS include the new investment?<\/strong><\/p>\n<p>Yes, the $75 million gross assets limit for QSBS does include the funding the company receives. If the company&#8217;s assets, including the new investment, are greater than $75 million, the stock will not qualify as QSBS. But if you\u2019re issued stock that qualifies as QSBS, and further down the line the company\u2019s gross assets exceed $75 million, this doesn\u2019t affect the QSBS status of the stock issued before. To deal with a fundraise that might push assets beyond the $75 million limit, the company can issue stock in tranches. It can issue a first tranche of enough QSBS to keep it below the $75 million limit. Then, a day or more after, it can issue a second tranche of non-QSBS which can take it above the $75 million limit. This approach lets you maximize the QSBS investment without risking its eligibility.<\/p>\n<p><strong>The assets of the company you&#8217;re investing in exceeded $75 million but have now fallen below it. Can it issue QSBS?<\/strong><\/p>\n<p>No, if the company&#8217;s gross assets exceed $75 million at any point, it can no longer issue QSBS.<\/p>\n"},{"acf_fc_layout":"text","text":"<h2 style=\"text-align: center;\"><strong>Got any questions? We\u2019ll get them answered<\/strong><\/h2>\n<p style=\"text-align: left;\"><a href=\"https:\/\/seedlegals.com\/us\/talk-to-us\/\" target=\"_blank\" rel=\"noopener\">Book a free call with our team<\/a> to find out how we can help with your fundraise.<\/p>\n<p>Want to try SeedLegals for free first? <a href=\"https:\/\/app.seedlegals.com\/signup\" target=\"_blank\" rel=\"noopener\">Start your 7-day free trial<\/a>.<\/p>\n"},{"acf_fc_layout":"form","layout":"custom","heading":"Get answers fast, for free","content":"Bring all your questions - we\u2019ve got the answers!\r\nWe\u2019ll match you with the right specialist.","custom":{"image":false,"button_text":"Get Started","form":{"type":"hubspot","hubspot_form":{"layout":"default","hide_founderinvestor_toggle":false,"default_community":"founder","custom_form_id":"21723609-6f1b-45c0-9691-77d462dc3bed","gdpr_disclaimer":"By subscribing, you agree to receive information from SeedLegals. You can unsubscribe anytime. View our <a href=\"\/privacy-policy\/\" target=\"_blank\" rel=\"noopener noreferrer\">privacy policy<\/a>"},"custom":{"embed":""},"gtm_form_type":"default","gtm_form_location":"default"}},"add_shadow":true}],"has_sources":false,"related_posts":false},"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v28.3 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Qualified Small Business Stock (QSBS) guide for investors | SeedLegals<\/title>\n<meta name=\"description\" content=\"Qualified Small Business Stock helps investors save on capital gains taxes from startup investments. 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