{"id":414015,"date":"2024-12-30T16:05:59","date_gmt":"2024-12-30T16:05:59","guid":{"rendered":"https:\/\/seedlegals.com\/?p=414015"},"modified":"2024-12-30T16:05:59","modified_gmt":"2024-12-30T17:05:59","slug":"can-a-safe-qualify-as-qualified-small-business-stock","status":"publish","type":"post","link":"https:\/\/seedlegals.com\/us\/resources\/can-a-safe-qualify-as-qualified-small-business-stock\/","title":{"rendered":"Can a SAFE qualify as Qualified Small Business Stock?"},"content":{"rendered":"","protected":false},"excerpt":{"rendered":"

Investors seeking to maximize their tax saving are asking whether a Simple Agreement for Future Equity (SAFE) be considered \u201cstock\u201d under Section 1202 of the Internal Revenue Code.
\nIt\u2019s not clear how SAFEs are treated for tax purposes in relation to qualified small business stock (QSBS). In th<\/p>\n","protected":false},"author":169,"featured_media":414267,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[141],"tags":[],"event_tags":[],"class_list":["post-414015","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--contain"},"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&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 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":414267,"has_custom_post_authors":true,"is_expert_reviewed":true,"post_content_width":"default","post_content":[{"acf_fc_layout":"text","text":"

Investors seeking to maximize their tax saving are asking whether a Simple Agreement for Future Equity (SAFE) be considered \u201cstock\u201d under Section 1202 of the Internal Revenue Code<\/a>.<\/p>\n

It\u2019s not clear how SAFEs are treated for tax purposes in relation to qualified small business stock (QSBS). In this article, we\u2019ll explain why SAFEs can be tricky when it comes to QSBS treatment, plus what can be done to give stockholders the best chance of qualifying for the tax relief.<\/p>\n"},{"acf_fc_layout":"text","text":"

What is the QSBS exemption?<\/strong><\/h2>\n

The QSBS tax exemption lets investors in eligible small businesses exclude eligible capital gains from federal tax \u2013 up to $15 million, or more, where the 10x investment basis rule applies.<\/p>\n

For startup investors and founders, this exemption can mean the difference between a large tax bill and a tax-free gain.<\/p>\n

Take a look at our articles on QSBS for investors<\/a> and QSBS for founders<\/a> for a deep dive into this topic, which explains it in more detail.<\/p>\n"},{"acf_fc_layout":"text","text":"

What is a SAFE (and how does it differ from stock)?<\/strong><\/h2>\n

SAFEs are a popular choice for investing in early-stage startups. Unlike traditional equity, a SAFE gives investors a right to future stock in the company, usually activated by a triggering event (typically, it\u2019ll be a priced funding round).<\/p>\n

But SAFEs don\u2019t have some of the rights that come with equity \u2013 they don\u2019t offer ownership, voting rights, or a place on the company\u2019s cap table until a triggering event converts them into stock.<\/p>\n

This hybrid nature \u2013 being \u2018future equity\u2019 without immediate ownership \u2013 is why there are questions of whether the IRS might recognize SAFEs as \u201cstock\u201d for the QSBS exemption.<\/p>\n"},{"acf_fc_layout":"text","text":"

Why does it matter if SAFEs are considered \u201cstock\u201d?<\/strong><\/h2>\n

The length of time an investor holds Qualified Small Business Stock (QSBS) can affect the tax benefit they receive. For stock issued after July 4, 2025, investors may qualify for partial QSBS tax exclusions after 3 or 4 years, with the full exclusion generally available after 5 years. Stock issued before this date may continue to follow the previous QSBS rules.<\/p>\n"},{"acf_fc_layout":"content_highlight","highlight_type":"tip","background_colour":"blue","show_icon":true,"content":"Holding periods for stock issued after July 4, 2025:
\r\n
\r\n3 years \u2192 50% exclusion
\r\n4 years \u2192 75% exclusion
\r\n5 years \u2192 100% exclusion","link":null},{"acf_fc_layout":"text","text":"

Say we have two investors, Alex and Jenny, each investing $100,000 in a startup in 2023. Alex buys preferred stock, while Jenny opts for a SAFE that’s expected to convert into stock during a priced round in 2025.<\/p>\n

Because Alex receives stock at the time of investment, his QSBS holding period begins in 2023. Depending on when he sells his shares, he may qualify for a partial or full QSBS tax exclusion.<\/p>\n

Jenny’s holding period is less certain. If the Internal Revenue Service (IRS) determines that a SAFE doesn’t constitute stock until it converts, her QSBS holding period wouldn’t begin until 2025, when the SAFE converts into shares. That means she’d reach each QSBS holding period milestone two years later than Alex.<\/p>\n

That’s why it’s important to understand whether a SAFE is considered “stock” for QSBS purposes. It can directly affect when an investor becomes eligible for QSBS tax benefits.<\/p>\n"},{"acf_fc_layout":"text","text":"

Why is it uncertain whether SAFEs qualify as QSBS?<\/strong><\/h2>\n

The IRS hasn\u2019t clarified whether SAFEs can be considered \u201cstock\u201d for QSBS purposes (they\u2019ve not announced any plans to issue guidance on this either). This leaves SAFEs in a bit of a gray area.<\/p>\n

Here are the main arguments for and against their qualification.<\/p>\n

Why SAFEs might qualify as QSBS<\/strong><\/h3>\n