Ep. 148 | Unveiling A Hidden Goldmine: QSBS Tax Exemption
Download MP3Hey, everybody, and welcome back to the podcast episode 148. Today, we're looking at something that some consider to be too good to be true. That's right. We're looking at section 12 o two from the IRS, QSBS. It's got a nice little ring to it. You're gonna learn more about it here in a moment with a great guest. But as always, let's take a brief moment and thank our episode sponsor.
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John Tripolsky:Hey, everybody, and welcome back to the Teaching Tax Flow podcast. Obviously, you know why we're here because, hopefully, you can read the title and the show notes if you dug in a little bit deeper. But on this topic, we got another good one, one that you may not expect from us with some of the content that we've been doing recently, but we promise it all ties together. And, Chris Pacquero, welcome back to your own show, sir. You know, we we do open the door for you every once in a while, you know, to to let you come back. So welcome.
Chris Picciurro, CPA:Well, I appreciate it. I'm really excited about our special guest this week. Couple of things. Remember, within teaching tax flow, we have three laws. One of the three laws is that that cash flow and tax flow are different, meaning not not all income is taxed the same.
Chris Picciurro, CPA:And one of the things we wanna focus on is not just tax deferral, not just tax, you know, putting money away into retirement, which could be important, but strategies for people, especially business owners that we're gonna talk about today to, enjoy tax free income, tax free capital gains. There aren't that many spots in the tax code that allow for this. One of the other laws is that that tax agencies are our involuntary business partner, and tax laws are written to encourage and discourage certain social, economic, environmental behavior. And one of the tax laws that we're gonna dive in into today, can really, really help those small business owners, small to medium sized business owners. Actually, lot of different business owners.
Chris Picciurro, CPA:And we get a lot of questions in the teaching tax flow community, not just in the on the private Facebook group, but in our private CPA practice. They really usually, the question is is that that the entrepreneur doesn't know what the heck they're asking about. Right? But they're what they're asking is, hey. I heard there's a way to to not pay tax on millions of dollars of gain when I sell my company, and they don't they might hear about QSBS or they might hear about section, 12 o two or, but they they don't really know what they're talking about.
Chris Picciurro, CPA:They just heard that they that that they might be able to take advantage of this, and and that's why we bring in the best guests. So so exciting. So excited.
John Tripolsky:You're so excited. I can't even get the words out, man.
Chris Picciurro, CPA:I'm so good. Right. I you know, John, you know, and and Brady, he's got Brady Weller's with us from QSPS rollover. I'm so excited to have him. And, John, you know that I've been waiting for this topic for for a long time.
Chris Picciurro, CPA:We've been really looking for that right person, and Brady is the man. So welcome to the teaching tax flow show, Brady.
Brady Weller:Thanks, John. Thanks, Chris. Appreciate it. Yeah. I love your content. Glad to be on.
John Tripolsky:Yeah. Yep. So, Brady, basically, Chris is so excited about this. Right? Like, this is kind of his, I guess, call it, like, the white whale content, very similar to the one that I put on the list a couple months back that he absolutely did not wanna do.
John Tripolsky:And I I used some, very bold I think I bolded him, italicized him, and put him in red. No complaining when, when I threw some topics in there. So this is his version of, of mine on the Venmo tax. So let's, don't let him down, sir. Don't let him down because I have to deal with him crying afterwards. So
Brady Weller:Yeah. I mean, Chris, you mentioned, like, you know, thing tax mitigation, especially capital gains tax mitigation that most people maybe know about and from listening to your content, some others content like opportunity zones, ten thirty one exchanges, QSPS fits right right in there, but it's even more powerful. So excited to jump in.
Chris Picciurro, CPA:Yeah. Well, can you give us a little bit of history? I a little birdie told me that you're a Baltimore Oriole fan, and we are recording this on your birthday.
Brady Weller:So Yeah.
Chris Picciurro, CPA:We're gonna we're gonna yeah. So for you you for those of you watching on YouTube, you could see, is that Camden Yard?
Brady Weller:Yep. This is opening day 1992 at Camden Yards. Well, it's a painting, but, I guess someone was up in the up in the box, sketching it out. So
Chris Picciurro, CPA:Yeah. It's a gorgeous, gorgeous, state of John and I actually were there a few years ago for a conference. We got to go in one of the boxes. It's just a that it's just not even it's a it's more than a stadium, but it's just a an awesome area. But
Ad Read:Basically a landmark.
John Tripolsky:Is. Come up with anything else.
Chris Picciurro, CPA:Yeah. It's been it's really nice. Tell us about a little bit about yourself, how you got into this QSBS space, and and what excites you about it.
Brady Weller:Yeah. Of course. Again, thanks for having me. We were running a a different business, actually, in the alternative asset space. So several years ago, was an early employee at a firm that was doing wine and spirits investing, and we still are working on parts of that entity, but today we do QSPS exclusively and that was a really big pivot for us but we came across qualified small business stock while we were exploring the alternative asset space back then.
Brady Weller:We had a family office who was making a lot of early stage investments and we were talking with them about QSPS. Ultimately, we started diving deeper, we found QSPS rollovers, which I'll dig into today. And we realized that it was again the most powerful tax exemption in The United States, but there was basically no infrastructure around advisors helping people to maximize it. When you think of ten thirty one exchanges in real estate or you think of opportunity zones or qualified opportunity zone funds, there's massive infrastructure both among financial advisors, attorneys and whatnot to support that industry, and there is absolutely none of that in the QSPS space. You'll find about 75 attorneys across the country who have any kind of advanced knowledge about QSPS and probably another 75 CPAs.
Brady Weller:And so I've spent the last two and a half years doing functionally nothing else except digging into QSPS, and we've developed a set of services to allow business owners exiting to capitalize on it if they qualify. So
Chris Picciurro, CPA:Awesome. And can you give us a 30,000 foot view of what QSPS is, and and what type of business owner should be should be thinking about this?
Brady Weller:Sure. Yeah. There are some you know, it's not one size fits all, but there some indications that a business or a type of stock might qualify. And so we're only looking at C Corps, so this is stock issued from C Corps that has been held for at least five years traditionally. So qualified small business stock is income tax exemption that can be claimed up to $10,000,000 mostly for founders or 10x the basis in the stock.
Brady Weller:I always use $10,000,000 because founders have no basis in their stock, they got it on day one. So for the purpose of this $10,000,000 exclusion, if you hold c corp stock for five years and you are not operating in a excluded business category. Those are businesses like financial services, medical services like doctor's offices, real estate, other investment companies. So tech, manufacturing, e commerce, any of those types of businesses qualify, and more than 90%, 95 or more of venture backed startups are gonna qualify for this exemption.
Chris Picciurro, CPA:Wow. And is that exemption per entity, per shareholder, and and are there and do you
Brady Weller:have to be the original shareholder to qualify? You do have to be the original shareholder. That is your stock has to be issued directly from the corporation. Okay. So founders obviously got their stock on day one.
Brady Weller:Early employees who exercise their options and take hold of stock would start their QSPS clock ticking. Nice. Now outside investors who purchase a minority interest seven years into the business through a secondary channel, they're not getting that stock original issuance, so they would not qualify. But the benefit applies per entity, so per issuer of stock, as well as per shareholder, which means that if John makes five different angel investments in five different companies, he might have five different $10,000,000 QSPS exclusions per investment that he's made.
Chris Picciurro, CPA:Wow. So so if he an individual could have multiple QSPS exemptions if but then if the $10 limit Yeah. Parenthly.
Brady Weller:Yeah. If he knocks it out of the park on all five of those angel investments and makes $8,000,000 on his $50,000 check-in each of them, That 8,000,000 is federal income tax exempt. And, John, I don't know if you pay taxes in Tennessee or where, but, probably state, tax exempt as well as long as you're not in California or Pennsylvania. Yeah.
John Tripolsky:And if that ever happens, I'm gonna completely hide my hide my crystal ball in the closet so nobody else can
Chris Picciurro, CPA:find it.
Brady Weller:Not gonna be on the tax flow podcast if he hits a, you know, $40,000,000 exit.
John Tripolsky:No. We're we're going to a cardboard cutout of me
Chris Picciurro, CPA:There you go.
John Tripolsky:At that point. So
Chris Picciurro, CPA:We would we would ask him to be a sponsor at that point. Nice. We named the studio after him.
John Tripolsky:There you go.
Chris Picciurro, CPA:That's up for grabs right now.
Brady Weller:So QSPS is that's section 12 o two. I know you mentioned the numbers early on. And some people, you know, when you're Googling around, you might see section twelve oh two, which is the code text or you might see qualified small business stock, QSPS. Now, there is another part of the code and that's what our firm works explicitly on and that's the number of the code is ten forty five and it's called QSPS rollovers is what we call it. Some people call it a ten forty five rollover.
Brady Weller:And what that means is you can actually take the gains from the sale of qualified small business stock, the type of stock that I described and you can reinvest those gains into new qualified small business stock. So if your listeners are familiar with the ten thirty one exchange where you take gains from a sale of property and roll it into like kind property, This is the ten thirty one exchange for company stock. Now the reason why someone would wanna do this is because when you do a QSPS rollover, it allows you to continue your holding period, meaning if you sell stock in your company at year three and you say, man I didn't reach the five year period for the QSPS exemption, now I owe taxes, you actually have sixty days to reinvest that money into new stock and it will continue your holding period. Maybe you hold that new stock for four years, so you're at a combined seven and then you exit, now you can take your exclusion because those holding periods tack on. So it's extremely powerful but it's not powerful if there are no good rollover options.
Brady Weller:So traditionally it's like, hey I exited my startup at year three, I have this big tax bill but I'm not gonna just go invest in John's startup, like he's gonna burn my money statistically or they're gonna fail statistically, so that's not a good tax planning tool, right? So when we step back and we looked at the code here, we said, hey, why is there so much infrastructure and help for people to execute other kinds of tax exemptions and there's none for QSPS and QSPS rollovers? And so we dreamed and we said, hey, what if there existed an always available downside protected and highly defensible option for people to execute these rollovers? We think internally that founders leave around $15,000,000,000 on the table every year because they don't maximize QSPS. We will see about $3,000,000,000 worth of exit volume next year from founders with this exact problem is our estimate.
Brady Weller:And from September to May, we saw more than a billion dollars just in the first, call it, six months of us running our newest program. Wow. Wow. Massive problem.
Chris Picciurro, CPA:No. It is because I we I'm in being a CPA firm owner for over twenty years, most let's put this aside. Most people that exit their business or get an offer, sometimes an offer that they can't refuse to exit their business, typically, c corps aren't used as much, or they didn't realize five years in advance that they were gonna get it. So the practical problem that solves is I've got a c I've got someone that's positioning as as a and and maybe elects for their LLC to be taxed as a c corp Mhmm. Two, three years ago, you're solving the problem that they didn't see five who the x sees five years in advance when you're a business person.
Chris Picciurro, CPA:Right? So you're kinda helping solve that that problem for them where
Brady Weller:they could still qualify for the QSPS. Yeah. Now, frankly, we work on the coasts just because, like, venture in New York or venture in California, and that's just right down the fairway for folks who are gonna qualify. But we're seeing so much more in Chicago, in Denver, in Austin, in Miami, in DC, Virginia, know, startup ecosystems are blooming in those places. Our bread and butter are the coasts because that's how sort of the capital is played out, but if you have a pass through entity, maybe you have an S Corp, you know a lot of these family businesses looking to exit in the next call it three to five years or looking to make a generational transition in the next three to five years, then you do sort of have an idea of hey, can we move things around, convert to a C Corp, reissue some new stock, reformat things here as we plan for an exit.
Brady Weller:Now it doesn't work for every industry because you do need to do a stock sale in order to execute QSBS. So I know for many of our listeners who have service businesses, any exit just isn't going to be a stock sale, it's gonna be an asset sale of some kind. But there are, you know, ways that you can fashion deals to make it work, and it it's certainly worth exploring given the benefits.
Chris Picciurro, CPA:And and a lot of the people that do more more asset sales and stock sales might be in an industry that aren't gonna is not gonna qualify for QSPS anyway. So
John Tripolsky:It's possible.
Brady Weller:Yeah. It's possible.
Chris Picciurro, CPA:You're you know, that so can can talk can you talk kinda through the mechanics? So, obviously, you know, someone that has a qualifying business, five year hold period can exclude up to the $10,000,000 of capital gain. Remember, it has to be a and we have some content on this, a stock sale, not an asset sale. Now a lot of times, what we're seeing in many of the industries is stock sales are becoming a little more prevalent because of, like, contracts. You you might have a contract with an entity that's not transferable to another one.
Chris Picciurro, CPA:So that that could be the that could be the case, or the c corp might have r and d credits carrying forward or NOLs. You know, there could be some tax attributes in that c corp that the the acquiring company would like. But how would can you tell us about some maybe, you know, a little more on the rollover mechanics just from a, like, a 30,000 foot PO game. Like, hey. I've I've got a tell us a client success story.
Chris Picciurro, CPA:Obviously, I'm gonna say what it means, but, yeah, that's that's probably the best teller of of someone that maybe has been working for two or three years and
Brady Weller:as a c corp or in in Well, we working out. We're we're seeing these all the time right now because of a the AI boom. I've seen full exits in less than a year. I've seen, you know, $100,000,000 plus seed in series a rounds, which, you know, are extremely large. Opportunities for founders to be taking large amounts of liquidity via secondary at series a.
Brady Weller:So mainly talking about venture backed businesses here, and I can tell you, give you an idea of a success story from maybe a place like New York where for larger exits, the combined federal and state tax rate can be 35, 37%. And so on $10,000,000, you're looking at a $3,500,000 tax bill. So say a founder in New York exits for $5,000,000 at year three, they have an AI business and they sold it to a larger company. At $5,000,000 they're on the hook for a 7 figure tax bill, taking that money, literally the cash that got wired to them, they would come to typically if they're working with us, they would come to us and say, hey, I wanna do a QSPS rollover, we'd say great, you have a couple of different options, You can make an angel investment or deploy capital to an outside business. We've described maybe not the best for most people situations, but there are two other things you can do.
Brady Weller:One, you can start your own new company and issue yourself stock in a new business just like you did when you founded your first company and you can immediately start running that in a qualified sector and that can be your rollover. Or you can start a new company and you can do market research and development work to go out and identify a business that you could acquire or start. The IRS is actually gonna give you a safe harbor period, call it like a rolling two to three year ish period where they're gonna say, hey, all of that research and development, that startup work, that exploration for a business to acquire, we're gonna call that working capital for these purposes and so you get QSBS credit for that. So that's a really interesting option. Now, something you can't do is just create a new c corp, throw money in there, sit in Cabo and say, yeah, I'm emailing some folks about buying their business.
Brady Weller:Right. We believe that the bar is extremely high for substantiating these and the larger the numbers get, a couple $100,000, fine, but you get into several million dollars, a little bit harder to substantiate that yeah, I'm actually going out and doing R and D work. And so that's what our firm does, We do end to end rollover compliance, substantiate substantiation and market research in order to justify the use of proceeds in your new rollover entity.
Chris Picciurro, CPA:It's a couple. Yeah. Oh, no. That makes sense. So just like we talked about, it's you know, ideas are cheap.
Chris Picciurro, CPA:Implementation's valuable. Yep. So having the right implementation partner like like your firm is important. You can't I do have a question. So when when someone does let's say they're doing the QSPS rollover.
Chris Picciurro, CPA:They sell their company stock. They get wired, you know, for, let's say, $8,000,000. Does that have to go through a call an intermediary similar to a ten thirty one exchange, or can they does it can it hit their bank account and then they they try to do a rollover?
Brady Weller:Yeah. It's actually they can just do it directly, and it's fungible as well, which means that you could get that money, you could throw that $8,000,000 in a treasury account, then you could pull a line of credit off of it and use the money from the line of credit. Like yeah, it's completely fungible, $8,000,000 and the rollover is a claim that you would make on your schedule D when you file your taxes. And so someone has their exit that $8,000,000, they have that $8,000,000 gain recorded, They're gonna work with their CPA to write, you know, below it. Basically, we're claiming $10.45.
Brady Weller:We're claiming a QSPS rollover and a gain deferral. What that means is if you do that within sixty days, whether you roll over $8,000,000 or $5,000,000 whatever portion, you can claim that as a deferral for the period that you're in that new business. And then down the line, maybe you hold that stock for another four years and then you get liquid again, pull it out. At that point, you'll be able to claim your tax exemption under section 12 o two on QSPS. So a rollover in itself is a continuation of QSPS and tax deferral, and then QSPS is ultimately what gets you to the exemption.
Chris Picciurro, CPA:Oh. And so if you're a tax professional and you have clients out there that you think Brady and his his team could work with, just reach out to us. If you're a business owner, you're thinking about exiting. Are there are there I I have two more questions, and I know we'll then we'll wrap it up. Are there related any type of, like, related party rules or or, you know, let's say I'm a I'm selling my stock to, one of my children.
Chris Picciurro, CPA:Yeah.
Brady Weller:Yes. That can come up and and really it's gonna come up when we're talking about, yeah, related party sales and conversions. So we wanna be careful with those transactions, we wanna be careful with the purchase, the sale, the reissuance of stock, all those sort of events that happen maybe on the balance sheet of the company, whether they're buybacks or redemptions, any of those types of transactions. If you have QSPS in mind, you're going to want to work with someone to pay attention to the implications there. We have maybe the broadest network in the country of those 75 folks in each camp, CPAs, attorneys, people who can help you navigate that.
Brady Weller:And we do free consultations in terms of checking out your situation and helping to point you in the right direction. So if you've heard me talking about venture and you say, well, that just doesn't apply, still worth reaching out and seeing what the options could be.
Chris Picciurro, CPA:And my final question is we wrap it up because a lot of people, want would like to know. Oh, you know, has has, OB three changed or or or allowed this to continue? Is this something that we have to do in before 2026? What's the future of of QSBS look like kind of, you know, that from a broader view?
Brady Weller:Yeah. Section 12 o two of QSBS started in '93. It was expanded to where it is well, was earlier this year by the Obama administration in 2010, 2011, and then it's been expanded again. And so back when it was expanded maximally the first time, it was a Democratic administration, Democratic Senate. Now we have it in a Republican White House and Republican Senate, expanded once again, seen bipartisan support for twenty five years or more, and rollover is the same.
Brady Weller:Rollovers were implemented in 1997. So we're extremely confident in the long term health of QSPS. It's clear that both sides of the aisle want to incentivize innovation and entrepreneurship and deployment of capital. So yeah, OBBBA made QSPS even more powerful, it expanded the exclusion cap from $10,000,000 to $15,000,000 per person per issuer, and it expanded the gross asset test. So when you talk about small business, these businesses issuing eligible stock have to be, used to have to be under $50,000,000 in gross assets, that's been expanded to $75,000,000 which means that for venture backed businesses probably up to series B and maybe even beyond depending on the size of fundraisers, they're gonna keep issuing that eligible stock.
Brady Weller:And the last thing is there's been a tiered exemption implemented, which means that if you have stock issued after July 4, when this went into effect, even if you hold for three years, you can take a 50% exclusion, four years a 75% exclusion, and five years that 100% tax exclusion up to $15,000,000 goes into effect. So, yeah, that's all stock issued after July 4. For most people we're talking to, that's just not in play yet. But over the next year, one to three years, we're gonna start seeing a ton of folks in that camp.
Chris Picciurro, CPA:That is awesome. Well, thank you so much. And, John, I know you're gonna put a lot of Brady's information in our in our notes. What's the best way to reach out to you and the team at QSPS rollover?
Brady Weller:We're easy to find, qsbsrollover.com. It's easy to schedule a call with us. Both my co founder and I and our our team are available to chat with anyone at any time. Happy to work through your situation. You can follow us on LinkedIn.
Brady Weller:We're pretty active there. Follow me on LinkedIn. I post funny stories about people missing out or being able to take advantage of QSPS. So look forward to seeing people. Nine, muted.
Chris Picciurro, CPA:You're muted.
John Tripolsky:Oh, there we go. Holy cow. Talk about missing out on things. Here I am. I muted myself, and I'm talking about missing I was gonna say there probably the the examples that you give of people missing out is absolutely hilarious at some point, but to other people, not to them.
John Tripolsky:So we'll definitely drop your contact in there. I know this we could we could take this down probably many avenues, many examples of of diving into specific stuff. So I'd probably say and tell me if I'm correct is if anybody has these questions a little bit more in detail, you know, the we just skimmed the iceberg, basically, on this one.
Brady Weller:Absolutely.
John Tripolsky:Any of those questions reach out to you directly, and you guys could dive into those on a really at a case by case basis. Correct?
Brady Weller:100%. Yep.
John Tripolsky:Yep. Awesome. Awesome. Well, thanks for joining us. I appreciate it.
John Tripolsky:And, Chris, hopefully hopefully, you know, this guest we have here stood up to your, your expectations on the topic. So now we
Chris Picciurro, CPA:Oh, I had no doubt he would. So We don't have
John Tripolsky:to get you, you know, a little cheese plate and play the fiddle for you. You should be okay. So awesome. Chris, thanks for the introduction to him. Ray, thanks for joining us, man.
John Tripolsky:We'll again, we'll drop your contact in there. And, if anybody has those questions, drop him a line, him and his business partner. Again, don't be lazy. Right there in the show notes and down here and off to the side, depending on what platform you're looking at. Check it out, and we will see everybody back here again next week.
John Tripolsky:Different date, same day of the week, completely different topic here on the Teaching Tax Reform podcast. Have a great week, everybody.
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