So-called “qualified small busines stock” has been around forever and in general has been one of those semi-useless tax benefits that only CPAs cared about (e.g., you hold your QSB stock for over 5 years and you pay 1% less than the prevailing federal capital gains tax rate but, oh, by the way, you have to include the amount you save in AMT and pay tax on it that way anyway).
Beginning in October, 2010, extending through 2011 and intermittently in subsequently years, QSB stock has taken on a potentially much greater value.
The first thing to understand about the changes made in the fall of 2010 and on concerning QSB stock is that they were intended as incentives to cause investors to want to invest in startups. But nothing in the rules limits these benefits to investors and many founders have had opportunities to capitalize on them. Check with a good CPA for particulars.
In essence, with QSB stock, if you hold the stock for over five years and then sell it, you can exclude up to $10M in gains for federal capital tax purposes and also exclude those same dollars from AMT. Now that is a real benefit. When you do qualify, the benefit can be up to $2M.
I won’t here try to sum up the exact issues on what it takes to qualify as QSB stock. Suffice to say that many Y Combinator founders have availed themselves of the benefit. It has to be a product company as opposed to a service company. But a typical software-based company would qualify.
You can’t do substantial reorganizations or repurchases or you blow the benefit.
But, the good news is that you can get acquired well before the 5-year period is up and, as long as you take replacement stock (say, from a public company in a stock-for-stock exchange), you can tack on the holding period of the replacement stock to that of the original stock to meet the 5-year requirement.
Just recently, QSB has been made permanent (sometimes not for 100% though). So, when you form your company, check with your professionals about the QSB status of your stock grant. If you qualify, you should factor it into your long-term planning for exit. The benefit can be substantial.