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QSBS Just Got a Massive Upgrade: How to Maximize Tax-Free Gains Under the New Law · MaxValue Podcast

• 0:11
  SPEAKER_00: Welcome to Max Value, a show for business owners and their professional advisors pursuing maximum value.
• 0:16
  SPEAKER_00: We talk about business valuation, exit planning, global staffing, and all sorts of fun stuff.
• 0:20
  SPEAKER_00: I'm your host, Ben Town.
• 0:22
  SPEAKER_00: Today, Gary Whitfield comes back on the show for an immediate update to an episode we just put out on qualified small business stock because it has been changed with a quote big, beautiful bill that just got signed over Independence Day holiday.
• 0:36
  SPEAKER_00: Normally we don't chase the news cycle, uh even with events that are uh so important as this exclusion of large amounts of capital gains taxes for business owners.
• 0:47
  SPEAKER_00: Uh but we also couldn't let Gary's good work go so stale so fast.
• 0:52
  SPEAKER_00: So, Gary, welcome.
• 0:54
  SPEAKER_00: Welcome back.
• 0:57
  SPEAKER_00: Uh Gary, in a nutshell, let's just dive right in.
• 1:00
  SPEAKER_00: What has changed in these new modifications to the section 1202 of the Internal Revenue Code that we lovingly call QSBS?
• 1:11
  SPEAKER_01: Right.
• 1:12
  SPEAKER_01: Um, well, actually, it's I I look at it as there's been an enhancement or a bolt-on of really three things.
• 1:20
  SPEAKER_01: Um, so you'll recall the prior law there was a exclusion cap, which is basically the greater of$10 million or 10 times the basis, right?
• 1:32
  SPEAKER_01: Whichever is higher, right?
• 1:34
  SPEAKER_01: And that was for stock issued uh after September 27th, 2010.
• 1:40
  SPEAKER_01: If you held it for five years in a day, you had 100% exclusion.
• 1:45
  SPEAKER_01: And that capital gain exclusion could be either 10 million or 10 times your basis in the stock.
• 1:51
  SPEAKER_01: Now the new law is for QSBS acquired after July 4th, 2025, that cap of 10 million has been raised to 15 million, right?
• 2:04
  SPEAKER_01: So that's a pretty big enhancement.
• 2:07
  SPEAKER_01: So now the rule is you can exclude 15 million or 10 times your basis, whichever is higher, right?
• 2:16
  SPEAKER_01: And um, if you held it five years or longer, there's a hundred percent exclusion, but they've also enhanced it by reducing some of the holding period requirements with these tiered exclusion.
• 2:31
  SPEAKER_01: And what I mean by that is if you held it three years and not five, you get a 50% exclusion.
• 2:37
  SPEAKER_01: If you hold it four years, you get a 75% exclusion, right?
• 2:42
  SPEAKER_01: And there's some on the on the three and four-year holding periods, there's some AMT preference, um, and as well as some nuance to calculating the tax on the excluded part of the gain.
• 2:56
  SPEAKER_01: Um, but we can probably get into how some of that works.
• 3:00
  SPEAKER_01: Um, also, an enhancement is not only get the 15-year cap, the asset threshold, right, is moved from 50 million to 75 million, right?
• 3:12
  SPEAKER_01: So before, if you had a qualifying trader business, um uh C Corp originally issued C Corp stock, right, valued at under 50 million before and after the transaction, now it's been raised to 75 million.
• 3:30
  SPEAKER_01: So you get a 50% increase in the asset threshold or the valuation threshold, and you get a 50% increase to the$10 million exclusion.
• 3:40
  SPEAKER_01: Um, so it's a it's it's it's a pretty good enhancement.
• 3:44
  SPEAKER_01: It's it's uh it's a net net, it's a great thing.
• 3:48
  SPEAKER_00: Well, and certainly understanding if your value is under 75 million, it might be where I would come in to to talk about that.
• 3:54
  SPEAKER_00: Really, though, in in short, it's not so much a complete overhaul as as you said, it's an addition, a bolt on an update.
• 4:01
  SPEAKER_00: Uh, and it sounds like there's a lot of really good provisions, including some uh instead of just a cliff, there's some partial uh benefits that you can get at three and four years instead of just only at five years.
• 4:14
  SPEAKER_00: Um and uh because it is a bolt on, you know, we we should just push everybody who hasn't seen it already to watch the previous max value episode talking about QSBS uh that that you you and I did uh not too long ago, uh, once you're finished with this one, because all of those same uh bones of that one still apply today.
• 4:37
  SPEAKER_00: Uh and that that one really goes into some of the details.
• 4:40
  SPEAKER_00: But for today, why don't we dive into uh some of the details or uh an example of you know what you're talking about that might lead us to some more advanced planning or some things that we can do now that we couldn't do before?
• 4:55
  SPEAKER_01: Yeah.
• 4:56
  SPEAKER_01: Okay.
• 4:57
  SPEAKER_01: Um well what let's let's then let's go through a couple of like just simple examples, right?
• 5:03
  SPEAKER_01: So let's say um Sarah invests in a startup in 2025 um with$70 million in gross assets, this the startup that is, which qualifies under the new$75 million threshold.
• 5:18
  SPEAKER_01: She buys QSBS for$1 million and sells it after four years for$13 million, realizing a$12 million gain.
• 5:28
  SPEAKER_01: So with that fact pattern, there's a 75% exclusion.
• 5:32
  SPEAKER_01: So 9 million is excluded.
• 5:35
  SPEAKER_01: And the non-excluded part of the gain, or 3 million, right, is not taxed at the capital gains rate.
• 5:42
  SPEAKER_01: It's taxed at a special rate, which equates to about 31.8%.
• 5:47
  SPEAKER_01: It's the 28%, which is the AMT rate, plus the 3.8% net investment tax.
• 5:54
  SPEAKER_01: So that's how you get the 31.8%.
• 5:57
  SPEAKER_01: But the 9 million is still excluded, right?
• 6:01
  SPEAKER_01: Um also there's a little bit of since it's not the five-year threshold, this would be a four-year holding period.
• 6:11
  SPEAKER_01: There's a seven point seven percent add back on the excluded gain, right?
• 6:17
  SPEAKER_01: So there's that, so it's an AMT preference uh add back, which which will, if they're in AMT, will bump up their tax a little bit, but net net, it's it's a home run.
• 6:31
  SPEAKER_00: Right, right.
• 6:32
  SPEAKER_00: That makes sense.
• 6:33
  SPEAKER_00: And you know, if as compared to the previous iteration of 1202, that's right.
• 6:39
  SPEAKER_00: Any of that benefit given the benefit, right?
• 6:42
  SPEAKER_00: That fact pattern.
• 6:43
  SPEAKER_01: That's right.
• 6:44
  SPEAKER_01: So in this in this fact pattern, there's a four-year holding period.
• 6:46
  SPEAKER_01: If it was a three-year holding period, right, she would have 50% of the gain uh excluded, right?
• 6:54
  SPEAKER_01: Whereas in the previous four years, 25% is excluded, but 70, I'm sorry, 75% is excluded, 25% non-excluded under the four years.
• 7:05
  SPEAKER_01: Under three years, 50% is excluded and 50% non-excluded.
• 7:10
  SPEAKER_01: So that 50% would be subject to the AMT preference and taxed at that higher rate.
• 7:17
  SPEAKER_01: But net net, you know, the three or four-year holding period wasn't even available before, right?
• 7:23
  SPEAKER_01: So it's still a really good benefit.
• 7:28
  SPEAKER_00: Cool.
• 7:28
  SPEAKER_00: And do you think these changes open up new strategies that weren't available before, besides the holding period?
• 7:37
  SPEAKER_01: Um I don't think it changes the strategy necessarily, but what it does do is it gives the so, for instance, the RD, right?
• 7:48
  SPEAKER_01: Part of the big beautiful bill is RD is expensed, right?
• 7:52
  SPEAKER_01: So if you if you have a startup under the old regime, that RD had to be capitalized so it could bloat the balance sheet, right?
• 8:02
  SPEAKER_01: Um, so you get a little bit of a relief from a gross asset uh test or the valuation test because those RD um costs are now expensed, right?
• 8:12
  SPEAKER_01: So there's a little bit of an additional benefit there, but really strategically speaking, um the overall strategies don't change.
• 8:23
  SPEAKER_01: Um, they're just enhanced by the additional gain uh on the cap of 15 million, um, or they are enhanced by having to basically having access to a shorter exit holding period, three or four years.
• 8:39
  SPEAKER_01: But at five years, there's 100% gain exclusion within the cap.
• 8:46
  SPEAKER_01: Um, and there's no AMT, right?
• 8:50
  SPEAKER_01: Uh, and I I could jump into um uh an example was very similar to what we talked about on a prior podcast, if if you'd like to do that.
• 8:58
  SPEAKER_01: So, Ben, you'll probably recall uh on a on our prior um episode, we talked about, you know, most startups, the founders will go to Delaware, start a C Corp, right, right away.
• 9:12
  SPEAKER_01: Um and you know, most of the time when you do that, you're really stuck with that$15 million benefit.
• 9:18
  SPEAKER_01: That$15 million becomes your cap because when you really uh start a business, you're putting in know-how, a nominal amount of cash, um, and and you know, maybe some other thing.
• 9:32
  SPEAKER_01: The point is you're gonna have a very low basis, right?
• 9:35
  SPEAKER_01: But maybe maybe in the seed round or the past the hat round, the pre-Series A round, you start as an LLC, right?
• 9:44
  SPEAKER_01: So if you start as an LLC, right, and let's say you go um you achieve MVP status, you have a minimally viable product, right?
• 9:56
  SPEAKER_01: And then you go out for that first round of funding, right?
• 10:00
  SPEAKER_01: And as an example, let's say that um a uh a VC is gonna come and for$20 million, they're gonna get one third of your company, right?
• 10:13
  SPEAKER_01: So in that example, right, they're gonna put in 20 million bucks and either the individual LLC owner or the the group that owns that LLC, they're gonna contribute their LLC units, right?
• 10:27
  SPEAKER_01: So if the VC is contributing 20 million, that means the LLC units contributed in exchange for that stock, right?
• 10:38
  SPEAKER_01: That means they're worth 40 million, right?
• 10:42
  SPEAKER_01: Um, one third of the company is worth 20, two-thirds is worth 40.
• 10:45
  SPEAKER_01: So what you've done right there, total enterprise value in that example after the funding is 60 million, right?
• 10:53
  SPEAKER_01: So that means for purposes of 1202, the fair market value of the property contributed in exchange for the C Corp stock is 40 million.
• 11:05
  SPEAKER_01: So for 1202, that 40 million is your basis for calculating the 1202 exclusion.
• 11:11
  SPEAKER_01: So you'd have 15 million or 10 times your basis of 40 million or 400 million dollars is your potential capital gain exclusion, right?
• 11:22
  SPEAKER_01: So that's a that's a pretty big benefit, just being thoughtful about how you come out of the gate starting your company.
• 11:30
  SPEAKER_01: In this instance, we said it's an LLC, right?
• 11:34
  SPEAKER_01: Create your achieve minimally viable product status, and then go get that A round of funding, right?
• 11:41
  SPEAKER_01: That example just created a potential$400 million capital gain exclusion.
• 11:49
  SPEAKER_00: Right, absolutely.
• 11:51
  SPEAKER_00: And and now that the your example illustrated it very well, uh, now that the total uh value cap of the company has gone from 50 to 75, it's it's allowing for potentially at a ton more of that.
• 12:07
  SPEAKER_00: And even companies that have uh already issued uh quite a bit of stock, there may be you know some window.
• 12:15
  SPEAKER_00: What do you think about that?
• 12:16
  SPEAKER_00: That that having that some small window to be able to issue uh new new shares under that$75 million cap.
• 12:24
  SPEAKER_01: Yeah, I mean I mean you said it right there.
• 12:27
  SPEAKER_01: I mean, as long as that is original issuance from the company directly to the acquirer and they're not acquiring it from another individual, right?
• 12:37
  SPEAKER_01: If it meets that 75 below 75 million dollar threshold, all of that additional issuance is qualified shares.
• 12:46
  SPEAKER_01: So that works.
• 12:48
  SPEAKER_00: Cool, that's great.
• 12:49
  SPEAKER_00: All right, hey Gary, you know what?
• 12:52
  SPEAKER_00: That's I think it's a pretty simple update.
• 12:57
  SPEAKER_00: Um, really appreciate it.
• 12:58
  SPEAKER_00: That's really valuable.
• 12:59
  SPEAKER_00: But but you know what?
• 13:01
  SPEAKER_00: I realized uh actually just earlier today that we didn't in our last episode do a getting to know you segment like I've done on basically every other episode.
• 13:12
  SPEAKER_00: Do you mind if we take a minute?
• 13:14
  SPEAKER_00: Sure.
• 13:15
  SPEAKER_00: Awesome.
• 13:16
  SPEAKER_00: Um because you're you're a cool guy and I want people to know you.
• 13:19
  SPEAKER_01: God bless you, Ben.
• 13:22
  SPEAKER_00: So tell me something that's not on your LinkedIn or website profile.
• 13:29
  SPEAKER_00: Um about me?
• 13:32
  SPEAKER_00: Well, I mean, I could be about anything, I suppose, but yeah, about you.
• 13:36
  SPEAKER_01: Yeah.
• 13:36
  SPEAKER_01: Um well uh what's what's probably not on the website or on LinkedIn is um I have a men's ministry, a private foundation called Second Man Group.
• 13:50
  SPEAKER_01: And it's it's it's really focusing on um on men.
• 13:55
  SPEAKER_01: It's a Christian ministry helping men recover the masculine heart that they had when you know at the beginning of time when when God uh basically when God first created them, he created them with a masculine heart.
• 14:09
  SPEAKER_01: Um, so it focuses on recapturing that masculine heart.
• 14:12
  SPEAKER_01: And so it's helping men understand um that masculine heart that God gave them, right?
• 14:18
  SPEAKER_01: So it's so that's one pillar of it.
• 14:20
  SPEAKER_01: Uh a lot of people don't uh know um that side of me, but uh I spend about a third of my time uh in that ministry.
• 14:30
  SPEAKER_00: I I know you're very, very, very dedicated to uh your your faith.
• 14:35
  SPEAKER_00: Uh and I think it's super cool that uh you you work on you know men being better men.
• 14:42
  SPEAKER_00: And that's well, that's half the human race, isn't it?
• 14:46
  SPEAKER_00: So uh that that's really cool.
• 14:48
  SPEAKER_00: Yeah.
• 14:49
  SPEAKER_00: About your your job, your profession.
• 14:52
  SPEAKER_00: Uh why is what you do rewarding to you?
• 14:56
  SPEAKER_01: You know what, Ben, uh that's a good question.
• 14:59
  SPEAKER_01: I I I think number one, because I uh I'm I've been gifted with being able to identify the parts of the internal revenue code, as you know, is it's it's two books about that thick, right?
• 15:12
  SPEAKER_01: So it's but there's really only a small piece of it um that is really dedicated to preserving and compounding capital for families and business owners and individuals.
• 15:23
  SPEAKER_01: Um and for whatever reason, I'm I'm just kind of a uh a dorky geek when it comes to that kind of stuff.
• 15:32
  SPEAKER_01: I'm good at it.
• 15:34
  SPEAKER_01: And um when the the penny drops on the value that we provide, and you see um the the the planning and all that come to fruition, of course I get a reward out of that.
• 15:48
  SPEAKER_01: Um and so I guess the short answer is I'm pretty good at it, and there's really only you know a small fraction of the code that applies to that, but I know it reflexively, right?
• 16:02
  SPEAKER_01: It's not the whole two volumes that I know real well.
• 16:05
  SPEAKER_01: It's that small piece um that's really about preserving and compounding and getting the most out of the internal revenue code because the default settings of the internal revenue code are not aligned with a business owner or a family's um unique asset base, uh, their values or their legacy goals.
• 16:28
  SPEAKER_01: You gotta you gotta really understand how to dig that out and align that to what the client's trying to do.
• 16:35
  SPEAKER_01: And I just enjoy doing that.
• 16:37
  SPEAKER_00: That that makes I mean, absolutely, the internal revenue codes aligned to raise revenue for the government.
• 16:43
  SPEAKER_00: That's that's kind of the whole point.
• 16:45
  SPEAKER_00: And and that's right.
• 16:46
  SPEAKER_00: Other things that I'm sure philosophers and economists could argue about at infinitum, but uh yeah, having subject matter mastery is is truly rewarding.
• 17:00
  SPEAKER_00: I agree with that for sure.
• 17:01
  SPEAKER_01: All right, and you then they call it the um they call it the unholy trinity, taxes, creditors, and predators, right?
• 17:09
  SPEAKER_01: So we we we build a strategy around um a client's goals in their unique asset base that mitigates those three risks.
• 17:20
  SPEAKER_01: And um, you know, everybody knows what taxes and creditors are.
• 17:24
  SPEAKER_01: Predators are like uh just an example of that would be like your children get married, and you don't want 50% of their property going to a potential uh spouse if the if there's a divorce or a breakup in the marriage.
• 17:39
  SPEAKER_01: So there's a way to title assets that protect um the family, you know, the family wealth from generation one, two, to three.
• 17:48
  SPEAKER_01: So we we like to say that we help mitigate against the unholy trinity.
• 17:54
  SPEAKER_00: Gotta be honest, I was a little worried where you were going with that for a second.
• 17:58
  SPEAKER_00: So glad that worked out.
• 18:00
  SPEAKER_00: All right.
• 18:01
  SPEAKER_00: So the very last question.
• 18:03
  SPEAKER_00: Uh we're all trying to improve ourselves over time.
• 18:08
  SPEAKER_00: One great way of doing that is with reading.
• 18:11
  SPEAKER_01: What are you reading these days?
• 18:14
  SPEAKER_01: Um, you know what, Ben, I was um, I just finished a book called God's Undertaker.
• 18:20
  SPEAKER_01: It's by John Lennox, and he is a PhD mathematician and PhD scientist from Oxford.
• 18:28
  SPEAKER_01: And uh the the book in a nutshell is basically um shedding shining a light or making the case that um theism is more aligned with science than atheism.
• 18:42
  SPEAKER_01: It's a fascinating book covering all kinds of interesting things from the cosmos uh to evolution, biology, quantum physics.
• 18:54
  SPEAKER_01: Um it it it's very, very interesting.
• 18:56
  SPEAKER_01: I just finished it on vacation.
• 18:58
  SPEAKER_01: So God's undertaker by John Lennox.
• 19:02
  SPEAKER_00: Huh.
• 19:02
  SPEAKER_00: That's funny.
• 19:03
  SPEAKER_00: The that it's not funny.
• 19:04
  SPEAKER_00: I mean, that's interesting.
• 19:06
  SPEAKER_00: The uh the funny part about it actually is the uh the book I just finished reading was uh The Demon Haunted World by uh Carl Sagan, which is kind of the the if you will, the the opposite take about that.
• 19:19
  SPEAKER_00: Not not that he's uh not that he's purely uh anti-religious, he he's uh got space in there quite uh quite a bit for religious.
• 19:28
  SPEAKER_01: Yeah, I've definitely heard of that.
• 19:29
  SPEAKER_01: I've heard that's a great book.
• 19:31
  SPEAKER_01: Absolutely.
• 19:32
  SPEAKER_01: I've definitely heard of that.
• 19:34
  SPEAKER_00: Yeah, yeah.
• 19:34
  SPEAKER_00: Any case.
• 19:35
  SPEAKER_00: Um, but maybe I'll check out Lennox too.
• 19:38
  SPEAKER_01: There you go.
• 19:39
  SPEAKER_00: All right.
• 19:40
  SPEAKER_00: Well, cool.
• 19:41
  SPEAKER_00: Hey, Gary, thank you very much for joining.
• 19:44
  SPEAKER_00: This was awesome.
• 19:45
  SPEAKER_00: I appreciate it.
• 19:46
  SPEAKER_00: Awesome, man.
• 19:46
  SPEAKER_00: Thanks for having me again.
• 19:47
  SPEAKER_00: Really enjoyed it.
• 19:48
  SPEAKER_00: See you on the next episode, man.
• 19:50
  SPEAKER_00: Thanks.
• 19:50
  SPEAKER_00: Yeah, you bet.
• 19:52
  SPEAKER_00: All right.