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Qualifying for QSBS

Lesson in Course: Finance at work (expert, 5min )

QSBS allows us to avoid paying taxes, but how do we know if we qualify?

Understanding when QSBS applies and when to early exercise can mean a huge difference with our potential payout if the company we work for becomes successful. The rules are clear on what QSBS is, but what does it mean for us and where do we find the information? Let's step through some basic qualification steps that we can ask ourselves. 

Starting out, we need to confirm that our company isn't on the industry exception list.

Exception list
  • Restaurants
  • Hotel or hospitality
  • Banking or brokerage services
  • Healthcare
  • Law
  • Engineering services
  • Architecture
  • Accounting
  • Actuarial services
  • Performing arts
  • Consulting
  • Athletics
  • REIT

 

Is my company a C-Corp?

Most companies are C corps—anything with an Inc is a C corp. If we work in a venture capital-funded startup, it's almost always a C corp.

If we can't find it on our company's marketing material, we should refer back to our workplace onboarding paperwork, including the I-9, W-4, or offer letter to double-check for the Inc. In addition, our HR or legal team should also be able to provide this information.

How much is $50 million in assets?

An asset is the sum of equity and liabilities on a financial statement called the balance sheet of a company.

For most tech startups, venture capital funding serves as a good proxy for the $50 million asset amount. Since tech startups operate with minimal appreciative assets and minimal debt, the total funding amount (equity) should indicate the value of assets.

If we don't work for a tech startup, the executives or finance department can provide a copy of the most recent balance sheet or should be able to answer if the assets total more than $50 million. Either way, we should always double-check with management. 

disqualification

Once the company exceeds $50 million in assets for the first time, the company can no longer qualify for QSBS exemption even if the total assets fall below $50 million in the future.

If management told us that the assets are below $50 million, we should always ask as a follow-up if the assets have ever been above $50 million in the past.

Can we Afford to early exercise?

It's important to note that the 5-year countdown starts when we hold the actual stock in the company. 

The equity grants we receive at work are often options, or the contractual right, to purchase company stock. These options are not the same as the actual stock or RSAs. To hold the stock in a company, we need to exercise our options by paying the strike price. In some instances, for QSBS exemption, it makes sense for us to early exercise all of our options (regardless of vesting) so that we hold the stock before the assets of the company creep over $50 million.

 

Can we afford to wait 5 years?

For QSBS exemption to apply, we need to wait at least 5 years after owning the stock before we can sell.

Life happens and there might be a liquidity event that happens before our 5 years holding period when we need to sell. The good news is that we may not lose all of our tax benefits. There is a QSBS rollover, which enables us to avoid paying taxes and allows us to take full advantage of the QSBS exemption if we invest in another QSB with the proceeds of our stock sale within 60 days. This can be used for early exercising options in another startup.

Otherwise, we will have to pay capital gains tax on all of the stock that was held for less than five years (not great).

If our company qualifies for QSBS exemption, and we can afford to early exercise, we will need to double-check with a tax accountant and our company to prepare the right paperwork. This includes filing an 83(b) election to the IRS. If you feel like you need help, reach out to the team at Archimedes.

At Archimedes, our goal is to make investment literacy accessible and free for everyone.

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