Trump's tax break: How to be a millionaire and not pay taxes

One reader and good friend pointed out that after writing on how to sell your startup, the logical next post should be on how to optimize your exit. That means how to pay less (or no) taxes on your sale.

There’s something about being a second-time founder that makes you think about optimizations earlier. Maybe it’s all the taxes you paid on the first one. Maybe it’s just experience.

QSBS might be the most important one. If you’re a repeat founder, the only part that matters is what’s changed under Trump. If this is new to you, maybe gift me some stock later as a “thank you” or “attaboy bonus.”

How to sell your startup and not pay taxes

Here how you sell your startup and not pay taxes, the way Steve Martin would present them:

• First, build a business that is valuable (growing fast and, even better, profitable).

• Second, sell it.

• Then, don’t pay taxes.

• When your accountant says, “Didn’t you sell your company for a pile of money?” You say one simple acronym: “QSBS”. And that’s it!

Ok, that’s not all of it. Let’s dive in. Here’s a short summary of QSBS and two other tax mitigation strategies.

What is QSBS?

QSBS stands for Qualified Small Business Stock, and is a way the tax code incentivizes investment in small business. It applies to founders and early investors. If your investment (as an actual investment, founder shares, or conversion from an LLC) meets certain criteria, you do not pay federal taxes. You may still have some federal tax liability and you may have some state tax liability (California, especially–but that’s out of scope). But none from the federal government.

This is about taxes so it’s necessarily a little wonky, but I’ll try to keep it straightforward. The two things to take away are:

1. Pay attention to QSBS qualifications and make sure your ownership of your startup, and (if possible) your investors’ ownership qualifies for QSBS.

2. Consider taking active steps early to maximize your QSBS impact.

The “Big Beautiful Bill” signed on July 4 increased a lot of QSBS limits and made more sales qualify for QSBS treatment. Why this giant handout to founders made it into the bill is a phenomenal question, but out of scope for this post (or newsletter). If you know, I’d love to hear–but for now, let’s stick to what you can do to take advantage.

Disclaimer

This is not tax advice. It is 100% worth talking to a professional about this if you are a founder about your specific situation. I’ll give you the basics–and even the advanced tactics. But this is just for your entertainment. Read on, young founder, and profit.

The basics–qualifying for QSBS

To qualify for QSBS, the following requirements must be met:

This might seem complicated, but for an early stage tech startup founder or angel investor, you probably meet all of these QSBS requirements without trying.

If you don’t do any optimization, but do qualify, each founder has a $15 million tax exemption if they sell after 5 years, and part of that starts after just 3 years. Who wants an I-banking bonus or truckloads of Google RSUs taxed at 37% when you could pay… drumroll…

0%

Don’t mess it up

The exclusions are important. Secondary sales are excluded, but not gifts. How you hold the shares matters. Trusts are fine. Many other entities are not, so talk to an advisor.

Some excluded business types are tech-adjacent, but you might be able structure two separate entities to get around this so the tech lives in a qualified entity while the unqualified aspect of the business lives in a separate entity. Again, get pro advice.

Advanced strategies for QSBS

There are two popular advanced QSBS strategies that are proven. They are called stacking and conversion.

Stacking is more straightforward. The $15 million cap applies to each individual shareholder. So if you have 1 founder, that’s $15 million. If you have 2 founders, that’s $30 million. If each founder gave shares to 1 child each, that’s 4 shareholders or $60 million.

To stack, early on–before the company is worth more than the $75 million gross assets limit–gift stock to other qualified people or entities. (Yes, this went up from $50 million with Trump’s BBB). For example, you could gift it to your child’s trust. Or a relative (probably not–but maybe, your spouse). Again, talk to your tax professional about your specific situation as there is some uncertainty in IRS policy.

Conversion is more complicated, but in some ways cleaner. The (new) $15 million limit is great if you sell your company for, say, $15 million. Or if you own 15% when you sell it for $100 million. Either way, you don’t pay federal tax.

But what if you sell it for $600 million?

If you are using the $15 million limit, you would owe tax on $585 million in gains. Even if you handed out shares to family members like Halloween candy, do you have enough children or family members to shield the remainder? Doubtful. Also, obviously, giving it away means you (might) get 0 benefit rather than whatever is left over after the taxman takes his bite.

Hence, conversion.

Instead of incorporating as a C-corporation and qualifying immediately, let’s say you start as an LLC. You build a nice business. It’s starting to take off, but before it really gets going you convert it into a C-corporation. You read this article, and have good tax advisors, so you do that when it’s worth $60 million–comfortably below the $75 million cap.

Your QSBS exemption applies to 10x your investment, which in this case is the $60 million. When you sell for $600 million, you would be liable for taxes on the $60 million you converted–but exempt on the remaining $540.

That’s right: you’d pay federal tax on ~10% of the sale. And pocket half a B tax-free. Well, at least federally tax-free.

Would you leave California and not come back for $77 million? (A lot of people answer “yes” to versions of this question)

There are only three downsides to this. First, the clock resets on the conversion. So if you ran your business as an LLC for 3 years, and then converted, you’d need to wait another 3-5 years to benefit from QSBS. Second, if your company takes off and is worth over $75 million, you cannot get any QSBS benefit (because the conversion would not qualify). Seems like decent risk-reward to me, but with the increase to $15 million it may not be worth it. Third, if you are reading this post after you’ve already started a C-Corp then that ship has sailed and you can’t use this strategy. There’s always next time.

The biggest way to mess up QSBS

The best way to mess up QSBS for everyone is to not build a valuable business, or to not get much for it if you do. You can optimize the shit out of your tax situation, and then not get a deal done – and get $0. Focus on customers. Build a great business. Then run a good process. Maybe it’s suboptimal, but paying taxes on a life-changing windfall is better than paying no tax on a total loss.

A great way to mess up QSBS for your early employees is to not let them early exercise. Yes, I’m still bitter about this. You know who you are. To benefit, the holder must hold the underlying shares (not an option) so let your employees early exercise and do their Schedule 83b election. If they leave, you can always buy the shares back at the strike price. I have a post in the hopper about reducing your admin work, but this admin work is 100% worth it.

Another great way to blow it is to take your eye off the ball during the actual M&A process. Many of these optimizations will be difficult to execute concurrently with a transaction, and could delay a transaction. Time kills deals. If you sort tax optimizations out early, you will have one less distraction. And some strategies require being set up early.

Other tax strategies

There are other, more aggressive tax strategies for US founders which may be worth talking about with your advisor. Both require some advanced planning and should not be done concurrently with or even in close proximity to a sale. One may be quite risky.

The first, risky strategy involves putting your ownership in an offshore trust for a non-US beneficiary. This is known as an offshore trust or foreign grantor trust (FGT). The goal is to move your assets out of US tax jurisdiction. Because the US taxes its citizens and permanent residents on a global basis, the only way to do that is to not own the assets.

This seems extremely risky to me on two basic levels. First, you are giving someone else your stock. That might be a close relative in a foreign country, but fundamentally has the potential to go badly. I’m sure lawyers have thought this through, but still. Second, the IRS is hip to this strategy and frowns upon it. If it determines that the beneficiary is a “straw man”, it can pierce the veil of the trust and tax you directly. I am not a tax lawyer or CPA, so if you are curious talk to someone who knows about this if you are considering it.

The second is a broader estate tax planning strategy, in which you set up a life insurance trust with grantor trust features, and do a lot of complex things beyond the scope of a simple newsletter. Again this is the purview of very advanced tax and estate planning, not for your everyday founder, but if you may receive a huge windfall–and if QSBS isn’t going to help you much–it’s worth talking to your advisors.

Both strategies incur significant up front cost, so if your company ends up being worthless and you’ve spent $20k+ to tax-optimize, well, that sucks. Which is perhaps why its mostly second-time founders who do this sort of thing–they have the money to blow. And are probably a little bitter about the tax bill the first time around.

QSBS has the advantage of requiring little to no extra work, time, or expense, while providing significant tax optimization–at no risk. The IRS guidelines are quite clear, and uncontroversial. After all, the supposed purpose is to encourage small business investment. Consider other options if you must, but at the very least–ensure you’ve got QSBS set up properly.

Good advice and the best advice

I talked to an entrepreneur this week who had never heard QSBS even though she was almost done with a fundraise. Shame on her lawyers and accountants. Make sure your advisers know their stuff and are, as Edith Harbaugh (LaunchDarkly) says–”stage appropriate”.

Take action early–not only to be able to focus on closing your transaction when the time comes, but also because some of the strategies mentioned need to be done early. But do so with experienced, professional advice! Too many zeros involved to DIY or trust ChatGPT with.

Perhaps the best advice? As Steve Martin said, explaining how you can be a millionaire and not pay taxes: “First, get a million dollars.”

Don’t forget–that part comes first.