In this episode of Legacy Lessons, Martin D. Hauptman, Partner in our Tax, Trusts, and Estates Practice Group, explores a powerful, yet often overlooked, tax planning strategy for business owners preparing to sell their companies with Qualified Small Business Stock.
To illustrate, Martin introduces us to “Mark,” a successful tech entrepreneur on the verge of selling his start-up. Like many founders, Mark spent years building his business from the ground up. Now, with a buyer lined up and a significant payday in sight, he wants to make sure the sale is handled wisely—not just legally, but financially and strategically.
The Problem: What’s the smartest way to handle a major liquidity event?
For tech entrepreneurs like Mark, the sale of a company often represents a once-in-a-lifetime financial event. But a sudden windfall can trigger a massive tax bill, potentially costing millions in capital gains taxes if not properly planned.
That’s where proactive tax strategy becomes critical.
The Solution: Qualified Small Business Stock (QSBS)
Martin recommends that Mark explore a key provision in the Internal Revenue Code: Section 1202, which covers Qualified Small Business Stock (QSBS). This powerful yet underutilized tool allows eligible business owners to exclude up to $10 million (or more, in some cases) of gain from the sale of qualified stock in a C corporation. However, specific requirements must be met for eligibility: Mark must have held the stock for a minimum of five years prior to the sale and must have acquired it in a C corporation that satisfied certain size and active business criteria at the time of issuance.
If those conditions are satisfied, the first $10 million in capital gains could be completely excluded from federal taxes, making it a potentially life-changing tax break.
Why QSBS Is Effective
Section 1202 was designed to encourage long-term investment in small businesses by providing meaningful tax relief. This strategy rewards long-term investment in small businesses by dramatically reducing the tax burden when founders like Mark finally cash out. For tech entrepreneurs with a vision and patience, the benefits are enormous. Martin also notes that with proper legal structuring, it may be possible to multiply the QSBS benefit by distributing ownership among family members or trusts. This creates additional flexibility and maximizes the exclusion potential.
Timing Matters
Eligibility for the QSBS exclusion must be established well before a sale is finalized. Once a transaction is underway, it is often too late to restructure or meet the necessary requirements. That’s why Martin advises business owners to speak with an experienced tax and estate planning professional well in advance of a potential sale. Whether you’re in the early stages of building a business or nearing an exit, understanding options like QSBS tax planning can have a meaningful impact when selling a business and focusing on your on your financial future.
The Takeaway
Martin’s Legacy Lesson underscores the importance of strategic tax planning, not only to reduce liability, but as a means of preserving and amplifying wealth. For business owners preparing for a sale, leveraging tools like the QSBS exclusion can ensure that more of what you’ve built stays in your hands, and supports your goals for the future.
Considering QSBS Tax planning for selling a business? Contact Martin D. Hauptman at mhauptman@mblawfirm.com or 973-243-7912 to explore strategies for your next move.
Watch the full YouTube video here.