Maximizing Qualified Small Business Stock Benefits

Disclaimer 

OK, so this isn't strictly about crypto, but I discovered something about QSBS benefits today that interested me.  The point is that it may be hugely beneficial to sell your low basis stock in year 1 and delay selling your high basis stock until a later year.

Generally, IRC Section 1202 says that if you hold QSBS for 5 years and then sell it, you are entitled to exclude the greater of $10 mm of gain or 10x your cost -- or at least that's how most people think about it. 

However, IRC Section 1202(b)(1) provides something a little different:
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In general: If the taxpayer has eligible gain for the taxable year from 1 or more dispositions of stock issued by any corporation, the aggregate amount of such gain from dispositions of stock issued by such corporation which may be taken into account under subsection (a) for the taxable year shall not exceed the greater of— 

     (A)     $10,000,000 reduced by the aggregate amount of eligible gain taken into account by the taxpayer under subsection (a) for prior taxable years and attributable to dispositions of stock issued by such corporation, or
     (B) 10 times the aggregate adjusted bases of qualified small business stock issued by such corporation and disposed of by the taxpayer during the taxable year.
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That does not say that you get the greater of $10 mm or 10x it says there are two separate calculations. 

So if you have 1 mm common shares with a $0.01/share basis and 1 mm Series A preferred shares with a $2/share basis you could have two different results:

If you sell the Preferred first for $22/share, you'd have $20 mm of gain and all of it would be excluded under the QSBS rule (1202(b)(1)(B)) because it doesn't exceed 10x your $2/share basis.  However if you then sell your common shares in the next year, you get only a $100k benefit because the limit under 1202(b)(1)(A) is reduced to zero by the prior year $20 mm exclusion.  (Same thing happens if you sell the common in the same year as the preferred.)

However, if you sell the common in year 1, you have $22mm of proceeds, $21.99 mm of gain, and $10 mm of that is excluded.  Then when you sell your preferred in year 2 (assuming the same sale price) you will get another $20 mm of exclusion -- for a total of $30 mm instead of $20.1 mm.

Take Aways:
  1. Always sell your low basis stock first;
  2. Track your shares when you convert or when you receive acquirer stock in a merger so you can easily identify which shares are low basis and which are high basis.
  3. If you didn't track, make sure to make a notation when you are selling shares that you mean to sell the low basis shares first.
This is contrary to the usual rule of selling high basis shares first to delay the tax as long as possible, but the benefit could be material.

One other point worth mentioning, is that the limits above are per taxpayer.  That means if you give shares of stock to your parents or children, they can shelter their own $10 mm.  In the old days where the amount that could be given away free of gift tax was relatively low, gifting stock immediately before selling it didn't make much sense, but now with a $20 mm exclusion for married couples, it's worth revisiting the question.





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