There are a lot of exclusions based on the type of business. No farming, banking, finance, insurance, hotels, restaurants, "or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees" such as doctors, accountants, consultants, etc.<p><a href="https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1202&num=0&edition=prelim" rel="nofollow">https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim...</a>
I would like to add that this exclusion is per person per company and can be multiplied with the use of irrevocable trusts.<p>For example, you can set up trusts for your wife and two kids, put in shares, and all receive the qsbs exclusion. Definitely speak to accountants and lawyers before trying this at home.
Incredibly important to know about for startup founders and early employees.<p>QSBS is not applicable in California and a few others, and some states only partially conform:<p><a href="https://www.mossadams.com/articles/2021/04/qualified-small-business-stock-tax-benefits#:~:text=The%20good%20news%20is%20that,conform%20to%20federal%20QSBS%20rules" rel="nofollow">https://www.mossadams.com/articles/2021/04/qualified-small-b...</a>.
Important to note that QSBS doesn’t necessarily make sense for some “indiehacker” type businesses.<p>You have to be a C-corp to benefit, which means either double taxation (paying both corporate tax and personal capital gains tax on all distributions) or paying yourself all in salary with payroll/income tax on all of it.<p>If you don’t intended to take on investors (or don’t intend to sell), an LLC or pass through type of arrangement may make more sense in the long run from a tax perspective. Under this arrangement you pay no corporate tax, and can elect to be treated as an S Corp for tax purposes. This way you can receive some of your comp as a dividend which would be at lower capital gains tax rates.<p>Of course, if at any point you plan on chasing investment, Delaware C Corp from the beginning (and QSBS qualification) is generally the best advice. This is complicated stuff, so consult a professional.
Other resources I’ve found informative include this write-up about QSBS [1] and this deep dive into Section 1045 deferrals [2].<p>[1]: <a href="https://www.wsgr.com/en/insights/understanding-section-1202-the-qualified-small-business-stock-exemption.html" rel="nofollow">https://www.wsgr.com/en/insights/understanding-section-1202-...</a><p>[2]: <a href="https://frostbrowntodd.com/advanced-section-1045-planning/" rel="nofollow">https://frostbrowntodd.com/advanced-section-1045-planning/</a>
How does this compare to funding a company by buying its stock inside a Roth IRA? (Not withdrawing, treating the company as an investment.)<p>Yes, there are penalties to withdrawing from a Roth before 55, so the profits are locked up for a while, but 0 state and federal income tax can be worth it.<p>Many Roth custodians (Schwab) only allow public company stock, so it does require some work.
In my opinion, an outrageous tax-giveaway to the rich. Very sad that this was expanded to 100% (from 50%) during the Obama administration.<p>Some people will say it doesn't apply to California, but this misses the point: you still avoid federal income taxation (and AMT). California is simply smart enough (IMO) to not follow the federal government's lead on this. So yeah, you'll still have to pay some tax to California. Big whoop you just saved 28% of federal tax.<p>The QSBS exemption is an excellent reason to remain a C corporation. Please don't ask how I know.<p>If you are a founder, you should definitely study/inquire about the benefits of this exemption.
Many people here are grabbing their pitchforks about QSBS and how it makes the rich richer. QSBS has a maximum per year rule of $10M. That means you save 20% (Federal LTCG rate) on $10M/year --> $2M.<p>That is not "making the rich richer", the person has to buy in a company worth less than $50M in value and hold it for 5+ years. This is a pretty rare case and helps people get into the single digit millions, not billions...