QSBS Stacking: How to Multiply Your Tax Exemption

QSBS stacking is a tax planning strategy to multiply the capital gains exclusion available under Section 1202 of the Internal Revenue Code for Qualified Small Business Stock (QSBS). The goal is to legally structure ownership to claim more than the single exemption an individual is allowed. This approach leverages existing rules that define a “taxpayer,” recognizing that entities other than the original owner can be separate taxpayers. Through early-stage planning, it is possible to establish multiple taxpayers, each eligible for their own full exemption from the stock of a single enterprise.

The Foundation The Standard QSBS Exemption

Under Section 1202, a taxpayer can exclude significant capital gains from federal income tax when they sell QSBS held for at least five years. The law provides a per-taxpayer limitation on the amount of gain that can be excluded from a single corporation’s stock. This limit is defined as the greater of two distinct calculations.

The first calculation is a $10 million lifetime exclusion for gains from one company’s stock. The second allows for an exclusion of up to 10 times the aggregate adjusted basis of the stock sold; a taxpayer’s basis is the amount they paid for it. For example, if an investor contributes $2 million for shares, their 10x basis limitation would be $20 million, making it the applicable exclusion limit.

Conversely, a founder with a low initial basis of $50,000 would have a 10x basis limit of $500,000, making the $10 million cap the more favorable limit. Understanding which of these two limits applies is the baseline for all QSBS planning, as it defines the single exemption that stacking strategies seek to multiply.

Stacking via Multiple Taxpayers

A primary method for multiplying the QSBS exemption is distributing stock from a single corporation to several different taxpayers. Since the exclusion is applied on a per-taxpayer basis, creating more taxpayers who own the stock can generate more exemptions. This strategy focuses on the ownership structure of the equity.

A straightforward way to achieve this is by gifting stock to other individuals, such as family members. When the gift is made, the recipient inherits the original holding period and other attributes of the stock. Upon a future sale, each individual who received the gifted stock can claim their own separate QSBS exemption.

A more structured technique involves using non-grantor trusts, which are treated as a distinct taxpayer separate from the person who created it (the grantor). By transferring QSBS into multiple non-grantor trusts, each trust can independently qualify for its own $10 million or 10x basis exemption, increasing the total excludable gain from a single company’s stock.

For this strategy to be successful, trusts must be structured to avoid being classified as grantor trusts by the IRS. The grantor cannot retain certain powers or benefits, such as the ability to revoke the trust or control its distributions. The trust must have an independent trustee and be irrevocable to be respected as a separate taxable entity.

Stacking via Multiple Corporations

Another approach to stacking exemptions involves creating multiple, distinct C-corporations. This strategy divides the business operations themselves across several independent corporate entities. An entrepreneur can then hold stock in each of these corporations, with each block representing a separate opportunity for a QSBS exemption.

When each distinct corporation is sold, the shareholder can claim a separate QSBS exemption for the stock associated with that entity. For example, if a founder establishes three separate corporations, they could potentially claim a $10 million exemption from the sale of each one. This method is predicated on each corporation being a legitimate, standalone business.

This strategy’s success depends on demonstrating a valid, non-tax business purpose for each corporation. The IRS can challenge arrangements created solely for tax avoidance. Each corporation must have its own operational integrity, separate records, and a clear business rationale for its existence, such as managing liability or separating distinct technologies.

Without a defensible business purpose for each entity, the IRS could disregard the separate corporate forms and consolidate them into a single entity for tax purposes. This would collapse the structure and result in the loss of the multiple exemptions. Careful planning and documentation are necessary to withstand potential scrutiny.

Planning and Reporting for Stacked Exemptions

Required Documentation and Planning

Successful QSBS stacking requires thorough documentation and proactive planning. For strategies involving multiple taxpayers, the creation of non-grantor trusts must be formalized through trust agreements drafted by legal counsel. These documents must define the trust’s irrevocable nature and the trustee’s independent authority. When gifting stock, the transfer must be documented as a completed gift, which requires filing Form 709, United States Gift Tax Return.

For strategies using multiple corporations, the taxpayer must demonstrate the legitimacy of each entity. This requires maintaining records that support the distinct business purpose and separate operations of each corporation. Documentation should include separate financial statements, board meeting minutes reflecting independent governance, and business plans that articulate the commercial reasons for each entity’s existence.

Reporting the Sale

When the time comes to sell the QSBS, each taxpayer claiming an exemption must file their own income tax return. For example, an individual founder and each non-grantor trust they funded would file separate returns. Each return reports that taxpayer’s portion of the sale and claims their respective gain exclusion.

The sale and exclusion are reported on Form 8949, Sales and Other Dispositions of Capital Assets, and the information flows from there to Schedule D, Capital Gains and Losses. On Form 8949, the taxpayer reports the full proceeds from the sale and the cost basis of the stock. The amount of the excluded gain under Section 1202 is then entered with a specific code to reduce the taxable gain accordingly.