QSBS is a big reason to not incorporate as an LLC
Published at : September 18, 2021
QSBS is a big reason to not incorporate as an LLC
Kruze’s tax team helps hundreds of startups cumulatively save millions on their taxes every year - even unprofitable startups can benefit from tax credits. See how much a tax return might cost your company at https://kruzeconsulting.com/startup_calculators/how-much-does-a-startup-tax-return-cost
Hey, it's Scott Orn at Kruze Consulting. And today, I'm talking about why you should not incorporate as an LLC, because it's very likely you can blow your QSBS. QSBS is qualified small business stock. And, basically, the government gives a really nice carve out on capital gains taxes for anyone who can take advantage of QSBS.
And, basically, you can save up to $10 million in gains or 10X your investment by using QSBS. There's a few things that QSBS requires, but one of the big ones is it needs to be a Delaware C-corp company. There's some other stuff, I have other videos on QSBS definitions. But, basically, have it have to have less than $50 million in net assets on a tax basis. Also, have to be in like essentially the hard sciences or like super innovative, hard science categories. You gotta hold the stock for five years. That's the quick QSBS.
I have other videos on the definition of QSBS that you can watch. But, for us, we see so many companies coming to us who mistakenly incorporate as an LLC, because like their uncle is a lawyer and maybe doesn't know a lot about startups, but knows how to get a company going, and tells them that LLCs are a better way to go, or simpler. They are not simpler. They are not a better way to go. If you're gonna ever take venture capital financing, you're gonna need to convert to a Delaware C-corp. VCs invest in Delaware C-corps because they're not pass-through entities. That means like the gains or losses don't hit the VC fund on an annual basis. They also know the case law in Delaware really well.
And guess what? Your venture capitalists actually care about QSBS too, because the GPs in the fund can actually benefit from it. A lot of the LPs in the venture capital fund tend to be, you know, non-tax paying foundations, endowments, things like that. They don't care about tax optimization very much, except they don't wanna mess up the tax structure of the fund, which an LLC or a S-corp can do. That's another reason why everyone insists in a Delaware C-corp. But the GPs are usually individuals, the people, you know, who make the investments, and they get the benefit from QSBS.
And it's one of the reasons you'll see in a lot of like funding documents, the legal docs will actually ask the startup to rep or warrant that QSBS is alive in the company at the time of investment. And you've gotta be a little bit careful with that, but that's a good thing generally to do on behalf of your investors. But if you are incorporated as an LLC, you actually are not able to take advantage of this. Now there's some super fancy, crazy conversion things you can do from LLC to Delaware C-corp that a lawyer who charges $3,000 an hour can do for you, and figure out after a huge bill. I am not that smart. I would never take that chance. I would never take the chance of doing it correctly, or actually finding a lawyer who can do it. It's not easy to do, very complicated.
Please don't put $10 million of gains or 10X your investment for not just you, but everyone in the company, at risk by doing it this way. Just if you're gonna take venture capital financing or seed stage financing, eventually VC, just incorporate as a Delaware C-corp. You will preserve the QSBS election. You obviously have to hit the other qualifications for that, but you can save yourself a lot of money. And this is a big deal. I'm recording this in mid-2021 when the Biden tax rates are on the table and essentially taxing capital gains at the ordinary tax levels, ordinary income tax levels. So capital gains would go up from like 20 to 39% for the highest tax bracket. And you sure as heck wanna have a QSBS exemption if you can preserve that.
So, again, incorporate as a Delaware C-corp, not as a LLC. Preserve QSBS, build a great company. Sell it, do an IPO. And live happily ever after paying less capital gains taxes. Thanks!
Kruze’s tax team helps hundreds of startups cumulatively save millions on their taxes every year - even unprofitable startups can benefit from tax credits. See how much a tax return might cost your company at https://kruzeconsulting.com/startup_calculators/how-much-does-a-startup-tax-return-cost
Hey, it's Scott Orn at Kruze Consulting. And today, I'm talking about why you should not incorporate as an LLC, because it's very likely you can blow your QSBS. QSBS is qualified small business stock. And, basically, the government gives a really nice carve out on capital gains taxes for anyone who can take advantage of QSBS.
And, basically, you can save up to $10 million in gains or 10X your investment by using QSBS. There's a few things that QSBS requires, but one of the big ones is it needs to be a Delaware C-corp company. There's some other stuff, I have other videos on QSBS definitions. But, basically, have it have to have less than $50 million in net assets on a tax basis. Also, have to be in like essentially the hard sciences or like super innovative, hard science categories. You gotta hold the stock for five years. That's the quick QSBS.
I have other videos on the definition of QSBS that you can watch. But, for us, we see so many companies coming to us who mistakenly incorporate as an LLC, because like their uncle is a lawyer and maybe doesn't know a lot about startups, but knows how to get a company going, and tells them that LLCs are a better way to go, or simpler. They are not simpler. They are not a better way to go. If you're gonna ever take venture capital financing, you're gonna need to convert to a Delaware C-corp. VCs invest in Delaware C-corps because they're not pass-through entities. That means like the gains or losses don't hit the VC fund on an annual basis. They also know the case law in Delaware really well.
And guess what? Your venture capitalists actually care about QSBS too, because the GPs in the fund can actually benefit from it. A lot of the LPs in the venture capital fund tend to be, you know, non-tax paying foundations, endowments, things like that. They don't care about tax optimization very much, except they don't wanna mess up the tax structure of the fund, which an LLC or a S-corp can do. That's another reason why everyone insists in a Delaware C-corp. But the GPs are usually individuals, the people, you know, who make the investments, and they get the benefit from QSBS.
And it's one of the reasons you'll see in a lot of like funding documents, the legal docs will actually ask the startup to rep or warrant that QSBS is alive in the company at the time of investment. And you've gotta be a little bit careful with that, but that's a good thing generally to do on behalf of your investors. But if you are incorporated as an LLC, you actually are not able to take advantage of this. Now there's some super fancy, crazy conversion things you can do from LLC to Delaware C-corp that a lawyer who charges $3,000 an hour can do for you, and figure out after a huge bill. I am not that smart. I would never take that chance. I would never take the chance of doing it correctly, or actually finding a lawyer who can do it. It's not easy to do, very complicated.
Please don't put $10 million of gains or 10X your investment for not just you, but everyone in the company, at risk by doing it this way. Just if you're gonna take venture capital financing or seed stage financing, eventually VC, just incorporate as a Delaware C-corp. You will preserve the QSBS election. You obviously have to hit the other qualifications for that, but you can save yourself a lot of money. And this is a big deal. I'm recording this in mid-2021 when the Biden tax rates are on the table and essentially taxing capital gains at the ordinary tax levels, ordinary income tax levels. So capital gains would go up from like 20 to 39% for the highest tax bracket. And you sure as heck wanna have a QSBS exemption if you can preserve that.
So, again, incorporate as a Delaware C-corp, not as a LLC. Preserve QSBS, build a great company. Sell it, do an IPO. And live happily ever after paying less capital gains taxes. Thanks!
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