Wealthy Silicon Valley investors in line for US$17 billion windfall in US senate Republican tax Bill

[NEW YORK] Silicon Valley’s favourite tax break may be getting an upgrade.

Venture capitalists, along with successful tech founders and early startup employees, already pay no taxes on billions of US dollars of gains annually, thanks to a lucrative and complicated provision called Qualified Small Business Stock, or QSBS. Now the carve-out could get even more generous in changes included in Senate Republicans’ proposed tax and spending Bill moving through Congress.

The once-obscure provision is the subject of “every dinner conversation in Silicon Valley,” said Christopher Karachale, a partner at law firm Hanson Bridgett in San Francisco. “It’s already an exceptional benefit for people who take risks on startups.”

Taxpayers claimed US$51 billion of QSBS gains in 2021, a record year for venture capital deal activity, according to a Treasury paper earlier this year, with the benefits skewed to a select group. While about 33,000 people reported QSBS to the Internal Revenue Service annually over the decade studied by Treasury, 90 per cent of the total income went to individuals reporting more than US$1 million of gains on eligible stocks.

Shares qualify as QSBS if they’re acquired early enough in a startup’s life cycle and held for more than five years. Once sold, capital gains aren’t taxed up to certain limits, which advisers to the wealthy have figured out how to stretch and multiply several-fold. With the right planning, a venture capital investor or founder can end up with hundreds of millions of US dollars of tax-free income.

Now the QSBS break could get even better. Though it was not addressed in previous versions of US President Donald Trump’s “One Big Beautiful Bill,” Senate Republicans slipped into their version tweaks relaxing its complex rules. Taxpayers would be able to invest at later stages in startups and still get QSBS, cash out earlier and still get a partial benefit, and skip taxes entirely on up to 50 per cent more of their windfalls.

‘I’m surprised’

Critics say the QSBS provision is unnecessary and overly expensive. House Democrats proposed restricting the tax break in 2021.

“I’m surprised they’re not killing this thing, but I guess the lobbyists did their work,” said Manoj Viswanathan, a professor at the University of California Law San Francisco who has studied QSBS. “I just don’t think it’s worth it.”

The Treasury projects the current QSBS break will cost the US$44.6 billion over the decade beginning in 2025. The Senate bill’s proposed changes would boost that by another US$17.2 billion over that period, the Joint Committee on Taxation estimates.

Defenders of the provision have spent several years pushing Congress to expand it, arguing it encourages innovation and risk-taking. “It brings more capital off the bench and into the game that might otherwise go to different asset classes,” said Patrick Gouhin, chief executive officer of the Angel Capital Association.

“QSBS encourages long-term investment in high-growth startups across the country by lowering the cost of capital,” Bobby Franklin, president and CEO of the National Venture Capital Association, said in a statement. “It tells investors and founders alike: building something new in America is still worth it.”

Despite the name Qualified Small Business Stock, the vast majority of small businesses are not eligible. Only C-corporations issue stock that qualifies as QSBS. Service industries are generally excluded, and the break is most valuable for technology or biotech that can grow quickly and generate large capital gains.

The Senate proposal would be a potential boon to investors in artificial intelligence and other hot areas.

‘Stacking’ strategy

To qualify under current law, taxpayers must have obtained their shares in a C-corporation at an early stage, when it had less than US$50 million of gross assets, an accounting definition often significantly less than its valuation. People who hold QSBS for at least five years can avoid taxes on up to US$10 million of capital gains or 10 times their initial investment, whichever is more.

An early investor who puts US$30 million into a startup, therefore, can theoretically receive US$300 million tax-free. Founders can maximise their initial basis, and thus their potential QSBS-eligible gains, by transferring intellectual property into a startup from a predecessor company.

Through a process called “stacking,” QSBS holders can multiply the benefits of the US$10 million exclusion as well.

“It’s the biggest game in town,” Brian Gray, a partner at accounting firm Gursey Schneider in Los Angeles, said of the strategy. His clients typically set up six or seven trusts, each benefiting a different family member, to get up to US$60 million or US$70 million in tax-free gains rather than just US$10 million.

Senate Republican lawmakers would turbo-charge those benefits. They would set a US$75 million limit on an eligible startup’s gross assets, up from US$50 million, on QSBS issued after the bill is enacted. Maximum tax-free gains would jump to US$15 million, from US$10 million. Both limits would be adjusted for inflation starting in 2027.

The bill would also make it easier for QSBS holders to exit their investments sooner than five years without forfeiting tax benefits, allowing them to exclude half their gain after three years and 75 per cent after four years.

That will be valuable to serial entrepreneurs, according to Gouhin of the Angel Capital Association. “This gives you an added incentive to turn that company as quickly as possible.” BLOOMBERG