Are there any QSBS-specific tax-optimization strategies for start-ups?

Because the QSBS gain exclusion for a holder is capped at the greater of $15 million, indexed for inflation (or $10 million for stock issued before July 5, 2025), or 10 times the stockholder’s aggregate adjusted tax basis, there are two main strategies for maximizing the potential QSBS gain exclusion: “Stacking” and “Packing,” which are discussed below:

Stacking

This strategy aims to increase the number of holders eligible for QSBS gain exclusion to maximize the up-to-$15-million exclusion on a per-taxpayer basis. This provides a planning opportunity for transferring QSBS to other taxpayers in order to increase (or “stack”) the up-to-$15-million gain exclusion.

For example, if a holder has four children and transferred portions of the holder’s QSBS to each child, each child would then have a $15 million gain exclusion for their respective QSBS, so the founder would have gone from having one $15 million exemption to four $15 million exemptions, creating $60 million of exemptions. This usually takes the form of “stacking trusts”—where the holder’s trust lawyer will create trusts for each recipient of the QSBS transfer and the trusts operate as separate individual taxpayers (please note that there are complexities with the simultaneous overlay of trust rules and gift tax rules with this strategy, and a holder considering this strategy should always seek independent tax and trust counsel).

The example above assumes that the relevant stock was issued on or after July 5, 2025. If the stock had been issued prior to July 5, 2025, the maximum gain exclusion would be $10 million per child and $40 million total.

Packing

This strategy aims to increase the holder’s QSBS basis by “packing” the corporation with value/cash to maximize the benefits of the 10x basis exclusion. This is possible because the basis of QSBS that is acquired in exchange for property will be no less than the fair value of such property on the date of exchange. Therefore, increasing the tax basis of the QSBS will maximize the gain exclusion realized through the 10x basis cap.

Packing an Existing Entity. This strategy commonly arises where a single founder (or co-founders) formed the business as a partnership or LLC and has been developing the business over time. Upon receiving a credible venture financing term sheet and obtaining a valuation report for the value of the LLC/partnership, the founder then converts the LLC to a C-corporation (at a time where it is worth less than $75 million, to maintain the QSBS status of the equity at conversion). This conversion locks in a higher QSBS tax basis for the founder than would have been possible if they had formed a C-corporation on day one.

For example, if a founder owns an existing LLC and receives a $20 million pre-money preferred stock term sheet from a tier one VC and then obtains a valuation report that values the LLC’s pre-transaction assets at $15 million, the maximum post-conversion QSBS gain exclusion will be $150 million (10 times the $15 million basis of the pre-conversion assets).

However, here are several reasons why packing may not always be an optimal strategy for founders: 

• The QSBS holding period requirement in an LLC conversion scenario begins at the time the LLC converts into a corporation, not when the company was originally founded as an LLC, meaning that founders may need to hold their stock longer than originally planned.
• The value of the pre-transaction assets ($15 million in the example above) does not qualify for QSBS treatment and instead will be taxed as a long-term capital gain when sold.
• Granting employees equity while a company is structured as an LLC typically requires a bespoke profits-interest plan that can be expensive and add significant complexity when the LLC is converted to a corporation. 

Packing Prior to Incorporation. The packing strategy may also be utilized in instances where repeat founders have not yet incorporated or formed a company but have received a credible term sheet for financing their proposed business. Prior to incorporating, the founder can obtain a valuation report on the underlying intellectual property (IP) that will be contributed by the founder in exchange for stock in the new company. This fair market value will serve as the QSBS basis subject to the 10x limitation.

For example, if a founder of a yet-to-be-formed company receives a $30 million pre-money preferred stock term sheet from a tier one VC and obtains a valuation report that values the founder’s IP at $15 million (and then incorporates the company, exchanging the IP for equity), the maximum post-formation QSBS gain exclusion will be $150 million (10 times the $15 million basis).

The above discussion is a basic overview and is not intended to be a comprehensive guide to QSBS optimization. Founders considering utilizing packing, stacking, or any other tax-optimization strategies should carefully consult with their legal and tax advisors.

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