New Tax Rules: A Game Changer for Startup Founders

The OBBBA has introduced some big changes to the Qualified Small Business Stock (QSBS) rules, which could be a game changer for startup founders. The cap on how much stock can be excluded from capital gains tax has been raised to $15 million, and it will go up with inflation after July 4, 2025. This means founders and investors can keep more of their profits when they sell their stock. One of the most exciting changes is the introduction of partial exclusions. Starting in year three, founders and investors can exclude 50% of their gains, increasing to 75% in year four and 100% in year five. This phased approach gives founders more flexibility to plan their exits and adapt to market changes. The OBBBA also raised the gross asset limit for companies to issue QSBS from $50 million to $75 million. This is a big deal for startups and small businesses that struggle to attract investment. The increased cap allows for more capital influx while keeping tax benefits intact, helping founders scale their businesses more effectively. To stay under the new cap, companies can use provisions like immediate expensing of research costs and bonus depreciation. These changes help reduce the tax basis of assets, keeping companies eligible to issue QSBS longer. This is especially useful for research-heavy businesses. However, it's important to note that these benefits only apply to domestic C corporations. Founders need to weigh the pros and cons of forming a C corporation versus a pass-through entity like an LLC or S corporation. While C corporations face double taxation, they offer significant tax savings through QSBS if planned correctly. Many startups don't distribute profits early on, making the double taxation less of an issue initially. Founders should take advantage of these new rules to strategize their growth, capital raising, and exit plans. The increased cap, phased exclusions, and expanded eligibility create new opportunities for innovation and growth. In a tough economic climate, these changes offer a unique advantage for savvy entrepreneurs.