In Episode 19 of How Tax Works, Matt Foreman concludes his discussion of Qualified Small Business Stock (QSBS), which is section 1202 of the Internal Revenue Code.  He discusses possible ways to increase the QSBS exclusion, including gifting, various trusts, and so-called stacking transactions, with a warning about the anticipatory assignment of income doctrine, finishing up with the ability to rollover QSBS stock.

Listen to the episode here:

  

Follow us on Twitter: @HowTaxWorks

How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

Whether you’re a seasoned entrepreneur, accountant, lawyer, or financial advisor, “How Tax Works” offers a wealth of knowledge to empower you in making sound business decisions. Tune in and embark on a journey to unravel the complexities of tax law, one episode at a time.

This podcast may be considered attorney advertising. This podcast is not presented for purposes of legal advice or for providing a legal opinion. Before any of the presenting attorneys can provide legal advice to any person or entity, and before an attorney-client relationship is formed, that attorney must have a signed fee agreement with a client setting forth the firm’s scope of representation and the fees that will be charged.

Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matthew Foreman [00:00:00]:
Welcome to the 19th episode of How Tax Works. I’m Matt Foreman. In this episode, I’m going to conclude my discussion of qualified small business stock. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising and it is not legal advice. Please, please, please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulation, case law, and guidance to demystify how taxes shape the financial and business choices that we all make.

Matthew Foreman [00:00:41]:
Before we get started, a few, a few things. Okay? New episodes every two weeks. Next episode, two weeks, March 3rd. We’re going to talk about why you should buy a professional sports team, at least from a tax perspective. Right? Any questions, comments, or constructive criticism, you can email me at my FRB email address, which you can find via your favorite search engine. And now let’s finish up qualified small business stock. So this episode is going to be focusing on a few kind of ancillary issues, but predominantly on maximizing qualified small business stock exclusion. Right.

Matthew Foreman [00:01:15]:
We just, we talked about before. But just as a reminder, it’s 10 times your basis, which may sometimes be your fair market value at the time you received it under certain circumstances, or $10 million. And it’s the greater. Right. So what a lot of people say is, look, you know, you could only get so much, but if you had more taxpayers, because it’s 10 million basically, right. For a lot of people per taxpayer. And I think that that’s really important. So before I kind of dig into that, I want to talk about the anticipatory assignment of income.

Matthew Foreman [00:01:44]:
Okay. So the goal is income or exclusion shifting, maximizing, and it’s really fact specific. Right. But you can’t assign income to someone else. There’s a case, Palmer 62 Tax Court 684. There’s a revenue rolling from 1978, 78, 197 that deals with this. And what the basic thing is, there’s a certain point prior to when the income comes in that if you give the income to someone else. I know it sounds weird thing to say that it’s what’s called the anticipatory assignment of income.

Matthew Foreman [00:02:15]:
And the key is to donate or gift it before you have that actual agreement to sell. Right. So a lot of times when I do this in the context of qualified small business stock, we’re talking about the sale of a business, the equity in a business. Okay. But the same concepts work for earning income from services. The same concepts exist if you were to sell the assets Right. Obviously doesn’t apply to QSPs, but same concepts. The key is to donate or gift it before that agreement, right? So definitely before you have the agreement, you actually sign it probably before the letter of intent.

Matthew Foreman [00:02:49]:
You want to avoid a prearrangement, right? You want to avoid that. That’s gonna be the key. And what happens if you fail? What happens if you have a, you know, anticipatory assignment of income? And the answer is the donor, the person who gifted the ownership interest, pays the tax. Applestein. Applestein. I’m not sure. ADTC331 tax court case. So let’s talk about gifting generally.

Matthew Foreman [00:03:13]:
After talking about only the best and most exciting things ever. Anticipatory assignment of income. There’s a lot of gray area. There’s a guidance, right? What is a gift? Right. There’s no definition in the tax code. What’s a gift? The case on that is Supreme Court case Duberstein, 363 U.S. 278. If my handwriting can be read.

Matthew Foreman [00:03:33]:
And what it says is that a gift is given due to detached and disinterested generosity. And I want you to contrast that with an employee, right, Being thanked by their employer. All right? That’s not detached and disinterested generosity. If you’re thanking someone for work that they did or something else they did for you, that is not a gift. That is compensation for services provided or for, you know, oh, that person gave me that dump truck. Used. That’s paying someone to use their property, right? That’s a lease. So remember, you can’t use, you know, we talked about this.

Matthew Foreman [00:04:13]:
You can’t use a grantor trust, you know, Reverend Ruling 8513, because it’s the same person for income tax purposes. The key for a gift is the intent to make a gift, and the recipient is a separate and distinct person from the donor, at least for income tax purposes. For 1202. I’m a big fan. Gift early when the value is low, right? There are people who. They’ll buy, you know, modify QSBS stock and they’ll donate it, you know, gift it eight years later. No, gift it now, man. You know, you got, you know, the.

Matthew Foreman [00:04:42]:
The gift exclusion right now is, man, it. You know, interest. It’s really getting high due to inflation, right? It’s at 19,000 or 76 per person. Gift, gift, gift. Keep gifting to your kids. Gift to your kids. Gift to your kids. So I think that that’s really important to do.

Matthew Foreman [00:04:56]:
But remember, for a gift, detached and disinterested generosity, right? That’s what you are with children. And you’re saying, well, no, I’m pretty interested in my children, interested in my spouse. No, no, no. Believe me, that, that, that qualifies for it. I suspect none of you who are listening to this are going to disagree with me here, right? So giving that gift to a friend, a parent, a sibling, right now we’re talking about stacking, right? And the key for stacking is that your goal, you know, for this purpose and for others is to give the gift to a separate taxpayer for income tax purposes. And I want to pause here before I get this, okay? This is not intended to be complete or particularly close on gifting. And more importantly, this is not intended to be complete or even particularly close about trust. I’m not trying to teach you about trusts, okay? I’m trying to give examples, talk about it conceptually, if you want to talk about trust and how to do this in detail, A, you’re going to have to pay for that and B, it depends.

Matthew Foreman [00:05:47]:
It really depends. There’s a thousand factors that I’m not going to go over here. What’s right, what works, how to do it, what to think about, which one to do. So again, you’re giving this gift to your parent, your siblings, your favorite podcast host who talks about tax, right? Which though that may be, actually not be a gift, right? Might not be disinterested generosity and maybe section 83 compensation for services. So we’re going to stick with parents, siblings, things like that, right? So the key is, you know, more individuals, but you really can’t. You know, at a certain point you may run out of individuals. You may not be able to gift it to that many individuals, right? You’re limited by the exclusion annual or lifetime. You know, we talked about grantor trust.

Matthew Foreman [00:06:25]:
They don’t work. They’re a disregarded entity, same taxpayer, even though it’s separate legal entity and it may have a separate ein. Doesn’t work. Disregarded entity, no go or anything similar, Right. Single member LLC also doesn’t work, right. So you need a non grantor trust. So let’s talk about them generally. Okay? Now this is really important.

Matthew Foreman [00:06:43]:
I think it’s one of the most important parts of this, you know, a gift, again gift 19,000 or times 4,76,000. So if you have two, two married couples, right? Married parents, have a child, child got married, right. You could actually do 76,000, you basically quadruple it. Or the lifetime is 13.99 million. But look, let’s pause some states have lower thresholds. Some states have gift taxes, some states don’t, et cetera, et cetera. Really important to note. So the goal is to create as many exclusions as possible, really to get that $10 million per taxpayer, per trust, effectively.

Matthew Foreman [00:07:16]:
The most important thing to understand about trusts is that if you have multiple trusts with the same grantors, grantor grantors, substantially the same primary beneficiary or beneficiaries, especially if there’s other similar factors, you have a single trust, they basically get collapsed into one trust for general purposes and for QSBS purposes. So that’s treasury regulation 1.643 F1. So make sure that if you’re going to use a non grantor trust that you do this properly. Take your time, make them different, get an advisor, go into the specifics. Okay, we’re going to move on to some real stacking, talking about a bunch of different trusts. First we’re going to take a quick break for some music. Hope you enjoy it. We’ll come back and talk about incomplete gift, non grantor trusts.

Matthew Foreman [00:08:13]:
All right, we’re back. Let’s talk about stacking QSBs. Incomplete gift, non grantor trusts Ings, right? They’re non grantor trusts for income tax, but they’re incomplete gifts. So you know, there’s no gift taxes. That’s the idea, right. So if you heard of a ding or a ning, right? Ding is Delaware Ning, Nevada, you know, something like that. I don’t know how you pronounce an Alaska one. A Ing, Ying Ang.

Matthew Foreman [00:08:39]:
I’m not sure. Some of them don’t work anymore. Right. New York, for example, looked at those and you know, wave their finger Dikembe Mutombo style and said, no, no, no. This is a grantor trust for New York state income tax purposes. So for 1202 it’s similar to a completed gift, which I already discussed. So. So don’t worry about it.

Matthew Foreman [00:08:56]:
But you know, you really don’t want to do ings. Watch out. A lot of states don’t like them. There’s other reasons to take them out, you know, to not use them outside of 1202. So watch out. You know, look for some states, solar lot don’t know minors heading New York, California don’t. Not attorney in California. So take that with your grain of salt, right? Then there’s, you know, grantor retained annuity trusts or GRATs.

Matthew Foreman [00:09:16]:
It’s grad idea. The donation is the remainder interest. The grantor retains access to the money. It’s a grantor trust. So maybe not the best idea. You notice I’m saying, hey, well, here’s some ideas. They don’t work. This is hard.

Matthew Foreman [00:09:30]:
I’m trying to kind of make this obvious that there’s a lot of things that don’t work. And there are things that I’ve seen sometimes which is kind of interesting to think about. Let’s talk about charitable Remainder Trusts. Crts. There’s cruts and cracks. The most common one is a flip crut. Charitable Remainder Unit Trust is what the CRUT stands for. I’m not going to discuss the 10 minutes to explain them in the detail that’s necessary.

Matthew Foreman [00:09:54]:
But what I’m going to say is that the unit trust payments to the beneficiaries, which can include the donor, are based on a percentage or fixed amount, often a percentage of the fair market value of the trust. Assets following a triggering event can be kind of whatever you want. CRTs are generally exempt from income tax. Section 664. Beneficiaries pay tax based on what they receive. I always think of them a lot like REITs. You know, the idea is that, you know, you pass the money out and you get it and the owners pay tax on it. That’s kind of the idea.

Matthew Foreman [00:10:25]:
But the, you know, the money can sit in the CRT a little differently. The taxes would include the proceeds from the sale of QSBS stock. I’m under the belief that that retains the character. I’ve never really gone through the mechanics of the details of it. That’s my understanding. Again, you know, this is not legal advice, but that’s what we want to think about, that. The details matter. Right.

Matthew Foreman [00:10:44]:
And there’s reasons for doing cruts and not doing cruts. You know, crts. Let’s reset for a moment. Right. We’re talking about stacking QSBs. We’re talking about stacking to increase the exclusions with the goal of decreasing tax. So you can’t use multiple identical trusts and you can’t use non grantor trusts. This is a important point.

Matthew Foreman [00:11:04]:
I’m kind of flipping over it. But you can’t use non guarantor trusts to avoid federal tax. The Treasury IRS released the regs in 2018. The focus was section 199 cap A. But the same general concern exists. Right. You know, if you’re just creating trusts to maximize. Right.

Matthew Foreman [00:11:21]:
199 Cap A is based on the taxpayers. You know, there’s a max amount that a taxpayer can take based on their income or else, you know, if it’s SSTB or there’s Just a maximum amount. You know, there’s sort of a money to take. People like, oh, just. I’ll just set up 94,000 trusts. No, no, it doesn’t work. The focus of those, again, was on 109 cap. A same general concern as this.

Matthew Foreman [00:11:42]:
You know, I also talk about. It’s not directly on point, but I think it’s relevant. 7701. I believe it’s O. I just wrote 7701 in my notes, but I think it’s 7701, though, is the codification of the economic substance doctrine. The premise there essentially is, you know, what the idea sort of sits is that you can’t do something just for tax purposes. People like, oh, but, you know, it’s kind of what we’re doing here. And it’s like, well, no, you know, you have to do it for estate planning, asset protection, things like that.

Matthew Foreman [00:12:11]:
There are other reasons that sometimes section’s a little flimsier, but, you know, we’ll see how that works. The key is to increase the number of taxpayers for 1202 purposes. Again, you know, greater of 10 million or 10 times the basis per taxpayer. The 10x doesn’t really benefit by increasing taxpayers because you’re getting 10x. So the key is that 10 million. I’m going to take one more little music break, then we’re going to come back. But talk about spouses. Spouses might be the most nuanced one.

Matthew Foreman [00:12:38]:
One. It’s really unclear. People have different opinions on it. So I think it’s a really important one to discuss in some detail. So let’s. Let’s get some music. Be back in just a moment. All right, we’re back.

Matthew Foreman [00:12:56]:
Let’s. Let’s talk about qualified small business stock and spouses. Okay. This is really important. You know, there’s a generalized lack of guidance in section 1202. So there is an open question. Some people, you know, even people who disagree with me on it, will say, yeah, I agree that it’s not. It’s not clear.

Matthew Foreman [00:13:12]:
It’s not super clear. Right. And the question is whether there’s one exclusion from couples filing jointly or whether there’s two separate ones. Right. Whether you’re doubling it. And basically section 1202 is an exclusion to a taxpayer other than a corporation. Right. 1202.

Matthew Foreman [00:13:29]:
And a taxpayer is defined in the code as any person subject to any Internal Revenue Tax. 7701A14. 1202 says, okay, well, a taxpayer filing separately has their exclusion limited to 5 million or 5 times their basis. 1202-B3. However, joint filing, you have to allocate the exclusion between spouses. So, and this is how I think about it, right? Let’s say you get a 1099 dividend for a taxpayer. When you put that into your return software, it asks you, is this spouse A, is this spouse B, or is it joint? Okay, so why do you need to allocate it between the two? Because the ownership is title. Title is obvious who owns it, spouse A or spouse B, you shouldn’t need to allocate it.

Matthew Foreman [00:14:13]:
That should be it. Okay. Should automatically work. So also, if this is community property, then you’re auto splitting it. It’s not. It isn’t. You really shouldn’t have a different result from community properties. Other that’s the whole premise of marriage.

Matthew Foreman [00:14:26]:
Filing jointly is that community property should not change how it works. So the notion of the allocation suggests to me at least, that each spouse has their own exclusion that is undisturbed by the other spouse. So in theory, for example, spouses could double their exclusion by divorcing, right? You listen to a previous podcast of mine, splitting stock and then, you know, getting the gain, getting the exclusion, waiting until after the year and getting remarried. I would love to see an IRS audit. Who said you got divorced and married for tax reasons and you can’t do it? Do that. Love it. Let’s bring it. Let’s do it.

Matthew Foreman [00:15:01]:
Be. Be weird, right? You’d actually increase your state and local tax deduction as well, Right? So to me, a logical conclusion, though not necessarily the logical conclusion, is that each spouse has their own distinct exclusion that is entirely undisturbed by the fact that they’re married and filing jointly. Also, and I always point this out, the code, right, Internal renewal code has a number of specific modifications for single taxpayers and taxpayers who file separately. Right? And jointly. And each one references a joint return to create the distinction. Right. 199 Cap A has it in D3.164, which is, you know, the SOL cap has it in B6 Cap B. And 121, which is the principal residence, deals with it.

Matthew Foreman [00:15:43]:
In B2 Cap A, it specifically says single is this merit? Fine. Jointly is double this one, just as taxpayer. Right? There’s two taxpayers in the return. I think that’s important to note. Am I right? Am I wrong? Pay me, we’ll find out, right? So I think that’s important to note. You know, so what do you do? Right? Do you get an opinion, you can disclose it on your return. Do you have a reasonable basis. You know, and I always say this, and I say this to clients in other contexts.

Matthew Foreman [00:16:09]:
Married filing separately is quirky. Quirky is all get out. And I think that’s important to note that sometimes you just get weird results and that’s, you have to think about, maybe it’s different, maybe it’s not. What is your risk tolerance? So final trust comment is slats, spousal lifetime access trust, right? Don’t think of a slat in a fence, right? No slat in a fence. We’re talking about trust, right? Donor is spouse A during the lifetime, spouse B has access to the income principal upon death of the donor, it goes to other beneficiaries. So the spouse, the non granting spouse has access to the money during their life. During the life of a granting spouse. So what if you divorce, right? You just, you just gave access to money to a spouse you don’t like enough to do it, right? Maybe that plays into the spousal thing.

Matthew Foreman [00:16:57]:
This is how you’re going to deal with it. Maybe you just decide you don’t like each other and now they have access to your QSBS stock, which is your upside stock, right? QSBs, you’re, you’re looking for the max gain, you’re looking for huge payouts, you’re looking for $1 billion. I guess you’re doing that anyway. But QSBs ask me the best way to do it. So with a slat, you know, you need a third party trustee. And I always say watch out for dual slats, right? Which are substantially similar trusts. You know, they’re, they’re going to be ignored like they don’t even exist. So use different trustees, different beneficiaries, different provisions, different terms.

Matthew Foreman [00:17:26]:
Don’t do it at the same time, yada, yada, yada. That’s kind of the big point there. I’m going to say his final point. You know, trusts matter. Look at the details. All right, final point we’re going to talk about. The final thing is rollover. I’ve been talking for too long already, so I’m not going to go into too much detail on this, but 10:45, okay, QSB stock, you sell it for cash, but you haven’t held it for at least five years.

Matthew Foreman [00:17:50]:
All right, you can roll it over under section 1045, you must have held this stock for at least six months. Can’t get it, then immediately roll it over. You have to invest into another qualified small business by buying their stock normally within 60 days of the sale. Day one is the day of the sale. So it’s one plus 59. Day of sale plus 59. It’s hard to reinvest so quickly. I know that sales can take time, but you may not want to do it.

Matthew Foreman [00:18:13]:
Just, you know, sometimes just take the money. You know, is it even a good investment to invest into it? I’ve never seen anyone actually pull this off. I’m sure it’s happened, but I’ve never seen it. It’s something I want to mention. It does exist. You know, don’t push too hard on it. And I think that’s important. All right, I have spoken enough.

Matthew Foreman [00:18:30]:
Next time, next time, next time, 20th episode. Right. And we’re going to talk about why you should buy a professional sports team From a tax perspective, I think that’s really important. Now, now, now for the very, very, very much greatest, greatest, greatest, greatest song of all time.