How Tax Works — Qualified Small Business Stock (IRC 1202): Part III

Podcast: How Tax Works
Host: Matthew Foreman (Co-Chair, Taxation Practice Group, Falcon Rappaport & Berkman LLP)
Date: February 17, 2025
Episode Focus: Strategies for maximizing QSBS exclusion, gifting, trusts, and planning nuances.

Episode Overview

Matthew Foreman wraps up his multi-part exploration of Qualified Small Business Stock (QSBS) under IRC Section 1202 by turning the spotlight on real-world planning techniques, focusing on maximizing the QSBS exclusion through gifting, trust strategies, and nuanced topics such as spousal ownership and rollovers. The episode features practical advice, warnings about tax traps, and clarifies frequent misconceptions, all delivered in Foreman’s characteristically direct, slightly irreverent tone.

Key Discussion Points & Insights

1. Maximizing QSBS Exclusion: The Basics

[01:00]

• The QSBS exclusion is the greater of $10 million or 10x basis, but this can potentially be multiplied by increasing the number of "taxpayers."
• "For a lot of people, it's basically $10 million per taxpayer." (01:20)

2. Anticipatory Assignment of Income

[03:10]

• Shifting income or gains by gifting equity before a business sale can be effective, but timing is critical to avoid “anticipatory assignment of income,” which could result in the donor being taxed anyway.
• Cite: Palmer (62 Tax Court 684), Revenue Ruling 78-197 (03:40).
• Key Point: The transfer (gift) must occur well before any sale agreement or even a letter of intent.
• "You have to donate or gift it before that agreement… definitely before you have the agreement, probably before the letter of intent." (04:25)

3. Definition and Nuances of Gifting

[06:20]

• No statutory definition of "gift": Refer to Supreme Court case Duberstein (363 U.S. 278): Gifts arise from “detached and disinterested generosity.”
• Gifting to family (kids, spouse, siblings) usually qualifies.
• Annual Exclusion: $19,000 (per 2025 inflation), can multiply for spouses. [08:10]
• Advice: "Gift early, when the value is low... Gift, gift, gift. Keep gifting to your kids." (07:40)
• Cautions against using grantor trusts or single-member LLCs—these are disregarded for income tax purposes and don't create separate "taxpayers."

4. Trusts — The Stacking Mechanism

[10:40]

• Main goal: Create as many exclusions as possible via gifts to different taxpayers, including non-grantor trusts.
• Regulatory caveat: If multiple trusts have the same grantor and substantially the same beneficiaries, they may be collapsed and treated as one trust for tax purposes (Treas. Reg. 1.643(f)-1).
• "Make them different, get an advisor, go into the specifics." (12:00)
• Stacking works only if done properly; don’t use disregarded entities or identical ‘clone’ trusts.

5. Types of Trusts and Their Pitfalls

[13:10]

• Incomplete Gift Non-Grantor Trusts (INGs): Popular in some states (e.g., Delaware, Nevada), not in others (e.g., NY, CA).
  • "New York, for example, looked at those and... said, 'No, no, no.' This is a grantor trust for New York state income tax purposes." (14:20)
• GRATs (Grantor Retained Annuity Trusts): Not well suited for QSBS because they are grantor trusts.
• Charitable Remainder Trusts (CRTs): Generally exempt from income tax and can be used with QSBS, but details matter. Most common is a flip-CRUT.
  • "I've never really gone through the mechanics of the details of it. That's my understanding... but that's what we want to think about." (16:00)

6. Anti-Abuse and Economic Substance Rules

[18:00]

• IRS regulations (2018, focus on Section 199A) warn against using "multiple identical trusts" simply to multiply exclusions.
• Referenced economic substance doctrine (Section 7701(o)): Transactions done purely for tax reasons without legitimate non-tax motivations won’t work.
• "No, you can't just set up 94,000 trusts. Doesn't work." (18:50)

7. Spousal Nuances in QSBS Planning

[20:00]

• Open question if married couples (filing jointly) receive one $10 million exclusion or two.
• "There is an open question... whether there’s one exclusion for couples... or whether you’re doubling it." (20:30)
• Foreman’s interpretation: Each spouse likely has their own exclusion, so splitting ownership can potentially double benefit.
• Quip: “In theory... spouses could double their exclusion by divorcing, splitting stock, getting the gain, waiting, and remarrying... I’d love to see an IRS audit about that.” (21:30)

8. Special Trust Structure: SLATs (Spousal Lifetime Access Trusts)

[23:15]

• A trust for the benefit of the non-grantor spouse (with details to prevent them from being collapsed as mirror trusts).
• "Use different trustees, different beneficiaries, different provisions, different terms. Don’t do it at the same time." (24:20)

9. QSBS Rollover (Section 1045)

[25:30]

• If you sell QSBS before holding for 5 years, you can roll into new QSBS within 60 days (must have held original at least 6 months).
• "I've never seen anyone actually pull this off. I'm sure it’s happened, but I've never seen it." (26:15)
• Practical note: It’s logistically difficult—“sometimes just take the money.”

Notable Quotes & Memorable Moments

• On gifting timing:
  “You have to donate or gift it before that agreement… probably before the letter of intent. You want to avoid a prearrangement, right? That’s gonna be the key.” — Matt Foreman (04:25)

• On aggressive planning:
  “No, you can’t just set up 94,000 trusts. Doesn’t work.” — Matt Foreman (18:50)

• On spouse planning quirks:
  “Spouses could double their exclusion by divorcing, splitting stock, getting the gain, getting the exclusion, waiting until after the year, and getting remarried… I'd love to see an IRS audit [on that].” — Matt Foreman (21:30)

• On the unpredictability of certain tax structures:
  “This is hard. I’m trying to kind of make this obvious that there’s a lot of things that don’t work.” — Matt Foreman (13:30)

Timestamps for Key Segments

• [01:00] – Establishing the maximum QSBS exclusion and multiplier effect.
• [03:10] – Anticipatory assignment of income and the case law.
• [06:20] – What constitutes a gift under tax law.
• [08:10] – Annual gifting strategies and exclusion amounts.
• [10:40] – How to “stack” the exclusion with trusts.
• [12:00] – Why identical or disregarded trusts fail for stacking.
• [13:10] – Trust types: INGs, GRATs, CRTs and why most are problematic for QSBS.
• [18:00] – Anti-abuse rules & economic substance doctrine.
• [20:00] – Nuanced spousal issues in maximizing the exclusion.
• [23:15] – SLATs and design considerations to preserve benefits.
• [25:30] – QSBS rollover provisions (Section 1045) and practical challenges.

Closing Thoughts

Foreman wraps up QSBS planning stressing that details matter, state law can undermine federal strategies, and attempting “clever” stacking without robust legal support is a recipe for disaster. While there are routes to multiply exclusions, each comes with intricate requirements and risks. Seasoned advisors are essential, and as always: document intent, timing, and maintain economic substance in every move.

“Trusts matter. Look at the details.” — Matt Foreman (24:50)

Next Episode Preview:
Ep. 20 (March 3): “Why You Should Buy a Professional Sports Team (from a tax perspective)”

For tax, legal, or structuring advice, consult a professional. The podcast and this summary are for educational purposes only.