March/April 2021 Tax Tips

Using qualified small business stock to attract investors

For businesses in need of funding, qualified small business stock (QSBS) can be a powerful tool for attracting investment capital. It entices investors with the prospect of tax-free gains on the sale of the stock (subject to certain limitations), provided they hold it for more than five years. Generally, to qualify, stock must be issued by a domestic C corporation that has aggregate gross assets of $50 million or less, must not be involved in certain types of business (for example, professional services, banking, insurance, farming, oil and gas, or hospitality), and must meet several other requirements. Among other things, the stock must be acquired by investors as part of an original issuance rather than from other shareholders.

Pass the SALT

Since 2018, individuals have been subject to a $10,000 limit on itemized deductions of state and local taxes (SALT). Until recently, however, it was uncertain whether that limit applies to entity-level taxes incurred by pass-through entities — such as S corporations, partnerships and limited liability companies — and passed through to their individual owners. Recently, the IRS announced its intent to issue regulations confirming that these taxes aren’t subject to their owners’ $10,000 SALT deduction limit. Although it’s not yet clear how the final regulations will work, the announcement appears to endorse a workaround to the $10,000 limit, adopted in some states. These states have imposed entity-level taxes on pass-through businesses, with the business owners receiving a corresponding tax credit or exemption.

Reducing taxes with net gifts

A “net gift” can be an effective tool for reducing gift taxes. It’s simply an agreement by the donee, as a condition of receiving the gift, to pay any resulting gift tax. This liability reduces the value of the gift, thereby reducing the tax. A “net, net gift” can reduce the tax even further. Here’s how it works: In addition to agreeing to pay the gift tax, the donee also assumes liability for any estate tax that might arise if the donor dies within three years of making the gift. (Under the “three-year rule,” gifts made within three years of death are included in the donor’s estate.) The actuarial value of this potential liability reduces the value of the gift.

Want to save taxes? Hire your kids

For business owners, hiring your children can be a great tax-saving strategy. By shifting income to family members in lower tax brackets, you can reduce your family’s overall tax bill. Plus, if your kids are under 18, they’re exempt from Social Security and Medicare taxes if the business is either a sole proprietorship or a partnership in which you and your spouse are the only partners.

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