Small businesses and startups create new markets and transform old ones, inspiring competition, driving innovation, and creating the job growth essential to growing the US economy. However, only 20-30% of early-stage tech startups succeed and most individuals willing to invest in these companies lose their money for the potential to collect on the significant tax exemptions that are offered. For this reason, the US Government created tax incentives like Qualified Small Business Stock (QSBS).
QSBS, Internal Revenue Code Section 1202, was enacted in August of 1993 as bipartisan legislation to aid in jolting the US economy out of recession. Senator Dale Bumpers, a key proponent in drafting the legislation almost three decades ago, summed up the advantages of QSBS, stating:
“This is a modest tax incentive that holds great promise for hundreds of thousands of small firms with good ideas but not enough capital.”
In 2010, QSBS was expanded up to a 100% tax exclusion. President Obama later spoke of the importance of entrepreneurship to America.
“This is a country that’s always been on the cutting edge. And the reason is that America has always had the most daring entrepreneurs in the world.”
With inflation spiking and the US economy shrinking in the first quarter of 2022, pulling back on incentives that drive growth can move the US ever closer to a recession, if not worse; however, Congress continues to push legislation that could curtail QSBS.
CapGains, Inc. conducted a poll to help gauge how Americans view these potential changes.
How Do Americans View Small Business Incentivization
While many entrepreneurs take advantage of these tax incentives, over 89% of Americans believe the US should do more to incentivize small businesses. Starting a small business or investing in one is a high-risk play, yet the potential for increased job growth and innovation is well-documented.
The survey of 1,047 adults, conducted by CapGains, Inc., sought to determine Americans’ views on the current state of small business incentivization in the United States, with 39% of respondents having started their own small business before.
There are currently multiple ways in which founders and investors are incentivized, but according to our respondents, over 80% of them would be more likely to start or invest in a company if their investment had a chance to be tax-free. Currently, Section 1202 provides this opportunity, as a small business that is eligible for the Qualified Small Business Stock (QSBS) tax incentive can receive up to 100% off in capital gains taxes.
In spite of the tremendous potential of tax incentives to incentivize small businesses, 87% of respondents believe that the current US tax incentives are hard to understand and take advantage of. Even with the opportunity for 100% savings in capital gains taxes, many individuals are unaware of the exemptions and how to best utilize them.
Further jeopardizing the potential of QSBS to incentivize small business creation and investment is the current BBBA proposal that aims to reduce the QSBS exemption to 50%. This not only contradicts what respondents said in regards to being more willing to invest if their investment had a chance to be tax-free, but it also goes against their belief that the U.S should keep pace with other countries that provide incentives for starting and investing in early-stage companies; 87% of those polled believe the US should keep pace with other countries, and reducing the QSBS exemption moves us back.
Many US companies we work with were started by entrepreneurs who came to the US to start their company. For one such company, which has grown to 53 employees over its 9-year history and is currently paying roughly $7 million in salaried compensation, with $2 million paid back to local, state, and federal tax revenue, the blow of the QSBS incentive cuts are almost too much to bear – as the founder notes:
“QSBS is the reason we took the risk…It’s the reason the founders and early employees took gigantic pay cuts and zero benefits, because it was worth the risk due to an incentive put in place by the government. The incentive worked, we have a valuable asset based on 9 years of hard and under-paid effort.”
The Impact of Curtailing QSBS
If tax incentives are not available as an economic tool to founders and investors, the impact could be felt throughout the economy with innovation and job growth stagnating. These survey results indicate a strong belief that expanding, not contracting, tax incentives could push small businesses and startups to new heights. The proposed cuts to the QSBS tax exemption could be highly detrimental and what has continually been an economic tool to stimulate the economy, would now carry less weight and could make it that much more challenging to continue America’s great entrepreneurial spirit.
Join our coalition to help make your voice heard and protect QSBS and our entrepreneurial ecosystem.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.