For most of us it is a dream to be living retirement on a beach while sipping a pina colada. If you are reading this, I hope you are not wasting your time on the beach reading about taxation, unless you think you own qualified small business stock (“QSBS”) through a British Virgin Island Corporation (“BVI”). Although BVIs bear great benefits from neutral taxation, low costs, and other efficiencies there are still some cons. A taxpayer can only hope to mix the tax benefits from a BVI “tax haven” and Section 1202 QSBS.
Taking one step back, if you are not entirely familiar with QSBS it is a government tax incentive to spur economic development and innovation by giving owners of QSBS up to a 100% capital gains tax exclusion. This exclusion is good for up to 10x the tax basis of the stock or $10 million, whichever is the larger.
According to Section 1202, QSBS can only be owned by an individual or pass-through entity. The meaning of a pass-through entity per 1202 is (i) any partnership, (ii) any S Corporation, (iii) any regulated investment company, and (iv) any common trust fund. Therefore, it is not possible to purchase or hold QSBS through a C Corporation or BVI. To shed light on a pass-through entity, the meaning “pass-through” refers to the income passing through to the owners without being taxed at the company level.
What If I Transfer My QSBS to a BVI or C Corporation Down the Road?
You can’t have your cake and eat it too…
One mistake founders and investors make is they transfer their QSBS to a BVI to reap the tax benefits. Although this is a good strategy for some folks it is not entirely ideal if you are planning to claim the 100% QSBS capital gains tax exclusion. QSBS can only be “held” by an individual or pass-through entity, which means at no time can the stock be transferred to a non-qualifying holder of QSBS.
Wouldn’t the Tax Benefits of the BVI Be More Beneficial Than QSBS?
It is quite subjective to argue the hierarchy of benefits and it is also tailored to the needs of the taxpayer. One factor to consider is that dollars earned through an offshore entity (i.e. a BVI) are only sheltered indefinitely and will have to be repatriated one day (i.e. the cash is brought back to the US and taxed). On the flip side QSBS is fully tax excluded forever up to a certain cap. There are no crazy tax strategies or hiring multiple tax attorneys. QSBS is very complex but the qualification, assessment, and documentation process is simple through QSBS Expert’s proprietary software.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.