Estate Planning for Founders with QSBS

Section 1202 of the Internal Revenue Code (IRC) promotes investment in certain small businesses by enabling investors to exclude eligible capital gains from qualifying small business stock (QSBS). This provision provides an immense opportunity for founders and investors of small businesses in fields such as technology, retail and manufacturing to exclude up to 100% of eligible capital gains.

Leveraging QSBS Through Nongrantor Trust Planning

For founders and early investors, Qualified Small Business Stock can represent a rare alignment of income tax efficiency and long-term wealth transfer opportunity. When substantial appreciation is anticipated, Section 1202 does more than reduce capital gains tax - it creates a strategic planning window.

Under current law, eligible taxpayers may exclude up to $15 million per issuer (for post–July 4, 2025 stock), or 10 times their adjusted basis, provided statutory requirements are satisfied. Importantly, the exclusion is determined on a taxpayer-by-taxpayer basis. This creates a meaningful estate planning opportunity when combined with properly structured nongrantor trusts.

A nongrantor trust is treated as a separate taxpayer for income tax purposes. When QSBS is transferred by gift to a properly designed nongrantor trust, the trust may be eligible to claim its own Section 1202 exclusion upon a qualifying sale, subject to applicable statutory and regulatory limitations. In appropriate circumstances, this structure can allow a family to access multiple exclusions while also removing future appreciation from the grantor’s taxable estate.

Beyond potential income tax efficiency, the use of nongrantor trusts can serve broader estate planning objectives, including:

Shifting future appreciation outside the taxable estate
Providing asset protection for beneficiaries
Establishing governance and distribution standards for multigenerational wealth
Coordinating liquidity planning around anticipated exit events

However, this strategy is not mechanical. Treasury Regulations include aggregation and anti-abuse rules that may limit the ability to treat multiple trusts as separate taxpayers in certain circumstances. In addition, the planning must account for gift and estate tax considerations, valuation requirements, trust income tax brackets, state income tax exposure, and overall control objectives.

When thoughtfully integrated into a comprehensive estate plan, QSBS and nongrantor trust planning can significantly enhance both income tax outcomes and long-term wealth preservation. The key is early coordination - ideally well in advance of a liquidity event - to ensure that structure, documentation, and timing align with both statutory requirements and family objectives.