updated 2021-05-02
Qualified small business stock (QSBS) is a United States federal tax break that allows your stock grant to be taxed at 0% federally when held for more than 5 years, instead of a standard income tax rate (when held for under 1 year) or a long-term capital gains (LTCG) rate (when held for greater than 1 year).
Lmao no, CA will still get its up to 13%.
Spike Speculator buys $1M shares of AAPL, holds them for 5 years, and sells them for $5M. Spike pays LTCG tax on the $4M of gains.
Joe Jobcreator buys an Apple orchard, or a small shop that sells Apples, for $1M. With hard work and good luck, they build the business, and sell it for $5M 5 years later.
Uncle Sam looks at Joe Jobcreator and concludes they're not doing the same type of thing as Spike Speculator. Joe is being an entrepreneur, building a business, and working hard. They even hodled for a full 5 years. The United States wants to encourage such behavior, so they don't tax Joe's $4M gains on their business.
The business must have under $50M in assets. Roughly, the amount a startup raised would be its assets. Its valuation would generally be a lot higher than that.
You must exercise the shares while the business is still under $50M in assets, which is why early exercise is key. Then, file an 83b election form with the IRS within 30 days.
The business must actually be doing stuff (not be some pass-through or weird financial entity).
You can only get QSBS tax treatment on shares you were awarded for work (like stock options), not shares you bought as an investor.
There's no official notification you qualified for QSBS after you exercised. My understanding is that after 5+ years, after the exit, you'd simply ... not pay federal taxes, and show paperwork that at the time of exercise you qualified for this deduction.