QSBS enters the chat

QSBS enters the chat

Author: The Carta Policy Team
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Read time:  5 minutes
Published date:  January 31, 2025
The Qualified Small Business Stock exclusion for shareholders faces potential threats amid tax reform cost pressures. Here's why it must be preserved, and what it means for the innovation economy.

Policy weekly is back, and we are taking a slightly different approach. Each edition will focus on a key policy development that impacts the innovation ecosystem, along with brief highlights on other pertinent issues. As always, thank you for reading and contact us with feedback, suggestions, and questions.

Taxing the builders: QSBS under fire

$4.5 trillion. 

That is the amount of tax increases that kick in at the end of 2025 if Congress fails to act, affecting more than 60% of American households. Policymakers will not let this happen—no elected official wants to go home to voters that just had their taxes increased because Congress could not legislate—and they will reauthorize key portions of the expiring Tax Cuts and Jobs Act. 

The issue: How do we pay for it? The budget deficit is twice the 50-year average, so Congress will have to find pay-fors to offset the cost of tax reform. 

So what does that mean for the innovation economy—growth companies, their employees, and their investors? Following an election that ushered in full Republican control, most in the innovation ecosystem felt more confident key tax provisions would remain intact. But this week reminded us we have work to do to ensure that happens. 

This week, qualified small business stock (QSBS) came under fire as the Yale Budget Lab, an academic research institute, raised the prospect of modifying or eliminating it, and the White House included it on a list of issues they want the Treasury to provide more information on. 

Quick background detour: QSBS provides an exclusion from capital gains taxes for shareholders—founders, employees, and investors—who were issued shares in certain small companies and held those shares for five years. This incentive drives capital and talent to the startup and growth companies.

Back to the story. The Yale Budget Lab report asserts eliminating QSBS would offset the cost of tax reform by around $80B. 

The Yale report notes there is a dearth of empirical evidence, but the research implies that QSBS largely benefits initial investors and does not extend to the majority of small businesses, as only ~5% of small businesses organize as C-corporations and are thus eligible for the benefit. Their theory of the case: It’s a limited benefit, largely for early investors, that if cut could raise up to $80B. 

Our Take: Adjusting or eliminating QSBS would raise revenue. Initially. But the long-term impact will be devastating. 

Let’s dive deeper into QSBS.  

Why QSBS matters: Building is hard. Creating a tax code that helps companies attract capital and talent helps. This is especially true for startups, which are the riskiest part of the curve: one-third of startups fail in year one; one-half fail within five years. 

But here is the thing: The startup ecosystem is critical to U.S. competitiveness and economic growth. Startups and growth-stage companies create the majority of net-new jobs, create value, and build the innovative products, services, and markets that help the U.S. maintain its competitive edge. We need to bolster them. 

QSBS benefits initial investors; it is designed that way. It incentivizes them to take the risk. In doing so, it not only helps founders turn a concept into a company, but it lowers their cost of capital (which the Yale report acknowledges). And we agree that more startups and small businesses should benefit from this provision. Carta supports broadening the corporate structures eligible beyond C-corporations.  

QSBS benefits founders and employees. QSBS is not just about investors. It is about the founders and employees building. QSBS incentivizes founders to start companies and employees to help them build. Looking across Carta’s platform of 40,000+ privately held companies, founders and employees make up nearly half of the QSBS-eligible shares. QSBS rewards the builders who take the risk and do the hard work.

QSBS drives economic growth, and curtailing it will come at a cost. 

  • Job creation: Startups and small businesses drive the bulk of net-new job creation, accounting for 2 million+ jobs annually; high-growth companies account for 50% of net new jobs annually.

  • Economic value: Today, approximately 50% of public companies and eight of the top ten publicly traded companies by value were VC-backed.

  • Innovative edge: At creation and through their life cycle, startups account for the bulk of R&D spending and investment. They build the future.

I concede these numbers don’t reflect all startups—they include companies that have succeeded on a large scale. But these large companies started with an entrepreneur who needed capital and talent to build. QSBS helped seed that. And those companies grew, added jobs, increased productivity, and—wait for it—paid quite a bit in taxes along the way.

To wrap: Although it’s hard to quantify, I would not concede that cutting QSBS raises $80B, as the Yale report states. In fact, I think it would cost more in lost revenue and—perhaps just as importantly—our country’s innovative edge.

(steps off soapbox)

What’s next? We should not over-index based on one report. But the report and QSBS got attention from political reporters, cutting QSBS has been included in legislative proposals in the past, and congressional staff have indicated this approach has been floated as an option. Plus, it was included on the White House request. So we are engaged. 

Speaker Mike Johnson is aiming to advance a tax bill through the House by the end of April. The first test will be passing a budget reconciliation package, which is the legislative maneuver that enables Congress to pass a tax and spending bill with a simple (Republican-only) majority. The reconciliation package will dictate how much a tax package can increase the deficit by, and it will require alignment across the Republican conference and the Senate to pass an identical package. The House Republicans spent this week at a Member retreat scoping that package. 

Simultaneous to that, the tax writing committees are building the tax policy package, holding hearings, soliciting input from non-Committee members, and of course meeting with industry. 

To inform this process, we will need to engage systematically. And that engagement is bigger than Carta. We worked with partners to launch the Innovator Alliance, focused on driving policies to protect and bolster the innovation ecosystem. This is a growing organization of partners focused on this vision. If you are interested in getting involved, contact us. 

More on tax reform for the innovation economy: Thinking about more than QSBS when it comes to tax reform? You should be. Here is a quick tipsheet from our more in-depth analysis that can be accessed here.

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News to know

—Anthony Cimino

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Carta’s Policy Team aims to connect the policymaking community and venture ecosystem to build an ownership economy and advance policies that support private companies, their employees, and their investors.