Tax treatment for searchers (QSBS vs flow-through LLC)

searcher profile

November 03, 2022

by a searcher from Western Governors University in Atlanta, GA, USA

Does anyone have a case study of buying a business using the QSBS versus using flow-through entities for search funders?

On one hand, if you use QSBS you avoid the gain on the business after the sale. However, it requires the business to be a C-corp which means no flow through of losses and potential double taxation on distributions.

Any thoughts on this?

Thanks.

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commentor profile
Reply by an investor
from University of Nebraska in Austin, TX, USA
This would definitely be an interesting case study. It's a topic that is coming up more frequently.

One thing that you may not know...an LLC can also qualify if it has *elected to be taxed as a corporation*. If your attorney or accountant filed a Form 8832 and on question 6 made that election, your company's stock could qualify for the QSBS tax exemption without having to convert to a C-Corp: https://www.irs.gov/pub/irs-pdf/f8832.pdf

Depends on a bunch of factors: expectations of distributions to investors, if you have investors, what your exit time horizon is. I've invested in 1 self funded search deal that after close the LLC elected to be taxed as a corporation to qualify for QSBS in 5 years: longer time horizon, don't expect to distribute ongoing earnings (all cash goes back into growing or building cash to acquire), don't plan to have significant earnings during first 3 years (business growth > ongoing distributions). Gain is expected to be large and contributed meaningful to both operator & investor outcomes. It was part fact based and part strategy/gut based. It's a calculated risk but made sense given the expectations here.
commentor profile
Reply by a searcher
from University of Pennsylvania in Seattle, WA, USA
The biggest thing I have run into when discussing tax advantages of corporate forms recently is your belief on the likelihood for the QBI to actually sunset and whether QSBS will remain and if if is axed in the near term, will there be any grandfathering language.

I don't think there is a perfect answer for every company type or hold period and would tend to delay the final decision as long as possible and utilize good advisors to model both scenarios before formation.
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