HoldCo's TOP 5 SMB Law Group Attorney Secrets You Need to Know Now

Summary

In this conversation, Jon Stoddard and Kevin Henderson delve into the complexities of business structures, focusing on LLCs, C-Corps, S-Corps, and Qualified Small Business Stock (QSBS). They discuss the benefits and drawbacks of each structure, particularly in relation to taxation and liability. The conversation highlights strategic considerations for business owners, including how to navigate corporate development, tax obligations, and long-term planning for acquisitions. Kevin emphasizes the importance of understanding the evolving nature of tax laws and the potential impact on business strategies.

Takeaways

LLCs provide limited liability and pass-through taxation.
C-Corps face double taxation but have lower corporate tax rates now.
S-Corps allow owners to take distributions without payroll taxes.
QSBS offers significant tax benefits for small business investors.
Tax strategies should be flexible and adapt to changing laws.
Complex structures can help isolate liabilities and optimize taxes.
Understanding the implications of dividends is crucial for C-Corps.
Long-term strategies may require different business structures.
Tax obligations can impact cash flow and investment strategies.
It's essential to stay informed about legislative changes affecting business taxes.

 Watch the Interview:

Transcript:

Jon Stoddard (00:00.61)
Welcome to the top &A entrepreneurs. Today my guest is Kevin Henderson. He is an attorney at SMB Law Group that specializes SMB business, know, the small business and also acquisitions and exit. So welcome to the show, Kevin. Thanks, John. Happy to be here. Been looking forward to this. So I appreciate you having me on. So Kevin, you were connected on LinkedIn and I saw a tweet that you put out was just

spectacular about acquisitions, LLC, S-Corp, C-Corp, holding companies. And it was just really thought out really well. And I want to talk about that today. Yeah, no, I appreciate that. was well received. A lot of people asked those questions to us as a firm. They asked them on Twitter. And there's a lot of great advice out there, but a lot of advice. And I thought, you know, let's

Let's put some of those thoughts into one tweet. Hopefully people can refer back to it, get something out of it, and it's enough to at least start asking more questions. Yeah, definitely. Stay to the end or look in the YouTube and the comments below because I will have this document. It's awesome. So let's go to that. I'm going to share the screen and we're going to do share screen. So can you see that? I sure can. Great. So the first we talk about

You say interested in building an expert dryer halfway, but you hear LLC, QSBS, qualified small business and pass through your eyes, glows over like a student listening econ lecture. yeah, that is very true. Let's go to this one here. Let's talk about this one, the LLC. Yeah.

You know, there's a lot of interesting information out there and you see some interesting takes in terms of tax treatment and things like that. So an LLC was really designed to be a limited liability vehicle in the same way that a corporation can be, but without a lot of the corporate C-corp problems that we'll get into or perceived problems as the case may be.

Jon Stoddard (02:22.552)
But interestingly, you can do kind of whatever you want with an LLC. And I think a lot of people don't appreciate this. Generally, an LLC is taxed as a pass-through entity, which is what I say here, meaning for tax purposes, it's treated as if it doesn't exist. That means whatever money your company makes passes right onto the individual. Right up to whoever owns the LLC. And if there's another LLC there, it passes through. So you see stacks and layers. And then eventually,

just goes up as if none of those LLCs exist until it hits someone that's a taxable entity. interestingly, an LLC can be a taxable entity if you elect for it to be that. So you can elect for your LLC to be taxed like a corporation, but generally the default is that an LLC is a pass-through entity that gets disregarded for tax purposes and it just moves up to whoever the member of the LLC is. Yeah, beautiful. Let's go to this next one here.

If you stack multiple LLCs in your structure, they are all disregarded up until you get to a taxable entity. That's right. So like I was just mentioning, if an LLC is disregarded and you have an LLC owning another LLC, that bottom layer operating company gets disregarded and it's as if its income was recognized or earned by the LLC up here. Well, that LLC is also disregarded.

that goes away and it immediately pushes up again. So it can go as many layers of disregarded entities as you want to until it hits somebody or something, someone that's taxable. That could be you as a person, that could be a C-Corp, it could be, you know, we'll get to S-Corp in a minute. But that's what happens if you stack these in your structure.

Is there any industries that do that a lot and say, hey, I don't want to create an S-Corp or C-Corp, just stack and hold bunch of LLCs? Yeah. I mean, it's really common in corporate structures where they want everything to flow through up to their taxable entities. So if you look at like a lot of public companies, for example, they'll have pretty complex structures and, and weds of subsidiaries down below. A lot of times those are passed through entities. Now,

Jon Stoddard (04:43.862)
It gets complicated when you start talking about international and outside of the US and blocker entities and things that are way beyond the scope of this thread or this podcast. But yeah, it's a pretty common strategy because what the LLC does, and I mentioned this in the previous tweet we moved on from, is it's designed to limit the liability of the members of that LLC. So liabilities get isolated in that entity.

But for tax purposes, it's as if it doesn't exist. So that entity doesn't pay corporate tax. Yeah, that's exposure to lawsuits. You sue the corporation, which is the LLC entity, not the individual that is part of the LLC. That's generally correct. And so that's why it becomes popular. And you'll see these complex webs of LLCs is because from a liability protection perspective, it can be very helpful.

even if you don't want to be paying income tax at every one of those levels, so it lets you create this complex web, but all of the income flows up to one point and you would pay one layer of tax, whether that's, again, you personally, a C Corp at the top or whatever you want it to be. Yeah. So the C Corp, I think everybody's pretty familiar with that, provides shareholds with limited allowable debts and obligations corporate taxes. That's right. All right. So

when cash is distributed to shareholders as dividends, shareholders pay additional taxes on those dividends. So you're taxed twice, double taxation. And you hear that all the time in the commentary, like C-Corps are terrible because of the double tax. And what they're talking about is when your C-Corp earns a dollar, it pays a corporate level income tax. And then what's leftover, there are other things you can do with it, which we get to later in the thread. But if you distribute it out to your shareholders,

that goes out as a dividend and now your shareholders are going to pay an additional dividend tax on that same money. And so the idea is $1 earned by the C Corp gets taxed both at the C Corp and dividend tax at the shareholder level. So you're paying tax twice on the same dollar. And that's where the concept of double taxation comes from. With the LLC, you've eliminated that corporate level tax and you only pay that

Jon Stoddard (07:05.518)
that personal tax. Yeah, you talk about the next slide. The drawback to double taxation has mostly evaporated since the jobs act, which lowered the highest corporate rate from 35 % to 21%. That's right. Yeah. So the problem with double tax is if you take, imagine you're a high earner and you're in the top income bracket of 30, 37%, right?

You know, with an LLC, a pass through LLC, and it gets more complex than this, but let's keep it simple. That money passes through the LLC, it's disregarded, and it shows up on your personal income tax statement, and you pay 37 % taxes. Historically, when the corporate tax was 35%, and then the dividend tax was anywhere from, you know, 20 plus percent, you paid 35 % at the corporate level, another 20 % at the personal level.

you're paying 55 % tax. Again, there's some math, but we'll put that aside. To keep it simple, you've paid 55 % of taxes on that $1 where you would have only paid 37 % on the LLC. And then add on state taxes like New York, New Jersey, or California. Exactly right. That was my next point. You could have been paying north of 60 % taxes with a corporate

double tax rate. I had some investors with a partner I'm working with said, Hey, we're not we're not going to be investing or buying any business out of California. Or, yeah, yeah, it's a very common because the California the, you know, the dividend rate that little fuzzy, I want to say like nine ish or 11%. I mean, it's, it's a substantial amount on top of what you're already paying. But, but you can see if you're 55 or 60 % on a C Corp and 30 %

37 % on an LLC, that was a no brainer to do an LLC. Well, now that your top corporate rate is 21 % with a 20 % dividend tax on top, you're comparing 37 versus 41, but then you get into some other factors of payroll taxes in the LLC and things like that. C-Corps are becoming much more in vogue again from a tax perspective because that large differential has evaporated.

Jon Stoddard (09:26.38)
So the next tweet is S-Corp. It's another type of corporation. I actually have an S-Corp, which Stonehouse Ventures, which is my holding company for acquisitions. Yeah. Yeah. Yeah. So the S-Corp, the point here, and there were a few comments on on the thread on Twitter, kind of applauding the point. I feel like this is rarely misunderstood. An S-Corp isn't an entity type. And so people talk about, you need to form an S-Corp.

You actually don't do that. An S-Corp is just a tax designation. It's a filing you make with the IRS. That's what my tax attorney did. Or my tax attorney, CPS, she did it. We're just filing a form with the IRS. That's right. So you don't form an S-Corp anywhere. You form a corporation which by default is taxed under as a C-Corp or you form an LLC which is by default taxed as a partnership and pass through.

but in either case, a corporation or an LLC, you can file with the IRS and S-Corp designation. You can actually have an LLC entity type, but elect to be tasked as an S-Corp instead of an LLC. So the next one is the S-Corp is a pass-through entity like an LLC, but structured like a corporation. So what's the big deal with the S-Corp and why do some people like them? So the...

this now is where we get a little more into the nitty gritty. Okay, so when an LLC is by default a partnership, partners in a partnership can't be employees of the partnership, right? They take what are called guaranteed distributions or whatever you want to call them out of the LLC. What that means is that when you're a partner in an LLC, all of the profit that your LLC earned, your allocated percentage if you own

50 % of the LLC, 50 % of that profit goes on your personal income tax return and you pay income tax and payroll tax on the full amount. In an S-Corp, because it's structured like a corporation, but with the benefit of an LLC, the S-Corp is disregarded for tax purposes, which means it pays no corporate income tax. But because it's a corporation, the shareholders can now also be an employee of the S-Corp.

Jon Stoddard (11:53.357)
So if you earned a million dollars in your S-Corp last year and you're the sole owner, if it's an LLC, you're recognizing a million dollars of profit and you're paying payroll tax and income tax on that full amount. If you're an S-Corp, you can make yourself an employee, pay yourself a salary of $100,000 and you pay income tax and payroll tax on that $100,000 and the other $900,000 you take out as a distribution

but it's a distribution that only gets taxed as income, not with a payroll tax. So if you're talking a million dollars and the payroll tax is several percentage points, this adds up pretty quickly, right? And so as companies start to grow out of their nascent stage of very small startup where they're looking into mid, high, six figures, certainly over into seven figures of profit,

it starts to become a benefit from a tax perspective to be an S-Corp so that you can draw a reasonable salary and take all the rest as a distribution and avoid that payroll tax. That's how the S-Corporations became really popular. All right. So having a pass through entity is important. S-Corps offer a unique advantage. Right. We just talked about that. Exactly what we talked about. That's right.

And yeah, having a one million dollar property. You got really specific here. It's a 37 % top federal income tax rate, 2.9 Medicare tax, 12.4. So yeah. Yeah. So a lot of people get tripped up on payroll tax because they're used to what they see in their W-2, you know, if they're a W-2 employee. It's important to remember that payroll tax is paid 50 % by the employee and 50 % by the employer. Right. So if you look, if you're a W-2 employee and you look at your pay stub,

you see 1.45 % Medicare and 6.2 % on your SSI or social security. And you may think, well, that's not that bad. Well, when you're an S-Corp, you're now the employer and the employee. So you pay both half. So it's a lot more than people sometimes appreciate if they're used to the W-2 world. It's doubled. Now the other nuance to point out here, and I wanted to avoid,

Jon Stoddard (14:18.061)
a million comments that says, hey, you ignored that there's a cap on social security. There is a cap on social security. It goes up incrementally every year. So that 12.4 % SSI is only owed up to $147,000. So everything north of that in for an LLC, for example, you wouldn't pay that 12.4%, but you still pay the 2.9%. 3 % of $900,000 in extra profit. That's a sizable amount of money.

That can be, absolutely. If you're an S corp, the shareholder can be an employee and pay himself a reasonable salary. And this is what you just talked about. Exactly. Exactly right. The rest is distributed as dividends, meaning no payroll taxes on 1 million profit, assuming reasonable salary is a fraction of that. So how do you, what's a reasonable salary? Yeah, that's a tough question. And the IRS, of course, as they do in all things, give you no guidance, right?

So you have to be a little bit, you know, you're shooting a little bit in the dark and what you're really worried about is an audit, right? So there's nobody when you file. $87,000 new agents. Well, yeah, let's not go down that rabbit hole, John. We'll be here all afternoon. But yeah, so in an audit, if they go back and look at this, they can challenge like, hey,

You're a lawyer, you did a million dollars in revenue last year and you paid yourself $30,000. Come on, really? Right now, they're gonna say, this is starting to look like you are disguising your income. Because the idea is that if you're the business owner, if you're an employee, you should be compensated like you are an employee. And the rest is your compensation that you're gonna pay.

take the distributions, your capital gains as an owner of the business. Generally, what you would do is you would look at what would someone in a similar position in the market get paid for doing this? Are they more concerned about hiding income versus maybe overpaying yourself? That's right. There's no penalty for overpaying. If you pay yourself a $200,000 salary- You're going to pay taxes or something. Yeah. You pay some extra tax and yeah.

Jon Stoddard (16:43.981)
Certainly the IRS loves for you to be conservative, right? It's where you get aggressive that they're gonna take issue. So like I said, if they can go out on glass door and see that small five-person law firm lawyers generally make $150,000 a year and you paid yourself 30,000, you're playing games, you are understating, we're gonna hit you for those back taxes and penalties. But if you're...

If you're within that range, right, that Glass Store says between 120 and 150 and you pay yourself $120,000, it'll be tough for an IRS auditor to say, hey, you were understating your income. So there's no science there. You just have to be a little careful and be reasonable. Yeah. I'm going to skip a couple of slides forward because it kind of explains, sets some questions up. But here we'd say, let's walk through a few of the many strategies and considerations.

and how entity form impacts them. Number one, allocation of profits, two corporate development, three dividends received deduction, and four qualified small business. Yeah. So you'll see through the rest of the thread and I say that there, I stuck with the $1 million in profit example to keep around numbers. So as we talk, we can keep referring. All so allocation of profits. Yeah.

Yeah, so one of the benefits here is that an LLC taxes a partnership lets you have unequal distributions, right? Yeah. Corporations don't. If you own 50 % of a corporation and your partner owns another 50%, if you dividend out a dollar, 50 cents has to go to you, 50 cents has to go to the other partner. It's pro rata based on your ownership. Yeah. An LLC taxes a partnership.

assuming it's set up properly and there's your plug for making sure you do this stuff right, that will let you do unequal distribution. So yeah, I give an example here of four shareholders, each owning equal amounts of 25 % each. On our million dollar examples, each shareholder gets 250,000. Yeah. I got a question for you. Four shareholders, does that work out? I I've already, I got an interview coming up soon where,

Jon Stoddard (19:00.097)
Finding partners is difficult because some just, they just blow up. Yeah, absolutely. Yeah, it's, it can be tough. And you see a lot in the small business space that it's solo buyers, you know, sometimes they'll bring in some small investors. And a lot of times you'll see those as sort of friends and family people you have good relationships with because it's, you know, the old adage partnerships are thinking shifts, you know.

Don't let my partners in the law firm hear that. Yeah, we have a great relationship, luckily, but it's tough. It's very tough. And you can find yourself, you know, essentially married to someone financially for a long, time that you may disagree with. Yeah. So this is just kind of an example. I'm just going to move a little bit forward to some other sectors. Corporate development. Suppose you want to use cash flow or portfolio to fund future acquisitions. So that's correct. Everybody in my audience watches that.

Yeah, absolutely. So the point here is that because an LLC is a pass-through entity, even if you as the member never take a cent out of that LLC, you still pay tax, right? That million dollars of profit, the IRS disregards the LLC for tax purposes, it shows up on your personal tax returns, and you owe income and payroll tax on a million dollars, even if that million dollars never gets taken out of the

the LLC. Yeah, you can you can shift some expenses, right? You can prepay rent and kind of get into the accounting game. Three quarter ton truck before. Yeah, it's paper 179. Yeah, no, absolutely. So there, there's some games you can play there. But the point is, if you're a member, and that LLC has profit, but you don't get money out, doesn't matter, you pay you pay tax. And where this becomes really important.

is where you're maybe an investor in an LLC and not an operator. I have a sizable investment portfolio of private investments in LLCs. And every tax season, I have to deal with phantom income. I get a K-1 that says, on paper, I earned $100,000 this year, but I never got a distribution. The LLC has kept that money for now to be able to fund future acquisitions or something like that.

Jon Stoddard (21:23.415)
The IRS doesn't care. I have to pay income tax on that $100,000. And so what ends up generally happening in the way most LLCs are structured is that the LLC has to make a mandatory tax distribution to the partners, the members each year to at least cover the tax obligation of whatever profit they're deemed to have recognized. So if you have the million dollars and you

you wanna save that million dollars for a rainy day or to fund an acquisition next year, you're gonna distribute out up to half of that money just to fund your members tax obligations for the year. So on a million dollars of profit, you're only left with $500,000 for future funding. The C-corp doesn't operate like that. If it's a C-corp, you pay your 21 % corporate income tax. So on a million dollars, a hundred and what is that too?

$210,000, you're left with $790,000 in the war chest that your shareholders don't pay any tax on because they haven't received the dividend. And so that's what this corporate development benefit can be is that if you don't plan to make distributions and you don't have a cash flowing investment strategy, it could be that a C-Corp makes a lot of sense for your entity so that you can block and trap income in that

in that C Corp and redeploy it on another acquisition next year, it preserves more of your capital that you don't have to distribute out to cover tax. Yeah, that's perfect. Yeah, we just talked about it. Yeah, that's what we're talking about there. So I put a little example for your viewers that want to go find that link in the Yeah, I'll put the link in the comments down below in the video. Sit back on the napkin. If you're a tax pro, don't.

Don't yell at me in the comments. I kept it very simple. There's some nuance of things, but I wanted to keep it high level. Right. All right. So let's move it down. Dividends receive deduction, building on number two. Yeah. So here's another benefit of using a C-Corp. So like we said, with a C-Corp, you pay a corporate level income tax.

Jon Stoddard (23:42.189)
at the C-Corp level where you recognize the profit. And then when you send money out, you pay an additional dividend tax. What the dividends received deduction says is that if you're a C-Corp owned by another C-Corp holding company, depending on how much that holding company owns, you can deduct a portion of the dividends that you receive and not pay dividend tax on it. And in fact,

if I believe the threshold is 80 % for 100 % deduction. So if it's a wholly owned C Corp or you've got a few minority shareholders, but you own 84 % or whatever, any of those dividends that you send up to that parent C corporation, don't have to pay, you get a deduction for the dividends tax. So this eliminates a large part of the problem of what we were talking about earlier. So you can pay that 21 %

corporate income tax in the operating C Corp, dividend the rest up to the parent C Corp, they take a dividends received deduction and pay no additional dividend tax. And then they can redeploy that capital out into, for example, a different subsidiary where they want to make another acquisition. it lets you move some of this capital around your organization without realizing all of those layers.

of dividend taxes as you move it up and back down in your structure. So it can be a very powerful tool if you go down the C-Corp route to keep your tax exposure low while redeploying cash outside of that one subsidiary instead of keeping it trapped. Yeah. So that's what he talks about in the next couple of things. Let's jump on to the...

QSBS, which is the super sexy, soundy, well-liked small business. Yeah. I call it the web three of small business, right? It's like that glipsey, glamorous term that everyone's in love with and no one's really sure where it's gonna go from here. So I'll say from the outset, QSBS can be incredible, but it's pretty new. And in fact, in the infrastructure bill,

Jon Stoddard (25:59.181)
There was a provision to remove it. There's a lot of chatter out there to remove the QSBS. It's seen as sort of a backdoor tax loophole. It ended up getting pulled out at the last minute, so it's still there, but there's a big giant target painted on the back of QSBS. So I always like to tell folks I talk to, clients on Twitter, whatever, you got to understand we're always one election away from blowing up a tax structure.

USVS is a great example. Next session of Congress, this could go the way of the dinosaur. And if you went all in, you're scrambling to restructure and limit your exposure. Yeah. So what is it? The qualified small business stock. That's for five years or more if you exclude up to 10 million in capital gains. Yeah. What this does is that if you're a qualified small business,

And there are some strict rules on what that can be. The principal ones are, you can't be, for example, a professional services firm. So a law firm could never be a qualified small business. We don't have the benefit of qualified small business stock. You can't be a REIT. There are a few other things, a FARM. But generally your rank and file, the normal small businesses that our clients are looking at, your HVAC and roofing companies, your tech companies, whatever.

You can qualify to be a small business if at the time that you issue stock, your gross assets are less than $50 million. And if they're less than $50 million, that stock that you issue to new stock to investors is qualified small business stock. And what that means is if that shareholder holds the qualified small business stock for five years or more, upon an exit, they can exclude

potentially, you know, $10 million of capital gains. What the code actually says is that the greater of $10 million or your basis in the stock. So it can actually be substantially higher than $10 million if your basis is more money, right? If your basis is $5 million, you could exclude $50 million. The way this normally plays out though, is that the stock is issued at startup time when it really has no value. And so,

Jon Stoddard (28:21.705)
the calculation is being done basically from zero, which means you're greater of 10 million or 10 times your basis ends up being a $10 million exclusion. The most incredible part of QSBS is it's an exclusion per person, like per shareholder and per company. So you as an investor can hold qualified small business stocks in 10 different companies. And if all 10 of those companies have an exit in the same year,

you get your $10 million exclusion on every single one of those companies, right? It's not limited to one exclusion per taxpayer. And the other reason that that's important, that it's per person, is a lot of times if you have significant value in these companies, you can do some advanced tax planning and for example, have some of the stock issued to a spouse. Now you just doubled your exclusion because your spouse gets 10 million and you get 10 million.

You could issue some to your kids for estate planning purposes. I've got three kids, so potentially 50 million across the five of us, right? Me, my spouse, and my three children. So it's an incredibly useful tool when the company qualifies for it and you qualify for the holding period of five years. Yeah, that's big sense of a roll-up. I mean, if you bought an HVAC company and it's two million either, but your still multiples are small.

You roll up 25 of those, now it makes 100 % sense. Yeah, it can be incredible. It became really popular and the reason it got implemented was post financial crash. That's when it went to the a hundred percent exemption to kind of stimulate the economy and what they thought this would do would encourage a large influx in startup investing. And so it became really popular in tech startups.

And no one really appreciated how useful it can be in, for example, an HVAC roll-up model, right? And because those tech startups were so risky, the idea was, well, let's really incentivize these investors to go put capital in and make it worth their while and give them a huge exclusion. Well, now we as small business investors, know, buying roofing companies can appreciate and realize some real benefits. Now, it doesn't come without

Jon Stoddard (30:46.903)
Some drawbacks, there you go. You're going to my next tweet. Qualified small business stock can only be stock in a C Corp. So you can't be an S-Corp or LLC. And what does that mean practically? You're paying corporate income tax and dividend tax on any dividends that you pay out of that C Corp. So it gets back to our original discussion on C Corp. You have to weigh the pros and cons of what's my long-term exit strategy against

what is my short-term potential tax liability? And the reason this became so popular with tech startups is they usually operated at losses for several years. And then could act on large valuations. So they weren't paying any taxes for several years. And then they go have a half a billion dollar exit and all the investors walk away paying no tax. But so when your ACVAC roll up,

you don't necessarily get that same benefit. You may very well have material profits that you're paying taxes on and there's a pro-con to be weighed there. I mentioned not all businesses qualify. The final point, this is a super important one because I think people don't appreciate this as well. By far the most popular way to exit in the small business world are asset sales and asset sales don't qualify for the exemption.

qualified small business stocks. In order to realize the benefit of that exemption, the exit has to be a stock sale. And so you're really going in on a model where you limit your potential transaction options down the road. What that means practically is not that you can't exit in a stock sale, but what it does mean is that there ends up usually being some negotiation with the potential buyer for the extra risk they may be taking on in a stock sale.

and the benefit you stand to gain from the qualified small business tax treatment. And there may be some negotiations, some, well, we'll massage the purchase price a little bit, maybe kick up the indemnity escrow a little bit more for trailing liability. But you as a seller are willing to do that because you stand to write off, to be exempt from $10 million taxes. The seller likes the stock sale because they're selling the assets and the liabilities.

Jon Stoddard (33:09.387)
Whereas the buyer likes the asset sale. That's right. That's right. Yeah. So that's so not without some drama. So let's move on. So let me before before we go on that. So where does that stand on this legislation? The QSBS? So we got pulled out of the infrastructure bill. There was a provision to do away with QSBS entirely. This whole thing we just talked about would have gone away.

and everyone on all these exits from what used to be qualified small business stocks would have been paying tax, right? That provision was pulled out in the final bill that got passed. So it didn't go away, it's still there. It's existing form, it's 100 % exemption up to the 10 million or 10 times your basis. I only raise it to point out that it being in the bill until the last minute and getting pulled out as a compromise or whatever was great that it happened, but it's just...

to point out there's a giant target on the back of QSBS and folks that are not in favor of it are not gonna stop coming after it. So again, you're always an election away from blowing up your tax structure. Any session of Congress could finally sweep through a bill that does away with it. And that could be a massive tax liability if they do. So something to be mindful of.

As the administration changes. Yeah. So want the benefits of a C Corp to trap cash in your holding company to redeploy it throughout your organization. You may structure a C Corp hold Co with LLCs for operating entities. This is where we're going to get profits throw flow through the chain of ownership tax free until it hits the C Corp hold Co. That's right. So your LLCs are disregarded. So all of the profit that your LLC operating subsidiaries realize

The IRS disregards those entities that rolls up onto the C-Corp, it gets consolidated and the C-Corp pays corporate income tax currently at 21 % on all of that consolidated income, but then it's trapped there. They don't pay anything else until you issue a dividend. So if you're wanting to trap cash in your holdco to redeploy for corporate development, to buy more businesses, things like that, having a C-Corp dealing with your 21 % corporate income tax

Jon Stoddard (35:28.929)
but with the flexibility to redeploy cash however you want throughout your organization could be a very valid and very sound strategy. Yeah. Why you want to start a hold cup? We talked to you just mentioned that. All right. Flexible Alligator Provocative Prorata. We talked about that. The C-Corp subs keep some cash in size to fund growth and pain can other benefits. Okay. We talked about that.

What's the benefit of a qualified small business stock for specific acquisition and portfolio? You may elect to have your whole cold LLC that owns the QSBS in a new C Corp subsidiary. Yeah. So let's pause on this one for a second because we didn't mention this with QSBS. But the other important factor with QSBS is the only benefit you as an owner get from the QSBS exemption is on an exit, right?

So if you are a small business buyer that has a long-term buy and hold strategy, you wanna build an empire that your kids are gonna work in and you're gonna pass it on to your children and they're gonna work it. And this structure you're building is gonna exist for 40 years. Qualified small business stock probably doesn't make a whole lot of sense because your ultimate strategy is not an exit, right? It's a long-term buy and hold. So what if...

You have a long-term buy and hold strategy in whatever industry verticals you want, but you identify that's great with opportunity. I can acquire this business, put my skills to use, triple, quadruple the profitability in the next five years and sell this thing back out of the portfolio. Well, you may have a whole strategy for your general structure and decide just on that one, we're gonna make that a C-Corp, do qualified small business stock for that C-Corp.

because I know I'm going to exit that C core. And the point here is just strategies can mix and match and layer and have multiple kind of arms and considerations to these things. There's no real one size fits all. And the only qualification with the qualified small business stock is it can't be owned by another C core. But as long as it's owned by a pass through entity,

Jon Stoddard (37:47.117)
it can be a downstream subsidiary. So you can have that one isolated operating entity as a C Corp because you know your strategy is short-term, increase profitability, flip it and get it back out of the portfolio. And as long as that's owned by a pass-through hold code, an LLC in this case, you can do that. Yeah, that's how I call Ferris Lawsky. He buys these $100,000 businesses from Flippa.

does his four things and then flips it within 12, 18 months or whatever it is until he finishes his four. Yeah, and there's the final thing I'll say. QSBS generally doesn't have any filing requirements. It's just a qualification. And if you qualify, you recognize the exemption. The one exception to that is if you sell qualified small business stocks prior to your five-year holding period, as long as you roll the profit,

into more qualified small business stocks, you can actually tax the holding period. And there is a filing for that. You then have to make an affirmative filing with the IRS to let them know that you're electing to roll over into new qualified small business. But the point there is that that means that, for example, this strategy of very short term, 12 to 18 months by flip, you could still potentially do that under qualified small business stocks as long as that flipping

is into additional qualified small business. So yeah, so you take the profits from the flip, put it back in a pass through and keep growing it until five years and you're exempt from that. Not not a pass through it has to flip into more qualified small business. Right, right. Yeah. You move back in to that's right. So if you hold for two years and exit, use your use the proceeds to buy more qualified small business stocks.

you get to tap those two years and you only have to hold the new business for three years to get your full five years and then you get the full exemption when you exit that second business. It's sort of like a 1041 for small businesses. There's more nuance that's a tortured analogy, but you can kind of think of it that way that there is some opportunities to tap. Yeah, this is what we talked about. This is what we just talked about. That's how Michael Barislawski is doing it with

Jon Stoddard (40:07.849)
making acquisitions, rolling it over into the new acquisition and flip. All right. So yeah. And trying to remember, we're always one election away from the structure blowing up. Yeah. And elections aside, it's important to note a lot of people call us wanting some help with some hold-co strategy and

I wanna know what my structure is and implement that structure so that I'm good to go. And it's really important to have a conversation. Tax, tax treatment, things like this are always evolving. And so your structure and strategy can be very organic and probably needs to be very organic. And five years from now, your structure and strategy may end up looking a lot different than what you implement today. Again, depending on.

You know, new election does away with qualified small business stocks. The corporate income tax rate goes back up and makes the C Corp less interesting again. You know, there's a lot that could happen and you just, you have to be nimble and understand you don't get to find the perfect structure implemented today and you're good to go for the next 30 years until you retire on a beach somewhere. Are you grandfathered in? If you started a strategy, QSBS and you distributed or sold stocks,

Are you grandfathered in or if the new administration comes in and say we're different? Depends on the legislation. The legislation could say, no, from here on out, there is no qualified small business exemption starting January 1, 2023. Doesn't matter how long you hold it when you acquired the stock, there's no exemption. They could have.

grandfather, that's what they did when the Obama administration raised the qualified small business stock has been around 25 or so years. The Clinton administration implemented it, but it was a it was only a portion of the capital gains that was exempt. In 2010, the Obama administration raised it to 100 % exemption. And what they did is they grandfathered in the other prior. So if you were in that first window, where the Clinton administration first

Jon Stoddard (42:28.557)
put it in place and I'm making up the numbers because I don't remember what they are, but say the exemption was 40%. Any qualified small business stock acquired in that window only gets the 40 % exemption. Then in the George W. Bush administration where they raised it to 60%, again, I don't remember the numbers, so I'm making it up. Anything in that window, 60%, and then anything from January 1, 2010 onward is the 100 % exemption.

They could do a similar thing to phase it out, but it's 100 % dependent on how a bill gets written. It doesn't have to be that way. They could just eliminate it entirely and it goes away. That's just part of the risk. Legislation and the meat packing plan. So, Kevin, this has been incredibly educational. So I do want to make sure this disclaimer is out. This thread is strictly for educational purposes and is not made for the purpose of soliciting legal service or employment.

I am going to recommend SMB Lawyer Group. these guys are great. Kevin, I want to appreciate that, man. This has been fantastic. Yeah, I certainly appreciate the kind words, John, and the chance to come on here and talk about this stuff. It's fantastic. Come find us on Twitter. We're always on there. I you my partners, myself, a lot of other folks. Yeah, yeah. A lot of other folks.

doing really high quality content in the space. And we're always happy to chat and talk, codes, talk business buying, talk business selling, talk about the healthy rivalry between lawyers and brokers, know, whatever it is. So would love to hear from anyone. It's perfect. So thank you very much for being on my show. If you like this, make sure you share, like, or, you know, comment below. So if you have any questions, definitely comment below and

I will attach this document in the comments. So Kevin, thank you so much for being on the show. Thanks again, John.

Jon Stoddard (44:30.926)
Thanks for watching this video. Make sure you're a subscriber by clicking on this button right here down below. And if you want to watch more serial acquirer interviews, click on this button right here. If you're ready to buy your first business, get my course at dealflowsystem.net right here. Take care. Cheers, John.