One of the most overlooked tax savings strategies is to avoid federal income taxes on large capital gains. Allowing investments to grow tax free over decades can result in tremendous growth in wealth. This is the tax strategy employed by almost all venture capitalists but is still relatively unknown by individual investors.
Our federal tax law has a permanent provision Section 1202 that allows investors who hold qualified small business stock for five years to take a tax-free gain on that investment. “Small” is liberally defined; the gains can grow into tens of millions.
To make the deal even better, the business can be arranged so that the investor is able to deduct the cost of investment from other earned income during the initial years of the investment. This is a step more complicated but certainly within the scope of service of a good tax adviser.
The best part of tax-free small business stock investment may not be the tax benefits at all. Small business stock provides diversity and can offer safety from a stock market correction. This is because small business stocks are more closely tied to what’s happening on Main Street than on Wall Street. For example, an investment in a local vegetable farm or seafood company is likely to perform well even if the stock market has a sudden drop in value. People still have to eat and their success of these small businesses is based on factors far removed from the stock market. For that reason, I primarily focus my small business stock advisory activity on agricultural and aquaculture businesses.
Investment in small business stock should be considered in coordination with the overall financial plan and tax management strategy. I am pleased to have a conversation about your situation and how it might be improves with investment in small business stocks.