Highlights
- Gifts of qualified small business stock (QSBS) to trusts may provide additional tax savings by increasing the amount of the gain subject to exclusion.
- The classification of the trust for federal U.S. tax purposes will impact the amount of income tax exclusion and possibly any gift tax that may become due.
- Given the nuances and overlap of the income tax and gift/estate tax regimes, careful planning with a qualified tax advisor should be undertaken prior to transferring QSBS.
In general, stock must be acquired at "original issuance" from the corporation in order to qualify for qualified small business stock (QSBS) treatment under Internal Revenue Code (IRC) Section 1202. As discussed in a previous Holland & Knight alert, there are certain exceptions to the requirement that QSBS must be acquired at "original issuance" from a corporation. One of those exceptions is for a transfer "by gift,"1 in which case the transferee is treated as having acquired the stock in the same manner as the transferor (piggybacking on the transferor's acquisition at "original issuance") and having held the stock for the period the transferor held the stock (piggybacking on the transferor's holding period in getting to the required holding period of three, four or five years). For an overview of enhancements to Section 1202 under the One Big Beautiful Bill Act enacted on July 4, 2025, including a shortened holding period for partial benefits, see Holland & Knight's previous alert, "One Big Beautiful Bill Act Increases Tax Benefits for Qualified Small Business Stock," July 10, 2025.
The gifting rule provides flexibility for transfers of QSBS among family members and trusts without giving up potential tax benefits. In addition, because the per-issuer limitation on gain exclusion applies to each "taxpayer," in cases where the $10 million limit (for stock issued on or before July 4, 2025) or $15 million limit (for stock issued after July 4, 2025) applies, making an eligible transfer "by gift" to another taxpayer, such as a child or a trust treated as a separate taxpayer, has the effect of multiplying the potential overall gain exclusion for the family.2
Meaning of "By Gift"
The phrase "by gift" is not further defined in Section 1202 or any directly applicable IRS guidance, so one must look at other guidance in determining the scope of an eligible transfer by gift. Because Section 1202 is an income tax provision, the relevant authority concerns the meaning of "gift" for income tax purposes. That said, the meaning of "gift" for federal gift tax purposes remains highly relevant because individuals are limited in the amount they may give to others during life or at death without paying the 40 percent gift or estate tax – this limit is $13.99 million for a U.S. resident individual in 2025, increasing to $15 million for 2026 and thereafter for inflation.
A starting point is the notable U.S. Supreme Court case Commissioner v. Duberstein, in which the Court held that a gift for income tax purposes is a transfer that proceeds from a "detached and disinterested generosity ... out of affection, respect, admiration, charity or like impulses."3 Duberstein and similar cases primarily focused on distinguishing a gift for income tax purposes from a transfer that has the flavor of compensation or a business transaction. This authority is certainly relevant in the context of purported gifts of QSBS to employees or business associates, where there should be a careful evaluation of whether the gift would be recharacterized for income tax purposes in a way that affects the potential tax benefits. But even if the basic requirements of a gift for income tax purposes are satisfied, there also is a need for evaluation of when transactions involving trusts will allow the transferred stock to remain QSBS-eligible.
Transfers in Trust
Modern trust planning creates a wide variety of income and transfer tax results depending on the types of trusts and transfers involved. Four key considerations when evaluating QSBS planning are:
- "grantor" vs "non-grantor" trust for income tax purposes
- whether the trust is treated as a "completed" or "incomplete" gift for gift tax purposes
- whether the transfer is structured as an outright gift or if there is a sale component
- whether the QSBS transferred is subject to any debt
Understanding These Distinctions Is Critical for Successful QSBS Transfer Planning
Grantor Trust for Income Tax Purposes: The grantor is treated as the owner for income tax purposes. Transactions between the grantor and trust are generally ignored for income tax purposes.4
Non-Grantor Trusts: The trust is its own taxpayer (separate from the grantor). A gift to a non-grantor trust is a gift to a different taxpayer.
Common Trust Transfer Scenarios
Transferring QSBS to a Revocable Trust: A revocable trust generally is treated as a "grantor" trust to the settlor. Under well-recognized tax principles, a transfer to a revocable trust should not be treated as a transfer for income tax purposes. The trust's sale of QSBS would be treated as if sold directly by the grantor, meaning that it would count against the grantor's per-issuer limitation on the amount of gain that is not taxed.
Gifting QSBS to an Irrevocable Grantor Trust: Even if a trust is irrevocable, if it is structured as a grantor trust for tax purposes (think of an intentionally defective grantor trust (IDGT), including a spousal lifetime access trust (SLAT)), the income tax treatment is similar to the revocable grantor trust described above – the QSBS is treated as if it were still owned by the grantor and subject to the grantor's per-issuer limitation.
Selling QSBS to an Irrevocable Grantor Trust: To reduce the use of estate tax exemption and increase the amount of assets that are "frozen" in value for estate tax purposes, practitioners often recommend selling appreciating assets to a grantor trust that is outside of the grantor's taxable estate (e.g., IDGT/SLAT). It is intuitive to conclude that if QSBS is sold to the trust, it has not been transferred "by gift," but the IRS in other contexts has generally treated the asset sold the same way as it would a gift of the asset due to the fact that the grantor trust remains the owner of the stock for income tax purposes and the sale is not recognized for income tax purposes.5
Gifting QSBS to a Completed-Gift Non-Grantor Trust: A non-grantor trust is treated as a separate taxpayer for income tax purposes. When QSBS is gifted to a completed-gift non-grantor trust, the transfer should qualify as a transfer "by gift" under Section 1202(h)(2)(A), and the trust would be eligible for its own per-issuer limitation. This strategy can be particularly effective for multiplying the gain exclusion benefits among family members, provided the multiple trust rule (discussed below) does not apply.
Transferring QSBS to an Incomplete-Gift Non-Grantor Trust (ING): INGs have become a popular income tax planning tool, especially in the context of moving investment assets to a trust in a state that does not impose an income tax. The IRS previously issued numerous private letter rulings confirming that trusts structured in specific ways can be treated as non-grantor for income tax purposes (separate taxpayer) while also not creating current gift tax consequences for the grantor or beneficiaries. Now these structures are on the IRS' "no rule" list, which could indicate additional IRS scrutiny for these trusts. Assuming an ING is respected as a non-grantor trust for federal income tax purposes and that the multiple trust rule does not apply, a transfer to an ING trust should be considered to be "by gift" and qualify for its own per-issuer limitation.
Transferring QSBS from a Grantor Trust to a Non-Grantor Trust or Individual: When QSBS is transferred from a grantor trust to a non-grantor trust or individual beneficiary, careful analysis is required. If the distribution is made pursuant to the trust terms and qualifies as a gift for income tax purposes, the recipient should be able to preserve QSBS treatment and begin utilizing their own per-issuer limitation. Note that when grantor trust status is "turned off" during the grantor's lifetime or at death, the trust property generally is deemed to be transferred to a new trust for income tax purposes. This is especially important if the grantor trust had outstanding indebtedness (e.g., a note payable to the grantor) because there could be deemed sale treatment for a transfer subject to debt (discussed below).
Transferring QSBS to a Grantor-Retained Annuity Trust (GRAT): A GRAT is typically structured as a grantor trust for income tax purposes. Though the initial transfer to a GRAT may be structured to minimize gift tax consequences, the transfer of QSBS to a GRAT would not multiply the per-issuer limitation since the grantor remains the owner for income tax purposes.
Transferring QSBS out of a GRAT: Upon the termination of the GRAT term, QSBS may pass to remainder beneficiaries or continuing trusts for their benefit. If the remainder passes to non-grantor trusts or outright to individuals, such transfers should qualify as transfers "by gift" that preserve QSBS treatment, allowing the recipients to utilize their own per-issuer limitations.
Transferring QSBS to a Charitable Remainder Trust (CRT): A CRT presents unique considerations for QSBS planning. Though a transfer to a CRT may qualify as a gift for purposes of preserving QSBS treatment, the tax-exempt nature of the CRT means that the gain exclusion benefits of Section 1202 would not be utilized upon the CRT's sale of the stock. When distributions are made out of the CRT to the lead beneficiary, however, the taxability of the distributions depends on the nature of the income previously accumulated in the CRT. If the CRT's sale of QSBS was eligible for exclusion, the beneficiary could indirectly benefit from the exclusion due to the fact that there is less (or no) taxable income for the CRT to "pass through" upon the distribution, but this is an uncertain area.
Special Considerations and Potential Traps
Effect of Transferring QSBS Subject to Debt: One potential trap in transferring QSBS is the impact of debt encumbering the stock (e.g., where stock is pledged on a margin loan or was the subject of a sale for a secured installment note). In general, where property is gifted subject to an outstanding debt, the amount of liability transferred is treated as an amount realized upon the disposition of the asset (i.e., it is deemed to be a sale to the extent of the debt transferred).6 In these circumstances, gain is recognized only to the extent the liability exceeds tax basis, but it is possible that any debt transferred alongside QSBS would jeopardize at least part of a transfer that is otherwise "by gift."
Multiple Trust Rule: Recognizing the potential for aggressive planning using multiple trusts to multiply tax benefits, the tax law will treat multiple trusts as one trust for income tax purposes if the trusts have substantially the same grantor(s) and primary beneficiary(ies) and a principal purpose of the multiple trusts is avoidance of federal income tax.7 Spouses are treated as one person for purposes of this rule. For this reason, separate trusts for each of several primary beneficiaries are believed to be respected as separate taxpayers for QSBS purposes, but trusts with the same grantor (or spouse) and overlapping beneficiaries could be susceptible to being treated as a single trust with only one per-issuer limitation.
Conclusion
The ability to transfer QSBS "by gift" provides significant planning opportunities for families holding valuable QSBS positions. However, the intersection of income tax, gift tax and trust law creates complexity that requires careful navigation. Taxpayers considering transfers of QSBS should work closely with their advisors to ensure that the intended tax benefits are preserved while accomplishing their broader wealth transfer objectives. As with many areas of tax planning involving QSBS, the lack of comprehensive guidance from the IRS means that taxpayers and their advisors must carefully evaluate the facts and circumstances of each proposed transfer.
Footnotes
1 IRC § 1202(h)(2)(A).
2 Generally, the "stacking" of the fixed dollar limits through multiple taxpayers would not enhance the benefit if the "ten times basis" limit applies rather than the fixed dollar limit, but making transfers could cause the fixed dollar limit to exceed the 10 times basis limit for the taxpayers.
3 Commissioner v. Duberstein, 363 U.S. 278 (1960), quoting Comm. v. LoBue, 351 U.S. 243, 246 (1956) and Robertson v. U.S., 343 U.S. 711, 714 (1952).
4 See Rev. Rul. 85-13.
5 See an analogous provision concerning "inclusion events" for qualified opportunity funds at Treasury Regulations § 1.1400Z2(b)-1, where a sale to a grantor trust is not treated as a "disposition" for those purposes.
6 Treas. Reg. §§ 1.1001-2 and 1.1015-4.
7 IRC § 643(f). This is not specific to QSBS planning but applies in any circumstance where a "principal purpose" of the planning is "avoidance of federal income tax," which could include multiplying other tax benefits, such as other limitation phaseouts.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
