Editor's Note: This article is part of the Financial Advisor series "How I Solved It." Advisors describe a client with a problem and what they did to help.
Shane Mason’s firm Brooklyn FI launched in 2018 to cater to creatives and young tech industry executives. From the beginning, the firm has benefited from co-founder Mason’s background at a Big 4 accounting firm, especially when it comes to the tech space and its thorny tax issues related to employee stock compensation.
“We’re still coming across things we haven’t learned before, which scares the shit out of me because I know that other people are working with advisors who have no idea how to deal with equity compensation and are ... frankly goofing it up all the time,” Mason said.
This year, the firm came across a problem with its clients at an e-commerce company that had issued qualified small business stock. The company was going public, and the first line of accountants missed the possible tax savings. In the end, he claims his firm ended up saving some of the employees at this company hundreds of thousands of dollars after it went public through a special purpose acquisition company, or SPAC, in 2021. About 15 or so Brooklyn FI clients are past and present employees of this consumer products company, and they include both executives and rank and file engineers. Further exclusions could end up saving these clients millions, said Mason and his director of financial planning.
After one review, Mason said it became apparent that a client's $500,000 gain actually qualified for a 100% exclusion from taxation. "So it saved them $175,000 in taxes,” he said.
The trick with SPACs, they learned, was figuring out what was and what wasn’t qualified small business stock, which grants holders huge tax exclusions up to a certain amount if they belong to the right type of company focused on the right type of business—a C corporation that’s not burdened by excessive outside business lines or property holdings (such as real estate).
In a regular IPO, a company’s shares are issued directly to the public. Not so in a SPAC, a publicly listed shell corporation that’s formed so it can eventually purchase a private company’s shares. When a SPAC takes a private company public, one of the ways it does so is by swapping or absorbing the private company’s shares in exchange for shares in the new entity (usually with an attendant stock split) and then—boom!—the once-private company is public.
It's a complicated deal, and it gets worse when planners and accountants don’t understand the structure.
“The tax forms that come with equity compensation, oftentimes they are flat out wrong,” Mason said. “These forms go to the government incorrectly, including W-2s and 1099s. And there have to be manual overrides to them to accurately report what actually happened. Oftentimes that all costs clients hundreds of thousands of dollars if they have high enough income.”
After the shares go through the SPAC, they play a strange game of limbo. SPACs list at $10 a share. Up to that price, the original qualified small business stock is still eligible for tax exclusions, even after they have been converted into the new entity’s stock in a public offering.
A key thing to remember is that the new shares issued by the SPAC company do not themselves qualify as qualified small business stock. What continues to qualify is the pre-merger QSBS shares that are “frozen” at $10 during the deal. That means if you took hold of a private company share at $1 in 2015, you can save on the additional $9 per share appreciation when it comes time to pay taxes five years later after the company has gone public. That’s huge potential savings.