I was there for Clark Schaefer Hackett and at the invitation of QCA Ventures. What resonated with me most was the session by FBT Gibbons on “Equity Awards,” i.e., the issuance of equity as compensation for employment or services. At its core, it was about the tax exclusion for Qualified Small Business Stock (QSBS) and how it interacts with the so-called Section 83(b) election. I took a closer look at the rules and compared them with Sec. 19a of the German Income Tax Act (EStG):
Index
Qualified Small Business Stock (QSBS)
The “magic number” of USD 15 million comes from the tax exclusion in IRC Sec. 1202, through which the U.S. legislature aims to encourage long-term investments in innovative companies. If all requirements are met, gain from the sale of the stock remains tax-free at the federal level (federal income tax), up to a cap. Many states conform, while others, such as California, go their own way.
Note: All information refers to stock issued after July 4, 2025. Different rules apply to older stock, which I deliberately do not cover here.
The requirements at a glance:
Cap
The exclusion per taxpayer and issuing company is limited to the greater of USD 15 million (inflation-indexed from 2027) or ten times the original cost basis (aggregate adjusted basis). Anyone who invested significantly early on can therefore exclude far more than USD 15 million. The exclusion is available to individuals, not corporations. Investing through a fund or partnership may also qualify in some circumstances.
Holding Period
The exclusion is tiered: 50% of the gain after three years, 75% after four years and 100% after five years. The non-excluded portion is taxed at 28% (plus the net investment income tax). In some cases, gain from an early sale can be rolled over tax-free into another QSBS company.
Entity Type and Size
The company must be a U.S. C–corporation (S–corporations are out; LLCs qualify only if taxed as corporations). Its aggregate gross assets must not have exceeded USD 75 million (inflation-indexed from 2027) before and immediately after the stock issuance.
Active Business Requirement
At least 80% of the company’s assets must be used in a qualified trade or business. Excluded are, among others, services in fields such as health, law, consulting or finance, banking, insurance, farming, extraction of natural resources, as well as hotels and restaurants. Tech startups, by contrast, typically fit well.
Original Issuance
The stock must be acquired directly from the company, in exchange for cash, property or as compensation for services. A purchase from another shareholder does not qualify.
Interesting especially for startups: This is not limited to employees. External service providers (consultants, developers, agencies) can also be paid in such stock, which makes it a powerful tool for startups with high valuation prospects but little cash.
The Timing Lever: The Section 83(b) Election
In the startup world, shares are usually subject to a vesting schedule: they become non-forfeitable (“vested”) only gradually (e.g., over four years with a one-year cliff). This is where the election under IRC Section 83(b) becomes particularly important:
- Without an 83(b) election: Tax is imposed only upon vesting, on the then-current fair market value (FMV) less the purchase price paid. If the value rises rapidly, this creates ordinary income taxed at up to 37% at the federal level, even though no sale has taken place and no cash has been received (so-called phantom income).
- With an 83(b) election: The taxpayer accelerates taxation to the grant date. They tell the IRS: “I am paying tax on today’s value even though the shares are still subject to vesting.” Because the value is usually still low, especially in the early startup phase, the tax burden is negligible. Any later appreciation is taxed at exit not as ordinary income but as capital gain (max. approx. 23.8% including the net investment income tax).
The bottleneck: The irrevocable election must be filed with the IRS within 30 days after the share transfer. The deadline cannot be extended.
The Perfect Combination: QSBS Meets 83(b)
Combining both provisions, the 83(b) election acts like a turbo for QSBS:
- Immediate start of the holding period: Without an election, it starts for each portion of the shares only upon the respective vesting. With the election, the entire tranche is treated as acquired on the grant date. The gross assets test is then also applied at the early issuance date, not at the later vesting date, when the company may already be larger.
- Freezing the tax basis: The tax basis is fixed at the low level of the initial grant. All later appreciation is therefore eligible for the potential QSBS exclusion.
After five years, the gain remains fully tax-free within the limits. Without the combination, a considerable portion of the appreciation would already have been taxed at up to 37% during vesting. Important, however: The benefit applies only to actual stock. For options, the holding period begins only upon exercise.
And in Germany? The Comparison with Sec. 19a EStG
As a German tax advisor, I naturally like to compare such rules with our domestic provisions, in this case Sec. 19a EStG, through which the legislature aims to make employee equity participation at “young” companies more attractive. The philosophy differs from the U.S. in one important respect: Sec. 19a EStG essentially offers “only” a deferral of tax on the benefit at grant, and no exemption of the later gain on sale.
Tax Deferral
If an employee receives shares at a discount or free of charge in addition to the wages otherwise owed, the non-cash benefit (less, where applicable, a tax-free allowance of EUR 2,000) is initially not taxed. The decisive point in time is the transfer, i.e., when the employee can economically dispose of the shares. Taxation instead occurs only upon sale or transfer, upon termination of employment, or after 15 years. The employer can, where applicable, avoid the latter two triggers by issuing an irrevocable liability declaration. In the U.S., by contrast, there is no such deferral until sale: there, the benefit is taxed at grant for shares without a risk of forfeiture, at vesting for shares subject to vesting without an 83(b) election, and, with the election, at the taxpayer’s choice already at grant.
Separation of capital gain from wages
At one of the above events, the deferred benefit is taxed as wages (compensation income) at the personal income tax rate of up to 45% plus the solidarity surcharge. After at least three years, the so-called one-fifth rule (Fünftelregelung) may apply. Only the appreciation from the transfer onward is, depending on the size of the shareholding, subject to the flat-rate withholding tax (Abgeltungsteuer; 25% plus solidarity surcharge) or the partial income method (Teileinkünfteverfahren). The separation of the appreciation, treated as capital gain, from the original grant as wages therefore resembles the consequences of the 83(b) election. Unlike there, however, there is a safety net: If the shares are worth less when the event occurs than at transfer, only the lower value is taxed. With the 83(b) election, by contrast, the tax paid on the grant value stays paid even if the shares later lose value (or are even forfeited). A tax exemption for gain on sale like QSBS in the U.S., however, does not exist in Germany (for individuals).
Several limits
Only employees qualify as recipients. The company may be no more than 20 years old and may not exceed twice the EU SME thresholds (revenue, balance sheet total) or four times the EU SME threshold (employees). Freelancers or external service providers, who in the U.S. can be incentivized with equity awards and QSBS without difficulty, are by contrast excluded from the benefit
My Thoughts on the Comparison
Nevertheless, one aspect of the U.S. rule particularly appealed to me. Startups rarely begin with much liquidity, and the budget is often initially insufficient for market-rate fees or salaries (especially when investors are lacking). In the U.S., they can therefore compensate not only employees but also external service providers such as freelancers, consultants or developers with equity. If this equity is subject to vesting, it binds the participants to the company in the long term. Combined with the QSBS exclusion and the 83(b) election, this creates a special opportunity for incentivizing and sharing in the company and its success.
In Germany, Sec. 19a EStG has been much discussed for years, and my impression is that the legislature is only hesitant to make employee equity participation more attractive, let alone extend the benefit to other service providers. Freelancers remain left out, even though they often play an important role in the founding phase. I therefore think it would be worthwhile to also look across the Atlantic in future reform considerations. The U.S. model will certainly not be a blueprint because of the fundamental differences, but it may well serve as inspiration.
I’d love to hear your thoughts: What should a good employee equity plan prioritize: avoiding tax before there’s liquidity, or reducing tax on the eventual gain? Should future reforms in Germany also do more to accommodate equity compensation for independent service providers?
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