Using one flexible trust to preserve Section 1202 options until an exit is closer.
Author: John Bunge, Senior Wealth Strategist, CFA
Part I: The Planning Concept
A founder holding a large QSBS position usually has two objectives that do not come due at the same time. The estate planning objective is to move stock out of the estate while it is worth relatively little, so that the future appreciation belongs to the transferees rather than to the founder. The Section 1202 objective is to have qualifying stock owned by more than one taxpayer at the exit, so that more than one per-issuer limitation is available against the gain.
The Section 1202 conversation almost always starts late. A founder with a substantial position wants to transfer shares to several non-grantor trusts, each of which may use its own per-issuer limitation, and the conversation begins six months before a sale when the stock already has real value. If the objective is to place $15 million of stock in each of six trusts, that is $90 million of transfers, which is well past the exemption amount and is not something many are willing to pay gift tax to accomplish. A sale process that is already far along creates assignment-of-income exposure for any late transfer as well.
Starting earlier creates more options
A GRAT can work where there is enough runway before the anticipated liquidity event. A two year GRAT may move appreciation to one or more remainder trusts with little or no taxable gift, but the amount that actually passes depends on the appreciation during the term and can fall well short of what is needed to fill several Section 1202 limitations. A founder who starts two or three years out is in a much better position than one who starts six months out, and the funding question can still remain.
Incomplete-gift non-grantor trusts are the other common answer. Because the transfer is not a completed gift, the structure can create separate income tax taxpayers without spending gift tax exemption, which is why it keeps surfacing in QSBS planning. It also carries more uncertainty, particularly where several trusts have overlapping beneficiaries or exist principally to multiply Section 1202 limitations, and it does not deliver the estate tax result of a completed gift.
The nature of the liquidity event matters as well. An IPO can increase the value and liquidity of the stock without causing a shareholder to recognize gain on the shares that are retained, which can leave room for GRATs, gifts, or other trust planning before a later taxable disposition. The same is true of other transactions that change the economics of the investment without producing shareholder-level gain. The cost is that the stock is worth considerably more by the time that planning happens.
Separating the estate planning decision from the Section 1202 decision
The best time to transfer stock for estate tax purposes is often when it is worth almost nothing, and that is the same point at which the founder knows the least, including whether the company produces a modest exit or a very large one, who the relevant family beneficiaries will turn out to be, and how many separate Section 1202 taxpayers would ever be useful.
One way to handle that is to separate the two decisions. The founder transfers low-value stock to a single flexible grantor trust at an early stage. That transfer removes future appreciation from the estate and, where appropriate, uses GST exemption while the value is still low. The trust is drafted for a broad group of potential beneficiaries and with enough flexibility to distribute or appoint stock to separate trusts later.
The initial trust does not produce an additional Section 1202 exclusion while it remains a grantor trust, because the founder continues to be treated as the owner of the stock for federal income tax purposes. Its value is in preserving options. If the company later becomes substantially more valuable, the stock is already held in trust, and the trustee can then consider whether shares should stay in the original trust, pass to separate non-grantor trusts for particular beneficiaries, be used for charitable planning, or be handled in some other manner based on the family’s circumstances and the Section 1202 rules then in effect. We refer to that initial trust as a QSBS mother trust.
Why the flexibility can matter
A founder who creates six separate non-grantor trusts at the outset has to make all of those decisions at the point when the company’s future is least knowable. The company may end up worth $20 million, $200 million, $2 billion, or very little. A young founder may not yet have a spouse or children. A trust funded for one child can also end up far larger than anyone intended if the company performs exceptionally well.
Treasury officials discussed QSBS stacking publicly in May 2026 and indicated that guidance is under consideration. Those comments do not change current law, but they are another reason not to hard-wire more separate trusts than the family actually needs.
A mother trust does not remove the need to make decisions later, it changes what the trustee is deciding about. Instead of attempting a new transfer of highly appreciated stock shortly before an exit, the trustee is allocating property that was already transferred when its value was low.
Part II: Section 1202 and the Mother Trust
The Section 1202 framework
Section 1202 permits a noncorporate taxpayer to exclude gain on the sale of qualifying stock in a domestic C corporation, subject to requirements relating to original issuance, the corporation’s gross assets, its business activities, the manner in which the taxpayer acquired the stock, and the taxpayer’s holding period. Trust planning does not cure stock that fails those requirements.
The 2025 amendments created a new regime for stock acquired after July 4, 2025. The exclusion is 50% after three years, 75% after four years, and 100% after five years. The fixed per-issuer limitation is $15 million, indexed for inflation beginning after 2026, or ten times the taxpayer’s aggregate adjusted basis in the qualifying shares disposed of during the year if that amount is greater. The corporate gross-asset ceiling was increased to $75 million.
Stock acquired on or before July 4, 2025 remains under the prior regime, including the $10 million fixed limitation and the $50 million gross-asset ceiling. For gifted stock, the better reading is that the recipient succeeds to the transferor’s acquisition date under Section 1202(h)(2), so the regime travels with the shares rather than resetting on the transfer. The gross-asset test is a separate question, because it is measured at the corporation at issuance and does not turn on who holds the stock afterward. There is no guidance addressing either point under the 2025 amendments, so the acquisition date and issuance history of each stock lot should be tracked carefully.
The partial exclusions carry a rate cost that is easy to overlook. Gain that is not excluded under Section 1202 is 28% rate gain rather than ordinary long-term capital gain, and the net investment income tax applies on top of it, so a sale at the three-year mark leaves half of the gain taxed at roughly 31.8% instead of the 23.8% that would otherwise apply. The difference between selling at three years and selling at five is therefore larger than the exclusion percentages alone suggest. There is no alternative minimum tax preference on the partial exclusion for post-2025 stock, unlike the 7% preference that applies to some older shares.
The fixed-dollar limitation and the ten-times-basis limitation also need to be modeled together. Creating another taxpayer is most valuable when the fixed-dollar limitation is the binding constraint, and dividing stock among taxpayers does not multiply the aggregate basis of the shares.
Why a non-grantor trust can provide a separate limitation
Section 1202 is written on a per-taxpayer, per-issuer basis, and a non-grantor trust is generally a separate taxpayer under the income tax rules. That combination is the basis for the familiar planning in which QSBS is transferred to separate non-grantor trusts and each trust claims its own Section 1202 limitation.
There is no regulation or published ruling specifically stating that a non-grantor trust receives its own Section 1202 limitation. The result nevertheless follows from the statutory structure and is widely assumed in practice, and Section 1202(h) expressly preserves QSBS treatment for certain transferred stock, including stock transferred by gift.
The harder questions generally arise not from the existence of one bona fide non-grantor trust, but from how far the same concept can be extended. Several trusts for genuinely different family beneficiaries present a different set of facts from a series of substantially overlapping trusts created principally to multiply the exclusion. Section 643(f), general substance principles, and Treasury’s authority under Section 1202(k) are all relevant to that distinction.
Why the mother trust generally begins as a grantor trust
The early objective is to transfer appreciation, not to create another income tax taxpayer immediately, and a grantor trust works well for that purpose. The completed gift removes future appreciation from the founder’s estate and GST exemption can be allocated where appropriate, while the founder continues to be treated as the owner of the trust assets for income tax purposes.
Grantor trust status is also economically useful. The founder bears the income tax attributable to the trust, which allows the trust assets to compound without being reduced by that tax. That benefit comes with a liquidity consideration, particularly after a large exit, and the governing instrument should address the circumstances in which tax reimbursement or a change in grantor trust status may be appropriate.
Grantor trust status also creates the opportunity to loan the trust funds to purchase stock, or for the trust to potentially purchase stock from the Grantor for a promissory note. Extreme care must be taken to ensure that the purchase will not be recognized for income tax purposes, both at the time of the transaction and if the grantor trust later distributes stock to non-grantor trusts, because a conversion to non-grantor status with debt outstanding may be treated as a real sale for income tax purposes, eliminating QSBS eligibility entirely.
The trust should be drafted for the later planning that may be contemplated. That ordinarily includes authority to distribute stock in kind, divide into separate shares, exercise powers of appointment where appropriate, change situs and fiduciaries, and retain the records needed to establish QSBS qualification.
What the early transfer gives up
Transferring stock out of the estate early forfeits the basis adjustment at death that the stock would have received if the founder had kept it. That tradeoff is usually acceptable in the QSBS context, because gain that is excluded under Section 1202 does not need a basis adjustment to escape income tax, and the estate tax saving on the appreciation is generally worth more than the step-up would have been.
The tradeoff looks different if the stock does not perform as expected or turns out not to qualify. Stock that fails an original-issuance, gross-asset, or qualified-trade-or-business requirement, or that is sold before the applicable holding period is met, is fully taxable gain in a trust with carryover basis and no step-up available. That is one more reason to confirm qualification at the front end rather than at the exit, and a reason to think about how much of the position should stay in the founder’s hands.
Funding separate non-grantor trusts later
The central mother-trust transaction is a gratuitous transfer of stock from a trust that is still treated as owned by the founder to one or more separate non-grantor trusts. The original trust can remain in place for the balance of the stock and other assets, and there is no need for the entire structure to become non-grantor at the same time.
For income tax purposes the founder is treated as owning the stock while it is in the grantor trust. When the stock is gratuitously transferred to a separate non-grantor trust, the receiving trust becomes a new income tax owner, and Section 1202(h) provides carryover treatment for QSBS transferred by gift, including the transferor’s manner of acquisition and holding period.
There is no Section 1202 ruling addressing this exact grantor-trust-to-non-grantor-trust sequence. In our view, an unleveraged gratuitous transfer from a grantor trust to a separate non-grantor trust is reasonably treated as a transfer by gift for this purpose. The founder is the income tax owner immediately before the transfer, the recipient gives no consideration, and the transaction is part of a completed donative arrangement. We would distinguish that relatively conventional fact pattern from transactions involving debt, consideration, or a late change in tax status undertaken principally to create another taxpayer.
Conversion of the original trust
A related approach is to end grantor trust status for some or all of the original trust, which can create a separate income tax taxpayer without moving the stock under state trust law. The federal income tax authorities generally treat a lifetime termination of grantor trust status as a transfer of the trust assets from the grantor to the trust.
Where the trust was originally funded by gift and has no debt to the founder, there is a reasonable basis to treat that deemed transfer as gratuitous and therefore within Section 1202(h). Published commentary has taken that view, but there is no direct Section 1202 authority.
Debt changes the analysis. If the trust owes the founder a note when grantor trust status ends, the founder may be treated as receiving consideration through liability relief, which can create gain and, for Section 1202 purposes, can cause part of the trust’s acquisition to be treated as a purchase rather than a gift. Where a conversion is contemplated, outstanding obligations to the founder should be reviewed and, where appropriate, retired with cash or non-QSBS assets before the conversion.
Multiple trusts and overlapping beneficiaries
Section 643(f) permits two or more trusts to be treated as one if they have substantially the same grantor or grantors, substantially the same primary beneficiary or beneficiaries, and a principal purpose of avoiding federal income tax. The regulation does not provide a numerical safe harbor for Section 1202 planning.
For most family planning, the practical distinction is between trusts that have real and different beneficial purposes and trusts that are variations on the same arrangement. A trust for one child and descendants, another for a second child and descendants, and a third with a materially different charitable or family purpose are easier to distinguish than several trusts with the same beneficiaries, similar terms, and no reason for their separate existence other than the tax limitation.
Treasury’s May 2026 comments appear directed at aggressive stacking, such as multiple trusts with overlapping beneficiaries. No proposed regulation or other binding guidance had been issued as of the date of this article. Until guidance develops, beneficiary design, fiduciary independence, timing, and the actual non-tax purposes of each trust remain central to the planning.
Timing relative to a sale or other liquidity event
A transfer that occurs after the right to sale proceeds has effectively ripened can be treated as an assignment of income rather than a transfer of stock carrying meaningful ownership risk. The cases do not supply a single mechanical deadline. Binding obligations matter, and courts have also looked at whether the transaction had become practically certain before the final closing documents were signed.
For planning purposes that makes the factual timeline important: banker engagement, buyer contacts, letters of intent, board action, shareholder approvals, tender commitments, regulatory conditions, and other steps that reduce the possibility that the transaction fails. A transfer made well before a sale process begins is easier to support than one made after the economics of the sale have largely been fixed.
An IPO is different in one respect. Stock that is retained through an IPO has not been sold merely because the company becomes public, so the IPO may leave time for later planning with the retained shares, although lockups, offering sales, valuation changes, and any contemporaneous plans to dispose of the stock all need to be considered.
Section 1045 as a backstop
Where the holding period is the problem rather than the limitation, Section 1045 can preserve the position. A taxpayer who has held QSBS for more than six months can roll the gain into replacement QSBS purchased within sixty days, deferring the gain and tacking the holding period of the original shares for purposes of the five year test. That can matter where a sale is forced on the founder or a trust before the applicable tier is reached. The Section 1045 rollover has its own requirements and its own uncertainties in the trust context, which are beyond the scope here.
Incomplete-gift non-grantor trusts
Incomplete-gift non-grantor trusts are sometimes used where the founder wants a separate income tax taxpayer but is unwilling or unable to make another completed gift. The structure is attractive in the QSBS context because it addresses the funding constraint directly, in that the transfer can remain incomplete for gift tax purposes while the trust is intended to be a separate taxpayer for income tax purposes.
That does not make the structure equivalent to the mother-trust approach. An incomplete gift does not remove the transferred property from the founder’s estate in the same way as a completed gift, and the income tax status of these trusts depends on careful drafting and administration. Some states, including New York and California, have also adopted rules intended to limit the state income tax benefits associated with incomplete-gift non-grantor trusts.
Using several such trusts principally to obtain several Section 1202 limitations moves further into the area Treasury has indicated it is reviewing. That may still be appropriate in some circumstances, but it should be evaluated separately from the more conventional use of completed-gift trusts for distinct beneficiaries.
State income tax can change the result
The federal exclusion is only part of the analysis. State conformity varies, and the state result can materially change the value of the planning. California does not conform to Section 1202, so a $15 million federal exclusion still carries roughly $2 million of California tax at the top rate. Other states have changed their treatment in recent years, and fixed-date conformity can produce a different result for the 2025 amendments than for the older version of Section 1202. State residence, trust residence, source rules, and the timing of any change in situs therefore need to be modeled along with the federal exclusion.
A simple illustration
Assume a founder acquires qualifying common stock in 2026. In 2027, when a meaningful block is worth $2 million, the founder transfers the shares to a long-term grantor trust designed to sit outside the estate. There is no sale process and the company is still at an early stage.
Several years later the trust’s shares are worth $100 million. The family now has much better information about the company, the likely exit, the beneficiaries, and the amount of wealth involved. If the trust remains a grantor trust through the sale, the gain is reported by the founder and uses the founder’s own Section 1202 limitation.
Before a taxable sale becomes sufficiently advanced to create assignment-of-income concerns, the trustee may instead consider distributing portions of the stock to separate non-grantor trusts for particular children or other beneficiaries. If those trusts are respected as separate taxpayers and the transfers qualify under Section 1202(h), each receiving trust may have its own applicable per-issuer limitation.
The number of trusts, the amount allocated to each, the ten-times-basis alternative, prior sales, state income tax, trust design, and the family’s broader estate plan all affect the result. What the mother trust supplies is the ability to work through those questions with information that did not exist when the original $2 million transfer was made.
Conclusion
The mother-trust approach is a way to preserve flexibility between two different planning dates. The estate planning transfer can be made while the stock is relatively inexpensive, without requiring the founder to decide at that time how many separate Section 1202 taxpayers the family will ultimately use. If the company later becomes valuable enough for stacking to matter, the family can evaluate the available choices with better information, which may include separate completed-gift non-grantor trusts, GRAT remainder trusts, charitable planning, or in some cases incomplete-gift structures.
The Section 1202 treatment of some of these trust transactions is not addressed directly by published guidance, and Treasury has indicated that it is considering the use of multiple trusts. Those uncertainties belong in the analysis. They do not change the more basic estate planning benefit of moving appreciating stock early, or the practical value of drafting the initial trust so that the later choices remain available. The trust instrument should be drafted with the later steps in mind. Authority to distribute stock in kind, create or fund separate trusts, and potentially change fiduciaries and situs, are all features more helpful when included at the beginning than when scrambling during a transaction process.
Important Considerations
This material is provided for informational and educational purposes only. It is not intended to be, and should not be construed as, investment, legal, tax, accounting, or other professional advice. Nothing herein constitutes an offer to sell, a solicitation of an offer to buy, or a recommendation of any security, investment product, strategy, transaction, or advisory service. Readers should consult their own investment, legal, tax, and accounting advisers before making any decision based on the information contained herein.
The information contained in this material is based on sources believed to be reliable, including public sources and other materials believed to be accurate as of the date of publication. No representation or warranty is made as to the accuracy, completeness, timeliness, or reliability of such information.
This material describes areas of federal and state tax law in which authority is limited or absent, in which reasonable practitioners differ, and in which the Treasury Department and the Internal Revenue Service have publicly indicated that guidance is under consideration. Statements characterizing the state of the law reflect the author’s reading as of the date of publication and may be superseded by subsequent developments, including changes in law, regulation, administrative guidance, judicial decisions, market conditions, or other relevant facts. The author and publisher undertake no obligation to update this material.
Any discussion of tax matters is general in nature and may not apply to a particular person or situation. Tax treatment depends on each taxpayer’s specific facts and circumstances and may vary based on federal, state, local, and other applicable law. Any examples in this article are illustrative only, are simplified, and do not represent actual clients, investments, or transactions.
