This is really only an issue for startups with effectively zero revenue.

Your company gets classified as a PHC (and is subject to additional tax) if investment income, including interest, is more than 60% of its revenue. This isn't something most startups need to worry about if you have any revenue.

QSBS is based on intent, if the IRS thinks more than 80% of your assets are used for investment purposes and not for actively running your business. Basically it's so people don't use a small business tax exemption as a loophole for their investments. But the IRS absolutely considers idle cash in your company treasury as part of running your business, or else any startup that's raised money and didn't immediately spend it all would be considered an "investment vehicle," which they obviously don't.

Moreover, any of these potential issues would apply equally to a startup doing anything with their treasury, including putting it in a money market fund as most startups do. So we're not introducing any new tax risk. But of course, if any startup thinks these might be an issue for their business, they should talk to their tax advisor.

▲

tjpd 4 hours ago | parent [-]

Agree on getting tax advice. But because QSBS is such a gift to VCs I really don’t want to jeopardize it particularly when a bunch of startups are raising $20m on $0 revenue, so the balance sheet is basically just cash. At ~5% that’s $1M/yr of interest, which can easily be the only income the company has. If that cash is sitting in an investment portfolio instead of boring cash equivalents, it feels like you could start getting into weird territory with the 80% active business asset test. The probability is Low but the impact for us is massive.

	▲	sam_palus 3 hours ago \| parent [-]
		Agreed, QSBS is too valuable to be cavalier about. The active business asset test is about "intent and substance" and not balance sheet line items. I think it's very clear in this case that you'd be using it as a cash equivalent, since floating-rate agency MBS have a comparable risk profile to money market holdings (short duration, government-backed, highly liquid). And economically they're serving the same function: parking working capital safely until your business needs it. And frankly, I think accessing those assets through a treasury management platform, rather than a brokerage account, helps establish intent and substance. That's my view on it at least, and I know many companies use these assets for long-term cash without issue. But I'm not a tax expert. I do really appreciate you bringing this up though, and I'll reach out to our tax lawyer to get a proper written opinion we can share with our customers. Of course it's not a replacement for getting your own tax advice, but I think it'll be helpful regardless.