Startup Treasury Account: QSBS and Personal Holding Company Tax

Does a startup's treasury account create tax, or cost QSBS?

Interest on a startup's raised cash is taxable income at the federal corporate rate of 21%. Personal holding company tax adds 20% only when most of the company's income is passive, it is closely held, and it has positive income left after its costs. For QSBS, the law tests the company's assets, not its interest income: cash is fine while it is working capital, with a cap once the company is two years old.

A case stops being simple when:

• taxable income turns positive while revenue is still near zero, for example because some costs must be spread over years;
• a few founders, their families or funds traced to a few people hold more than half the stock's value;
• the company is older than two years and cash is most of its balance sheet;
• the cash sits in fund shares rather than Treasury bills or bank deposits.

Gather the year's interest and fund statements, the cap table with option holders and fund owners, expense detail that separates US and foreign research costs, last year's return, and quarter-end balance sheets.

Is interest on the raised cash taxable to the company?

Yes. A C corporation reports taxable interest, including interest on US obligations, on Form 1120 line 5 (Form 1120 instructions). The money raised is not income; see SAFEs and convertible notes for why. Only what the money earns is.

The discount on a Treasury bill is interest (Publication 550). A company using the accrual method includes the discount day by day while it holds the bill, not only at maturity (26 U.S.C. 1281). Money market fund payouts are generally reported as dividends, not interest (Publication 550); a corporation's dividends-received deduction on them is limited to the amount the fund reports as qualifying (Form 1120 instructions).

What is personal holding company tax, and when could a startup owe it?

Personal holding company tax is an extra 20% on a closely held corporation's undistributed income when most of that income is passive (26 U.S.C. 541). A corporation is a personal holding company only if it meets both tests (26 U.S.C. 542):

Interest and dividends are personal holding company income (26 U.S.C. 543). A pre-revenue startup whose only income is interest therefore meets the income test: its personal holding company income is all of its income. Capital gains are left out of the measure. The income test turns on the mix of gross income, not on profit, so one customer contract can tip it the other way.

Excluded interest is narrow: interest a primary-market dealer earns on US obligations it holds for sale to customers, and interest on condemnation awards, judgments and tax refunds (Schedule PH instructions). A startup's Treasury bill interest is not excluded.

Do founders and venture funds meet the ownership test?

The ownership test traces stock to the individuals behind it, so a startup can meet it even after a funding round. Stock held by a corporation, partnership, estate or trust counts as owned by its owners in proportion; a person also owns what their spouse, brothers and sisters, ancestors, lineal descendants and partners own; and options count as stock when that makes the company a personal holding company (26 U.S.C. 544). Convertible securities can count the same way.

The test uses value, not votes, across common and preferred stock (26 U.S.C. 542). Certain pension trusts and private foundations count as single individuals (Schedule PH instructions). If two or three founders and their families hold more than half the value, the test is met without looking further. If funds hold the majority, the partner rule matters: stock traced to a fund's partners is treated as theirs, and each individual partner also owns what the other partners own, so one person can count as owning a fund's whole stake (26 U.S.C. 544(a)(2), (a)(5)). A few funds can meet the test even when no one person holds much. Checking it takes a look-through of each fund.

Why does a loss year usually mean no tax, and when doesn't it?

The tax applies only to undistributed personal holding company income, which starts from the year's taxable income. If current costs exceed the interest, there is nothing to tax, even when both tests are met (26 U.S.C. 545).

The risk appears when taxable income turns positive while revenue is still small:

• Costs that must be capitalized. Research done outside the US is still amortized over 15 years under section 174, so a startup with developers abroad deducts only a small part of that pay in the first year. US research costs are deductible in the year paid or incurred for tax years beginning after December 31, 2024, under section 174A (Public Law 119-21, section 70302). See deducting US software development and development done abroad.
• Old losses. The tax base starts from taxable income before the net operating loss deduction. Only the loss of the year just before reduces it; older carryforwards do not (26 U.S.C. 545; Schedule PH instructions). A company whose carryforwards wipe out most of its regular tax can still owe this tax. How carryforwards work generally is in net operating losses for startups.
• Credits. Business credits, such as the research credit, do not reduce it, because personal holding company tax is not part of regular tax liability (26 U.S.C. 26).

The base is reduced by the year's federal income tax and by dividends paid, but not by the dividends-received deduction (26 U.S.C. 545(b); Schedule PH instructions).

What does a personal holding company file: Schedule PH and dividends?

A personal holding company checks box 2 in Item A of Form 1120, attaches Schedule PH, and carries the tax to Schedule J line 8 (Form 1120 instructions). The Schedule PH worksheet runs the income test; if the result is under 60%, the company does not file the schedule (Schedule PH instructions). A company that meets both tests files Schedule PH even in a loss year when the tax is zero. If a personal holding company leaves it out, the IRS has six years after the return was filed to assess the tax (26 U.S.C. 6501(f)).

Dividends are the way to reduce the base, and each route has limits:

Because the after-year-end route depends on dividends paid during the year, a startup that paid none cannot use it alone. Paying a dividend from investor money also has charter, investor and shareholder tax effects, so this is a decision to make before year-end, not on the return.

Does holding cash or Treasury bills break QSBS's active business test?

No, not by itself. At least 80% of the company's assets by value must be used in an active qualified business (26 U.S.C. 1202(e)). Assets held as reasonably required working capital, or held for investment and reasonably expected to be used within two years for research or to grow working capital, count as used in the business (26 U.S.C. 1202(e)(6)).

Interest income itself does not fail the test, because the test looks at assets. What matters is whether the cash is tied to a plan to spend it on the business. A budget, a board-approved plan and spending that matches it are the records that show this. The company's statement to investors is covered in the QSBS guide for startups; whether a holder's own shares qualify is in QSBS for founders and early employees.

What changes once the company is two years old?

After the company has existed for at least two years, no more than 50% of its assets can count as active through the working-capital rule (26 U.S.C. 1202(e)(6)). A company with most of its balance sheet in cash can then fall short of 80% unless its other assets are used in the business.

The test must be met during substantially all of each holder's holding period (26 U.S.C. 1202(c)(2)). A large round after the second anniversary can push cash above the cap; quarter-end balance sheets show where the company stood.

Do money market fund shares count as stock in other corporations for QSBS?

This is unsettled. The company fails the active business test for any period when more than 10% of its net assets is stock or securities of corporations that are not its subsidiaries, but assets that meet the working-capital rule are carved out (26 U.S.C. 1202(e)(5)(B)).

A money market fund is generally a regulated investment company, which is taxed as a corporation, so its shares may be stock of another corporation. The statute does not say whether fund shares above the two-year working-capital cap still fall within the carve-out. Treasury bills are obligations of the US government, not stock of a corporation, so this particular limit does not reach them. Where fund shares are a large part of the balance sheet after year two, get a written view before relying on QSBS.

Does the raised cash count toward the QSBS gross assets limit?

Yes. Aggregate gross assets are cash plus the adjusted basis of other property, and the test includes the money received in the issuance itself (26 U.S.C. 1202(d)). The limit is $75,000,000 for stock issued after July 4, 2025, and $50,000,000 for earlier stock (Public Law 119-21, section 70431).

Treasury bills count at their basis, and interest kept in the account adds to cash. Exceeding the limit affects stock issued at or after that point; stock issued earlier is tested at its own issue date.

Do states tax Treasury interest a corporation earns?

It depends on the type of state tax. States may not tax interest on US obligations, except through a nondiscriminatory franchise tax or similar non-property tax on corporations (31 U.S.C. 3124). Each state's law decides which kind of tax its corporate tax is.

California shows both cases. A corporation doing business in California is subject to its franchise tax and includes all interest on government obligations; one with California income that is not doing business there pays the corporation income tax instead and excludes interest on federal obligations (Form 100 booklet). Whether a fund's dividends keep the interest's treatment is a separate state rule. Where the company files at all is in business income tax in other states.

Example

These examples are illustrative and use US dollars. Each assumes a calendar-year C corporation.

Series A cash in Treasury bills, still losing money

A startup holds an $8,000,000 Series A in Treasury bills and earns $350,000 of interest. It spends $3,000,000 on US salaries, rent and software, all deductible. Interest is its only income, so it meets the income test, and two founders hold more than half the value. Taxable income is a loss of about $2,650,000, so undistributed personal holding company income is zero and there is no personal holding company tax. It still attaches Schedule PH, showing no tax.

Developers abroad, three years traced

A startup's only income is $200,000 of interest each year; two founders own more than half the value. Its developers work abroad, so their pay is amortized over 15 years.

• Year 1: costs exceed interest; net operating loss of $300,000. No tax.
• Year 2: taxable income before the loss deduction is $80,000. The loss deduction is capped at 80%, $64,000, leaving $16,000 taxed at 21%: $3,360. For Schedule PH, Year 1's $300,000 loss is the preceding year's loss, so the base is zero.
• Year 3: same $80,000 and the same $3,360 of regular tax. Year 2 had no loss, so only $80,000 less $3,360 remains: $76,640. At 20%, personal holding company tax is about $15,330, more than four times the regular tax.

Three-year-old company, 70% of assets in cash

A company formed three years ago has $20,000,000 of assets: $14,000,000 of Treasury bills earmarked for its operating plan and $6,000,000 of equipment and other assets used in the business. The working-capital rule can count only $10,000,000 (50%). Active assets are $16,000,000, exactly 80%. If cash rose to 75% of assets, active assets would be 75% and the test would fail.

Different for you?

• Your income is positive and nearly all interest: check the ownership test and Schedule PH before filing, with corporate tax help.
• Investors want the company's QSBS statement: see the QSBS guide for startups and corporate tax help.
• You want to know if your own shares qualify: see QSBS for founders and early employees.
• You are using past losses against income: see net operating losses for startups.
• You worry about a state taxing your QSBS gain: see state tax on QSBS gains.
• You plan to keep profits in the company once revenue starts: see how C corporations are taxed.
• This is your first return with no revenue: see the first corporate return for a pre-revenue startup.