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Author: Jamie Norrdin, Attorney
TL;DR: Startup founders and investors can potentially exclude up to 100% of capital gains from federal taxes on the sale of Qualified Small Business Stock (QSBS), resulting in tax savings of up to $10 million or $15 million (or more in some cases), depending on when the QSBS was issued.
To qualify for the full QSBS exemption, the stock must be originally issued by a C-corporation, held for at least five years and issued by a company that operates in a qualified trade or business (e.g., tech, biotech) and, depending on when the QSBS was issued, had gross assets on the date of issuance under $50 million or $75 million.
Key Update: Certain taxpayer-favorable changes to the QSBS exemption were recently enacted under the One Big Beautiful Bill Act (OBBBA) for stock issued after July 4, 2025. See the comparison chart below to determine which QSBS exemption rules apply.
Proper structuring, avoiding disqualifying actions such as certain redemptions, and strategic planning (e.g., stacking via trusts) can maximize QSBS benefits. However, state tax treatment may vary, and tax rules could change. Consult legal and tax advisors to ensure QSBS eligibility and optimize tax savings.
Consult with a startup attorney today!
The sale of shares or equity in a company is typically subject to either short or long-term capital gains taxes. However, the U.S. tax code offers significant tax savings and benefits to startup founders and investors holding Qualified Small Business Stock (QSBS). The primary purpose of the QSBS exemption is to incentivize investment in small, high-growth companies, particularly in industries such as technology, biotechnology, climate technology, and life sciences.
The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, increased the potential tax benefits that founders and early investors may receive upon a sale of QSBS issued after its enactment.
Continue reading to learn more about QSBS, why it matters to your startup, how to qualify for this key tax benefit, and specific strategies and real-world situations to help you optimize QSBS tax treatment.
What Is Qualified Small Business Stock (QSBS)?
QSBS is a tax benefit available under Section 1202 of the Internal Revenue Code. If specific QSBS requirements are met, stockholders can exclude from federal taxes up to 100% their capital gains from the sale of their stock in your company, subject to exclusion limits and holding period requirements.
Depending on when the stock was issued, the maximum gain exclusion for QSBS is $10 million or $15 million (or more in some instances). In each case, QSBS tax treatment yields substantial tax savings upon sale.
- Under the OBBBA, QSBS issued after July 4, 2025 allows the holder to potentially exclude from federal taxes up to 100% of capital gains from their sale of QSBS, subject to a limit equal to the greater of (1) $15 million or (2) 10X the stockholder’s basis in the shares of QSBS. The $15 million limit will increase over time as it is indexed to inflation.
- Before the OBBBA, QSBS issued on or before July 4, 2025 is subject to a limit equal to the greater of (1) $10 million or (2) 10X the stockholder’s basis in the shares of QSBS.
Key Requirements of QSBS Include:
- C-corp: The stock must be purchased directly from a C-corporation (i.e., originally-issued stock), with limited exceptions discussed below.
- Qualified Small Business: The issuing company must be a “Qualified Small Business” that meets specific criteria when the stock is issued.
- Required Holding Periods: To take full advantage of this tax exclusion, stock must be held for at least five (5) years from its original date of issuance. However, for stock issued after July 4, 2025, stockholders may receive a partial QSBS tax exclusion if the stock is held for at least three (3) years from the original date of issuance (more on this below).
How much you can save on taxes under IRC Section 1202 depends partly on when the stock was issued.
| QSBS Issued Pre-OBBBA (on or before July 4, 2025) | QSBS Issued Post-OBBBA (after July 4, 2025) | |
| Required Holding Period | At least 5 years from the date of issuance. | At least 3 years from the date of issuance. |
| Gain Exclusion Percentages |
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| Cap on Gain Exclusion | Greater of $10 million or 10X the stockholder’s basis in the QSBS. | Greater of $15 million (adjusted for inflation beginning in 2007) or 10X the stockholder’s basis in the QSBS. |
| Gross Asset Limit | $50 million on the date of issuance. | $75 million on the date of issuance (adjusted for inflation starting in 2027). |
Why Qualified Small Business Stock Is a Game-Changer for Startup Founders and Investors
The founders and investors holding QSBS can receive a significant tax break when your startup has a successful exit, whether through an M&A exit or following an initial public offering (IPO). QSBS also makes early-stage investments more attractive for investors due to the potential for significant federal tax savings upon a successful exit. QSBS is one of the primary reasons why most venture capital firms prefer to invest in C corporations. To wit, we often see venture capital investors require that the target company convert to a C corporation as a condition of their investment.
$15M+ in Potential Tax Savings:
Imagine selling your company after holding QSBS for the minimum holding period. If you meet the QSBS criteria, your tax savings on that sale could be enormous, reducing your federal capital gains tax to zero in certain circumstances.
On or Before July 4, 2025: For stock issued on or before July 4, 2025, stockholders may exclude from federal taxes up to 100% of the capital gains on the sale of their QSBS, subject to a cap equal to the greater of $10 million of capital gains or ten times (10X) their original investment amount (i.e., their basis in the shares).
After July 4, 2025: For stock issued after July 4, 2025, stockholders may exclude from federal taxes up to 100% of the capital gains on the sale of their QSBS, subject to a cap equal to the greater of $15 million of capital gains or ten times (10X) their original investment amount (i.e., their basis in the shares).
Other Practical Benefits of QSBS under the OBBBA:
The OBBBA includes practical QSBS incentives for startups and investors, providing them with more flexibility to entertain short-term exit opportunities while retaining partial QSBS gain exclusion upon the sale of their QSBS. Additionally, by increasing the qualified small business asset limit to $75 million (or more as adjusted for inflation), more companies will be able to attract investment and retain talent.
How to Qualify for Qualified Small Business Stock: Requirements for the Issuing Company
The company issuing the stock must be a Qualified Small Business meeting specific criteria to ensure its shares are considered QSBS-eligible.
To qualify, the company:
- Must be a domestic C-corporation (LLCs and S-corps do not qualify).
- Cannot have gross assets exceeding $50 million at any time before and immediately after issuing the shares if the shares were issued on or before July 4, 2025.
- Cannot have gross assets exceeding $75 million (with such amount indexed for inflation going forward) at any time before and immediately after issuing the shares if the shares were issued after July 4, 2025.
- Must be actively engaged in a “qualified trade or business,” with at least 80% of its assets used in that business.
Some types of businesses are excluded from QSBS treatment, including those in the law, finance, insurance, or other professional services. Hospitality and restaurant businesses generally are excluded from QSBS as well. However, suppose your company engages in research and development or focuses on developing a tech, biotech or consumer product. In that case, it likely meets the qualified trade or business requirement under IRC Section 1202.
How to Qualify for Qualified Small Business Stock: Requirements for Stockholders
Stockholders (such as founders and investors) must also meet specific criteria to take advantage of QSBS.
For stockholders:
- They must acquire the stock directly from the company when it is issued for cash, services or property. In other words, they can’t buy shares from a third party and claim QSBS tax treatment.
- They must hold their stock for a minimum holding period to qualify for this capital gains exclusion. There are limited exceptions to these rules, such as in cases of death or certain types of mergers and acquisitions; however, a minimum holding period is required in most cases.
- Stockholders that are C-corporations themselves may not benefit from QSBS – QSBS only benefits stockholders who are individuals, trusts or other pass-through entities.
Minimum Holding Periods:
The 100% capital gains exclusion is only available to stockholders who hold their QSBS for at least five (5) years.
But, for QSBS issued after July 4, 2025, stockholders who sell their QSBS may receive a partial gain exclusion if the following holding periods are met:
- Sales of QSBS after three (3) years will qualify for a 50% gain exclusion. The remaining 50% gain is subject to a 28% capital gain tax rate (resulting in an effective tax rate of 15.9% on the gain).
- Sales of QSBS after four (4) years will qualify for a 75% gain exclusion. The remaining 25% gain is subject to a 28% capital gains tax rate (resulting in an effective tax rate of 7.95% on the gain).
No partial gain exclusions are allowed for stock issued on or prior to July 4, 2025.
Pitfalls to Avoid When Trying to Qualify for Qualified Small Business Stock
You will need to watch out for the following common pitfalls when trying to qualify for QSBS:
- Converting from LLC to C-corporation: Timing is crucial when converting your business from an LLC to a C-corporation. If done too late, you may disqualify the stock from being treated as QSBS. Also, if you initially elect for your business to be taxed as an S-corporation, then you cannot later qualify for QSBS by converting your business into a C-corporation.
- Redemptions: If a company redeems stock (i.e., buys back shares from its stockholders), it can affect QSBS eligibility for all stockholders. Certain redemption events can disqualify stock from receiving QSBS benefits, so careful planning is essential when redeeming stock.
- Investor Strategies: Some investors may use strategies like “stacking” (i.e., acquiring QSBS through multiple entities or trusts) to maximize tax exclusions. However, these strategies require careful tax and legal planning to avoid QSBS pitfalls or IRS challenges.
Maximizing Qualified Small Business Stock Benefits: Strategies for Founders and Investors
To fully realize the tax benefits of QSBS, it’s essential to plan and work with experienced legal and tax advisors. Here are a few strategies to consider:
- Proper Structuring from the Start: Founders of QSBS-eligible businesses should ensure that their companies are set up as C corporations and meet the asset and operational requirements to qualify for QSBS from the outset. Investors should invest in C-corporations that meet these requirements.
- Fundraising Considerations: When raising funds through convertible notes, SAFEs, or equity, both founders and investors should ensure that any agreements are structured to help preserve QSBS eligibility.
- Estate Planning Opportunities: QSBS stock can provide tax-efficient estate planning opportunities for founders and investors.
Real-World Examples of QSBS in Action
Here are three simple real-world examples highlighting the potential tax savings available through QSBS.
Example 1: Founder Exits Tech Startup: A founder sells their tech company (a Delaware C-corporation) after holding QSBS for six years. The founder received their shares prior to July 4, 2025. The founder’s basis in the stock (i.e., the amount they invested) is $100. The sale nets the founder $25 million in capital gains. Thanks to QSBS, the founder can exclude up to $10 million of capital gains from federal taxes, representing $3 million in tax savings (assuming an effective tax rate of 30%).
Example 2: Early-Stage Biotech Investor: An early-stage investor holds QSBS for five years in a biotech company (a Delaware C-corporation) that is acquired for $300 million. The early-stage investor received their stock after July 4, 2025, and the sale nets the early-stage investor $25 million. The investor’s original investment was $1 million. Under QSBS, the investor can exclude 100% of its capital gains, up to the greater of $15 million (or more depending on inflation) or 10x their original investment (i.e., $10 million), resulting in significant tax savings on the sale of its shares.
Example 3: Partial Gain Exclusion: A tech startup employee received QSBS after July 4, 2025, and sells their shares after three (3) years. The employee’s basis in their shares was $100 and the sale nets the employee $2 million in capital gains. Because the QSBS qualifies for additional benefits under the OBBBA, the employee will be able to exclude 50% of their capital gains (i.e., $1 million) from federal taxes upon sale. The remaining 50% (i.e., $1 million) of capital gains will be taxed at a capital gains rate of 28%.
Important Caveats
This blog focuses on QSBS tax treatment, generally applicable under U.S. federal income tax rules as of July 2025. These rules may change as new legislation is put in place.
Also, some states do not provide a similar tax exclusion for QSBS (like California), so it’s essential to consult with your own legal and tax advisors to determine the availability of QSBS for your shares and any resulting tax impacts.
Conclusion
For founders and investors in tech, biotech and other startups, QSBS represents significant tax-saving opportunities. However, ensuring your stockholders qualify for QSBS treatment requires careful planning in structuring your company as a C-corporation, meeting the necessary holding period and other key requirements.
By understanding the rules and avoiding common pitfalls, you can maximize the financial benefits of QSBS and realize significant tax savings. As always, it’s crucial to consult with legal and tax advisors to tailor your strategy to your specific situation.
Consult with a startup attorney today!
Clients Also Ask Us:
What qualifies as a Qualified Small Business for QSBS?
The company must be engaged in an active business that is not excluded under IRC Section 1202. For example, companies that provide professional services (such as law, finance, or consulting) or are engaged in hospitality or real estate do not qualify. However, companies focused on tech, biotech, life sciences, and climate tech typically meet the criteria.
What is the 80% rule for QSBS?
The 80% rule for QSBS requires that at least 80% of the corporation’s assets be used in the active conduct of a qualified trade or business for substantially all of the stockholder’s required holding period.
Is QSBS exempt from state tax?
QSBS may or may not be exempt from state taxes, depending on the state. For example, California does not conform to the federal QSBS exclusion, so QSBS gains are taxable at the California state level.
How do I get QSBS for my LLC?
LLCs do not qualify for QSBS, but you may be able to convert your LLC to a C-corporation before issuing QSBS-eligible stock.
