For founders and early investors, few tax incentives are as valuable as the Qualified Small Business Stock (QSBS) exclusion under Section 1202 of the Internal Revenue Code. If properly structured and documented, the QSBS rules can allow you to exclude up to 100% of the capital gains on the sale of qualifying stock. With the changes to QSBS that are effective as of July 4, 2025, the benefit is now more flexible (shorter holding periods in some cases), more generous (higher exclusion caps), and more accessible (higher asset thresholds).
However, the QSBS rules are complex, and eligibility often depends on decisions made early in a company’s life. As an experienced tax attorney who works closely with founders and investors, my role is to help you plan, document, and preserve this powerful benefit from day one.
What is QSBS?
Qualified Small Business Stock (QSBS) is a special tax category of corporate stock that, when certain requirements are met, allows holders to exclude a significant portion—sometimes all—of the gain from federal taxation upon sale. To qualify, both the company and the stockholder must meet several conditions.
C Corporation Requirement
- The issuing company must be a “corporation” for federal tax purposes for the entirety of the holding period. S corporations and partnerships do not qualify. LLCs may qualify, if the LLC chooses to be taxed as a corporation rather than a partnership for federal tax purposes. If you’re currently an LLC, you may be eligible for a “check-the-box” conversion that doesn’t require significant changes to your corporate structure.
Asset Test
- Aggregate gross assets must be under $50 million (for stock issued on or before July 4, 2025) or under $75 million (for stock issued after July 4, 2025) before and immediately after the issuance.
Qualified Trade or Business
- The company must use at least 80% of its assets in an active trade or business that is not in an excluded category (e.g., most professional services, banking/finance, certain real estate, hotels, restaurants).
Original Issuance
- You must acquire the stock directly from the company (not by buying from another shareholder), in exchange for cash, property (not stock), or services.
Holding Period
- For stock issued prior to July 4, 2025, you must hold the stock for 5 years.
- For stock issued after July 4, 2025, you can receive a 50% tax exclusion after 3 years; a 75% exclusion after 4 years, and the full 100% exclusion after holding your stock for 5 years.
No Disqualifying Transactions
- Certain redemptions, restructurings, or changes of entity type can disqualify you for QSBS status if not planned correctly.
Don’t Wait Until Your Exit!
Many startup founders or investors only think about QSBS when a liquidity event is looming. By that point, crucial elements may be too late: entity form, asset thresholds, original issuance, and documentation might already be fixed. With the changes that took effect July 4, 2025, the opportunity is richer—but it also demands earlier action, sharper documentation, and sophisticated structuring.
If you’re a founder, early employee, or investor in a company that may qualify for QSBS—or you want to convert your entity or restructure your financing to benefit—let’s schedule a QSBS Readiness Consultation. We’ll map your current status, quantify the potential gain exclusion under old vs. new rules, and develop a roadmap to maximize and preserve this valuable tax benefit.
Disclaimer: This article is for general informational purposes only and does not constitute legal, tax, or financial advice. Individual circumstances vary, and readers should consult their attorney or financial advisor before taking any action based on this information.
