QSBS: What is Qualified Small Business Stock (QSBS)?
Note that the July 2025 “One Big Beautiful Bill Act” (OBBBA) made some major changes to QSBS rule for stock issued after July 4, 2025, which we’ll cover in more depth in next week’s post. Today’s post focuses on the “old” QSBS rules that still apply to stock issued on or before July 4, 2025, which the vast majority of founders and early investors still hold.
This week’s question: What is Qualified Small Business Stock (QSBS) and why should founders care?
Our answer: QSBS is one of the most friendly parts of the IRS federal tax code for founders and early stage investors. If your startup meets certain requirements, you and other early stockholder may be able to exclude up to $10M (or 10x your basis) (now $15M for QSBS stock issued after July 4, 2025) of gain from federal taxes when you sell your shares after a 5-year holding period (now there is a tiered approach that allows for a portion of QSBS as early as 3-years for QSBS stock issued after July 4, 2025). This can translate into millions of dollars in tax savings at exit. But the rules are highly technical, so it’s easy to miss out if you don’t plan early and carefully comply with the rules.
Key Considerations
C-Corporation Status. Only stock in a C-corp qualifies, so equity issued by LLCs and S-corps are not eligible. If your startup is currently an LLC but expects to raise venture funding, converting sooner rather than later helps you start the QSBS “clock” and avoiding missing QSBS eligibility.
Gross Asset Test. Your company must have had less than $50M in aggregate gross assets (now $75M for QSBS stock issued after July 4, 2025) immediately before and after issuing the stock. After you exceed this threshold, new share issuances do not qualify.
Original Issuance. QSBS only applies if you acquire stock directly from the company (e.g. typically as founder and restricted stock grants, stock option exercises, or early stage investments). Purchasing shares from another stockholder generally won’t qualify.
Active Business and Qualified Fields. At least 80% of the company’s assets must be used in an active trade or business. Certain fields are excluded, including most service businesses, finance, real estate, and hospitality.
Holding Period. To get the full exclusion, you need to hold your stock for more than 5 years (now tiered with a portion qualifying as early as 3-years for stock issued after July 4, 2025). Importantly, the clock usually starts when you acquire your shares (or when they vest, unless you filed an 83(b) election).
Exclusion Cap. The tax-free gain is capped at the greater of $10 million per taxpayer per company (now $15M for QSBS stock issued after July 4, 2025) or 10x your basis in the stock.
State Law. Not all states follow federal QSBS rules; for example, California, New Jersey and Pennsylvania disallow the exclusion, meaning founders there may still owe state tax on their gains. However, other major states such as Colorado, Illinois and New York allow the exclusion.
Why It Matters
The potential tax savings from QSBS are enormous. Even under the old QSBS rules, founders and early investors can save roughly $2 to $3M in federal taxes alone, and potentially more if the holder’s state allowed the exclusion too or shares qualify for the new QSBS rules for stock issued after July 4, 2025 . Blowing QSBS eligibility can mean writing big checks to the IRS and your state tax authority that you could have avoided. By understanding and planning QSBS early, the more likely it is you can capture QSBS’s benefits and avoid the regret of potentially missing millions in tax savings.
