QSBS: the founder and investor tax break worth planning for

Qualified small business stock, or QSBS, lets founders, employees and investors exclude some or all of their gain from federal capital gains tax when they sell stock in a qualifying company. For a successful startup, the difference can be millions of dollars. The rules changed in July 2025, and the requirements are strict, so it pays to understand them early.

What QSBS does

If you hold qualifying stock long enough, part or all of your gain on the sale is excluded from federal income tax. The benefit is capped per company, per taxpayer.

What changed in July 2025

The One Big Beautiful Bill Act, signed July 4, 2025, expanded QSBS for stock issued after that date:¹

Does the company qualify?

• It must be a domestic C corporation. LLCs and S corporations do not issue QSBS. A company that converts to a C corporation can issue qualifying stock from that point.
• Gross assets must be under the limit ($50 million or $75 million, depending on when the stock was issued) both before and immediately after the stock is issued.
• It must be an active business. At least 80% of its assets must be used in an active qualified trade or business.
• Some industries are excluded, including health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, banking, insurance, leasing, investing, farming, hotels and restaurants, fossil fuel production, and any business whose main asset is the reputation or skill of its owners or employees.¹

Does the shareholder qualify?

• The stock must be held by a non-corporate taxpayer, such as an individual, a trust or a pass-through entity.
• It must be acquired at original issuance, directly from the company, in exchange for money, property or services. Shares received by exercising options, converting SAFEs or notes, or exercising warrants can qualify. Shares bought from another shareholder cannot.¹
• The holding period for shares from options starts at exercise, not at grant. When the holding period starts for SAFEs and convertible notes can be less clear, so ask your tax advisor how yours will be treated.

State taxes

QSBS is a federal benefit, and not every state follows it. According to Carta, Alabama, California, Mississippi, Pennsylvania and Puerto Rico do not offer the exclusion, and Hawaii and Massachusetts offer partial conformity.¹ Where you live when you sell matters.

Other rules worth knowing

• Rollovers. Section 1045 lets you sell QSBS held more than six months and defer the gain by reinvesting in other QSBS within 60 days.
• Gifts and inheritance. QSBS status can carry over when stock is gifted, inherited or transferred in some other ways, which some founders use in estate planning. Most other transfers end it.
• Redemptions. Significant stock buybacks by the company around the time of issuance can disqualify stock. Check before any repurchase.

What to do about it

For founders:

• Form as a C corporation early if you plan to raise venture capital.
• Track gross assets at every issuance, and keep records showing the company met the active business test over time.
• Consider an annual QSBS attestation from the company, which makes it easier for shareholders to support their claim later.

For investors:

• Confirm the company's entity type and industry before investing, and ask whether it has assessed QSBS eligibility.
• Keep documentation of when and how you acquired your shares. The burden of proving eligibility falls on the taxpayer.