For startup founders, building a company from scratch comes with no shortage of challenges—raising capital, attracting talent, finding product-market fit, and navigating growth. But one major upside of starting and owning a business often gets overlooked until it’s too late: the potential for significant tax savings under the Qualified Small Business Stock (QSBS) exclusion.
If you’re a founder or early employee who holds equity in a C-corporation, understanding whether your shares qualify for QSBS could be the key to saving millions in federal taxes upon a successful exit. Yet many entrepreneurs aren’t aware of this benefit, or worse, lose eligibility by making preventable mistakes.
This post breaks down what QSBS is, why it matters, and offers a clear checklist to help you assess whether your stock qualifies—before it’s too late.
What Is QSBS?
QSBS stands for Qualified Small Business Stock, a special provision in the U.S. tax code (Section 1202 of the Internal Revenue Code) that allows eligible shareholders to exclude up to 100% of capital gains on the sale of qualified stock, up to $10 million—or 10 times the initial investment, whichever is greater.
This exclusion can apply to shares held in qualifying C-corporations in sectors like technology, biotech, and manufacturing, among others. If your startup equity qualifies, and you hold it long enough, the tax savings could be substantial.
Why QSBS Matters for Founders
Let’s say you started a company, issued yourself founder shares, and five years later sell the company. If those shares meet QSBS criteria, you could potentially exclude up to $10 million in capital gains from federal tax.
Here’s what that means in real terms:
- Without QSBS: A $10 million gain could result in up to $2.38 million in federal capital gains taxes (not including state taxes, NIIT, etc.).
- With QSBS: That $10 million gain could be entirely tax-free at the federal level.
Now multiply that by multiple co-founders or by issuing QSBS-eligible stock through proper estate or trust planning, and the value of this provision becomes even clearer.
But there’s a catch—actually, several. Your company and stock must meet strict criteria to qualify.
The QSBS Eligibility Checklist for Founders
To determine whether your startup stock qualifies for QSBS treatment, work through the checklist below. Note that this is a general guide, not a substitute for legal or tax advice.
1. Was the stock issued by a U.S. C-Corporation?
QSBS only applies to stock issued by a domestic C-corporation. S-corps, LLCs, or partnerships don’t qualify, nor does stock purchased on the secondary market.
If your company was a C-corp at the time of issuance and you received your shares directly from the company, you may qualify.
2. Was the stock acquired at original issuance?
To be eligible, you must have acquired the shares directly from the company—not through secondary sales or open-market transactions.
This includes:
- Founder stock issued at incorporation
- Equity received in exchange for services
- Stock purchased directly from the company in a financing round
If you bought shares from another individual or through a secondary platform, they’re not QSBS-eligible.
3. Have you held the stock for at least five years?
QSBS requires a minimum five-year holding period to take advantage of the full capital gains exclusion.
Some exceptions exist—such as a tax-free reorganization—but in general, premature sales will make your gains ineligible. Keep this in mind when considering early liquidity options like secondaries or tender offers.
Check the exact date your QSBS-eligible stock was issued to you, and plan your holding strategy accordingly.
4. Was the stock issued when the company had less than $50 million in gross assets?
This is a core requirement. To qualify, your company’s total gross assets must not have exceeded $50 million at the time the stock was issued—and immediately after.
This includes all cash, IP, equipment, and anything of value held by the company, including recent funding rounds.
This test must be met at the time of stock issuance, not at the time of sale.
5. Is your company engaged in a qualified trade or business?
Certain types of businesses are excluded from QSBS treatment. Generally, service-based businesses like:
- Law firms
- Accounting firms
- Medical practices
- Financial advisory services
are not eligible. The IRS defines these as “specified service trades or businesses.” The same goes for banking, insurance, farming, and hospitality.
However, most tech, biotech, manufacturing, and product-focused companies do qualify.
Double-check your company’s industry classification and confirm it falls within the acceptable bounds of a qualified business.
6. Has the company retained QSBS eligibility over time?
Here’s where things get tricky. Even if your company qualified when you were issued the stock, certain changes can cause it to lose QSBS eligibility. These include:
- A conversion to an LLC or S-corp
- Mergers with ineligible entities
- Pivoting to a disqualified line of business
- Significant asset increases beyond the $50M threshold prior to stock issuance
Founders should work with legal and tax professionals to monitor ongoing eligibility—especially around financing rounds, structural changes, and business pivots.
How Founders Can Preserve QSBS Eligibility
Even if your stock is QSBS-eligible now, maintaining that status requires diligence. Here are a few steps to help preserve the benefit:
1. Document Everything
Keep detailed records of:
- The date your stock was issued
- The type of shares (common vs. preferred)
- The company’s gross assets at issuance
- Your stock purchase agreement
- Any board resolutions or cap table history
These will be essential when claiming the exclusion—and when answering questions from the IRS.
2. Coordinate With Advisors Before Major Decisions
Thinking of selling stock on the secondary market? Accepting a tender offer? Converting to an LLC?
Consult your legal counsel and tax advisor before making any moves that could jeopardize QSBS eligibility.
3. Explore Tax Planning Opportunities
With careful planning, you may be able to multiply the QSBS benefit:
- Spouses can each claim their own $10M exclusion
- Gifts to irrevocable trusts can each access their own $10M cap
- Certain reorganizations can preserve QSBS status if done correctly
These strategies are complex—but the upside is real.
Final Thoughts: Don’t Leave QSBS on the Table
For founders and early employees, QSBS is one of the most powerful tax incentives available in the startup ecosystem. But it only works if you know about it early, plan accordingly, and preserve eligibility over time.
Unfortunately, many discover it too late—after restructuring, selling early, or making decisions that could have been structured differently.
If you’re building a startup and hold equity, take time now to assess your QSBS status. Talk to your legal and financial advisors. Ask the right questions. Document what you need. And most importantly, treat your personal tax strategy with the same thoughtfulness you bring to your business strategy.
The opportunity is there. Make sure you’re positioned to claim it.