Maximizing Qualified Small Business Stock (QSBS) Tax Benefits

Author: Mike Haenel, Tax Partner

As CPAs guiding entrepreneurs and investors through the ever-changing landscape of tax law, it’s crucial to stay ahead of powerful tax-saving opportunities. One such opportunity—often overlooked or misunderstood—is the Qualified Small Business Stock (QSBS) exclusion under Section 1202 of the Internal Revenue Code (IRC). When combined with timely planning and a technique known as “stacking,” this provision can dramatically reduce or even eliminate federal capital gains taxes on the sale of qualifying stock.

Qualified Small Business Stock refers to shares in a C corporation that meet specific IRS criteria. If these criteria and the holding period requirement are met, taxpayers may exclude up to 100% of the gain on the sale of QSBS, subject to certain limits.

Key QSBS requirements include:

• Entity Structure: The stock must be issued by a domestic C corporation.
• Qualified Business: The corporation must be a “qualified small business,” generally with gross assets under $50 million at the time of stock issuance. For stock issued after July 4, 2025, the gross asset limit is raised to $75 million, indexed for inflation.
• Active Business Test: At least 80% of the corporation’s assets must be used in an active qualified trade or business. The IRS excludes certain businesses from QSBS including those “involving the performance of services in the field of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”
• Original Issuance: The stock must be acquired directly from the company in exchange for money, property (not stock), or services.
• Holding Period: The shareholder must hold the stock for at least five years for stock acquired on or before July 4, 2025. For stock acquired after July 4, 2025, partial gain exclusions now begin as early as 3 years of holding (see table below for a side-by-side comparison of stock acquired before and after the One Big Beautiful Bill “OBBB” enactment).




	Stock Acquired On or Before July 4, 2025	Stock Acquired After July 4, 2025
Holding Period for Exclusion	5 years	Partial exclusion (with no AMT preference) starting at 3 years: – 3 years: 50% – 4 years: 75% – 5 years: 100%
Gain Exclusion Limit	$10 million	$15 million (indexed for inflation after 2026)
Gross Asset Limit for QSBS Eligibility	$50 million	$75 million (indexed for inflation after 2026)

Early employees of startup companies should consider the QSBS tax savings potential when deciding whether to early exercise their options and file an 83(b) election. For example, if the employee exercises options while the company still meets the QSBS eligibility requirements prior to assets exceeding $75M (for stock issued after July 4, 2025), future gains on the sale of stock could avoid federal tax all together. This opportunity could be missed if options are exercised later when the Company’s assets exceed $75M.

Investors who make SAFE (Simple Agreements for Future Equity) and convertible note investments need to consider their tax position on the holding period. Currently there is no guidance from the IRS on whether a SAFE constitutes stock for purpose of Section 1202. An investor can consult advice from a qualified tax advisor to determine their tax position.

If short of the 5-year holding period for stocks issued before July 4, 2025, the gain can be deferred as a QSBS rollover instead by reinvesting in new QSBS company stock within 60 days of the sale and meet the other requirements of IRC 1045. This rollover strategy can be a tax efficient method to fund new startup company investments for angel investors and need to be weighed against the new expanded QSBS benefits under OBBB.

Stacking Gains Across Multiple Taxpayers

The maximum gain exclusion is limited to the greater of $10,000,000 (or $15,000,000 for stock acquired after July 4, 2025) or 10 times the adjusted basis of QSBS disposed of in the year.

“Stacking” is a strategy to multiply the maximum QSBS gain exclusion by leveraging multiple taxpayers – typically through family members or non-grantor trusts. Additionally, a non-grantor trust can be created in a tax-friendly state jurisdiction for additional tax savings. This strategy has its own rules that need to be considered. For example, a founder sells QSBS with $30 million in gain. On their own, they can exclude $10 million. But if they had earlier gifted QSBS to two separate non-grantor trusts—each with its own $10 million exclusion—they could potentially exclude the entire $30 million from federal capital gains tax. The gift must occur before the sale while the valuation is low to shift assets outside of a taxable estate for both substantial income and estate tax savings.

Increasing QSBS Basis for a Higher Exclusion

When the Company starts out as an LLC and later converts to a corporation before $50 million (or $75 million after July 4, 2025) of gross assets, the fair market value of the LLC at conversion can multiply for a much higher QSBS limitation as 10 times basis. For example, if the value of the LLC is $10M when it converts to a C Corporation, the Taxpayer can exclude up to $100M (10x basis) of QSBS gains for this investment.

Common Pitfalls to Avoid

Taxpayers cannot contribute QSBS stock to a family limited partnership as this will taint the original issuance requirement. It would be beneficial to make direct gifts to a non-grantor trust instead.

Certain offsetting short positions with respect to QSBS will disallow future gain exclusion unless certain requirements are met and elections are made.

If the Company holds excess cash reserves (more than 50 percent of the Company’s assets) QSBS eligibility could be in jeopardy under the active trade or business requirement.

There are rules related to corporate buybacks that could taint QSBS for shareholders.

Final Thoughts

The QSBS exclusion offers one of the most significant capital gains tax planning opportunities for founders, investors, and employees in high-growth startups. With early planning, attention to compliance, and strategic stacking, it’s possible to maximize tax planning. To discuss how Frank, Rimerman + Co. tax professionals can support your broader tax planning objectives, we invite you to connect with our team.






About the Author Mike Haenel, Partner
Tax / LinkedIn / E-mail

Mike Haenel is a partner in the Tax practice at Frank, Rimerman + Co. He specializes in working primarily with high-net-worth individuals, their closely-held businesses, partnerships, and their fiduciaries. His expertise lies in serving executives and officers of public and pre-IPO companies, venture capital and private equity general partners, and sophisticated investors. Mike helps optimize tax efficiency with complex investment vehicles, concentrated stock positions, and stock option planning.

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Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Investing in QSBS involves significant risks and potential loss of tax benefits. Qualification requirements are complex and ongoing, including active business, asset composition, and holding period criteria. The company must continuously meet the 80% active business test throughout the investor’s holding period. Certain activities and industries are excluded, and exceeding size limitations can disqualify the stock. Early sale before the five-year holding period will result in loss of tax benefits. Insufficient documentation of QSBS status throughout the holding period may lead to disqualification upon IRS scrutiny.