What Is QSBS, and How Do I Make Sure My Startup's Stock Qualifies?

QSBS stands for qualified small business stock, and it is one of the most valuable tax breaks in the federal code for anyone who owns part of a startup. If you hold qualifying stock long enough and then sell it at a profit, some or all of that profit is free of federal income tax. For stock issued after July 4, 2025, a three-year hold excludes half the gain, four years excludes three quarters, and five years excludes all of it, up to $15 million per person per company (or ten times what you paid for the stock, if that number is bigger). To put rough numbers on it, a founder who sells $10 million of stock she got for almost nothing would normally owe something like $2.4 million in federal tax on the sale. With QSBS and a five-year hold, she would owe none.

Whether a share qualifies depends mostly on the company. The company has to be the right kind of company in the right kind of business, it has to be under a size limit on the day it issues the stock, and it has to avoid a few transactions that can disqualify stock after the fact. Most of that is in the founders' hands, and almost all of it gets decided years before anybody sells.

Who is asking, and why now

The questions I get come from two directions. Founders want to know whether their own shares qualify and what they have to do to keep it that way. Investors, or the lawyers representing them, want to know whether their investment can qualify, and more of them are asking before they wire the money rather than after.

The 2025 tax law is a big part of the reason, because before it you had to hold for a full five years to get any benefit, the cap was $10 million, and the company had to stay at or under $50 million in assets. The new rules made the benefit easier to reach and put a lot more companies inside the limit, although stock issued before July 5, 2025 still runs under the old rules, which matters if your cap table has a mix of both.

The company has to be a C-corporation in a qualifying business

QSBS only applies to stock of a U.S. C-corporation, the standard corporate form venture investors expect. LLC interests never qualify, and neither does stock of an S-corporation. A company that starts as an LLC and later converts can issue qualifying stock from that point forward, but the clock only starts at conversion (I wrote about that choice in Delaware C-Corp or LLC for My Startup?).

The business itself also has to qualify. The law carves out a long list of fields, including health, law, accounting, consulting, financial services, brokerage, banking, insurance, and hotels and restaurants, along with any business whose main asset is the reputation or skill of its people. Most software companies are fine, and so are most consumer product companies, whether they sell direct, through retail, or both. A packaged-food brand sold in grocery stores qualifies, but one that makes most of its money from its own cafes starts to look like a restaurant. The conversations get nervous at the edges, where a fintech product starts to look like a financial services business, or a healthcare platform starts to look like a medical practice with an app on top. At least 80% of the company's assets have to be used in the qualifying business for nearly the whole time someone holds the stock, and what counts is what the company really does day to day, whatever the charter says.

There is one more wrinkle for companies that raise a lot of money. Cash in the bank counts as a business asset when it is earmarked for operations or research in the near term, but after the company's second birthday, that can only cover up to half of its assets, which matters for a company sitting on a large round it does not expect to spend for years.

The $75 million size limit

For stock issued after July 4, 2025, the company's gross assets cannot be more than $75 million at any point before the stock is issued or immediately after. Gross assets is roughly the cash in the bank plus what the company paid for everything else it owns, and "immediately after" includes the money from the round itself. Say a company has $45 million in the bank and raises $35 million. It crosses the line by taking the money, and the investors in that round get no QSBS on those shares. Stock the company issued earlier keeps its status.

Valuation has nothing to do with it. A company valued at $400 million with $30 million in the bank can still issue qualifying stock, which surprises people, and so does the reverse, a modestly valued company that sold a business line and suddenly has too much cash. Inventory and equipment count at what the company paid for them, so a consumer product company carrying a lot of inventory can reach the limit at a far lower valuation than a software company that raised the same money. What matters is the balance sheet on the day each share is issued.

Employees and advisors: the clock starts when they actually own stock

A stock option is not stock. It is a right to buy stock later, and the QSBS clock and the $75 million test both wait until the day the option is exercised. A founder whose shares were issued at formation qualifies, while an early engineer who waits to exercise until after the Series B may not, because by then the company may have crossed $75 million. Some companies allow early exercise, meaning the employee buys the shares up front and they vest over time, and paired with an 83(b) election (a one-page filing with the IRS, due within 30 days) that starts the clock much sooner. RSUs work like options for this purpose, starting when the shares are actually delivered.

Restricted stock, meaning real shares that vest over time, avoids most of this, with one catch. Without the 83(b) election, each batch of shares is treated as acquired on the day it vests, and each batch is tested against the $75 million limit on that day. The 30-day deadline has no extensions. The version I see most often is an advisor grant where nobody filed it, because the advisor assumed the company would and the company assumed the advisor would.

Stock issued for work counts the same as stock issued for cash, so employees and advisors can qualify on the same terms as founders. What never qualifies is stock bought from another stockholder. An investor who buys shares from a founder or a departing employee in a secondary sale doesn't get QSBS on them, since the company never issued those shares to the investor.

Investors: priced rounds, SAFEs, and notes

Preferred stock from a priced round qualifies just like common. SAFEs are harder. A SAFE is the simple agreement many startups use to raise early money that turns into stock later, and nobody can say for certain whether a SAFE holder's clock starts when it is signed or when it converts into stock. The cautious view is conversion, which also means the $75 million test gets applied at conversion. A SAFE signed when the company had $3 million in the bank can convert in a Series A that takes the company past the line. Convertible notes are loans, so the clock generally starts when they convert.

Investors increasingly raise this in diligence, and the right answer in the documents is a promise by the company to make reasonable efforts to keep the stock qualifying and to give holders the information they need. The company should not promise that anyone's stock is QSBS. It has no way to know that, because part of the answer depends on each holder's own situation.

Buybacks can disqualify stock you never touched

When a company buys back its own stock (lawyers call it a redemption), two rules can disqualify other stock. If the company buys back more than 5% of its total stock value within a year before or after an issuance, the stock issued in that window fails for everyone who got it. If the company buys stock from a particular person (or a relative or related entity) within two years before or after issuing stock to that same person, that person's new stock fails. Very small buybacks don't count, and neither does repurchasing a departing employee's or director's shares when they actually leave the company.

The trap I would worry about most is founder liquidity. Sometimes a priced round includes cash for the founders. If the investors buy shares directly from the founders, that is a secondary sale and the company's QSBS picture doesn't change. If the company takes the investors' money and uses it to buy back founder shares, that is a redemption, and it can disqualify the stock everyone bought in the round. Because the founders walk away with the same cash either way, the difference usually goes unnoticed until someone asks about QSBS in the next round's diligence.

What to keep on file

Almost every question above gets answered by a record the company kept, or didn't. The file itself is not complicated. It holds a dated balance sheet for each issuance showing gross assets before and after, a short description of what the business does and why it falls outside the excluded fields (updated when the product changes, because products do), a log of every buyback with its date, amount, and reason, copies of every 83(b) with proof of mailing, and the conversion date if the company started as an LLC. Acquirers and stockholders' accountants ask for it at exit, and rebuilding five-year-old balance sheets at that point can take weeks.

This is corporate housekeeping, and it is work I do for clients. Whether a particular person's gain is excluded, how much of it, and what their state does with it are tax questions, and they belong with that person's accountant. (California, for one, doesn't follow the federal rule at all.)

The bottom line

QSBS can be worth millions to founders, early employees, and investors, and most of what decides it is in the company's hands: what kind of company it is, what it actually does, its balance sheet on the day each share goes out, whether the 83(b)s got filed, and whether it bought back stock at the wrong moment. Documenting those things as they happen costs very little. Most of the expense comes from trying to piece them together years later, usually with a buyer already waiting.

FAQ

What is QSBS in simple terms?

Qualified small business stock is stock in a U.S. C-corporation that meets a set of federal requirements. If you hold it long enough and sell at a profit, some or all of the gain is excluded from federal income tax: half after three years, three quarters after four, and all of it after five, for stock issued after July 4, 2025, up to $15 million per company or ten times your cost if higher.

Does LLC equity qualify for QSBS?

No. Only stock of a domestic C-corporation qualifies. If an LLC converts to a corporation, the QSBS holding period starts at conversion, and gain built up before conversion is not eligible for the exclusion.

Do stock options qualify for QSBS?

Options themselves do not. The stock received on exercise can qualify, but the holding period starts at exercise, and the company must be under the $75 million gross-asset limit at that time. Early exercise with an 83(b) election starts the clock sooner.

Does a SAFE start the QSBS holding period?

The law is unsettled. The cautious view is that the holding period starts when the SAFE converts into stock, and that the gross-asset test is applied at conversion. Convertible notes are generally treated the same way.

What happens if my company passes $75 million in gross assets?

Stock issued before the company crossed the limit keeps its status. Stock issued afterward, including shares from options exercised afterward, does not qualify. Gross assets are measured mostly by cash and what the company paid for its other assets, not by valuation.

Can a stock buyback ruin QSBS?

Yes. A company repurchase of more than 5% of its stock value within a year of an issuance disqualifies the stock issued in that window, and buying stock back from a specific holder within two years of issuing to them disqualifies that holder's new shares. Buybacks of a departing employee's shares are generally excepted.