Hot Tax Deal: Qualified Small Business Stock

Startup founders and investors could miss out on huge tax savings if they fail to consider the potentially significant tax benefits of holding qualified small business stock (QSBS). QSBS refers to shares of stock in certain small corporations that may be eligible for special federal tax benefits under Section 1202 of the Internal Revenue Code upon a sale or exchange of such shares to the extent that the taxpayer held the QSBS for more than five years prior to the applicable sale or exchange.

Why It Matters

Stockholders may exclude from income all or a portion of the gain recognized on the sale of QSBS. This may mean no federal tax.

(Note: Some states, including California, have not adopted QSBS rules, so state taxes could still apply.)

The One Big Beautiful Bill Act (OBBBA), enacted in July 2025, made significant changes to the QSBS rules. These changes are effective and apply to stock acquired post-July 4, 2025, and in summary, the changes include (1) a tiered QSBS gain-exclusion regime that introduces the potential for partial gain exclusion prior to satisfying the prior law’s five-year holding period, (2) larger QSBS gain-exclusion caps, and (3) an increased ability for corporations to qualify to issue QSBS, including by reason of the OBBBA’s increase to the “aggregate gross assets” threshold.

How Big Is the Benefit?

How much gain can be excluded from the sale of QSBS depends on when the stock was acquired and whether the gain exceeds the applicable limitation.

For QSBS acquired on or before July 4, 2025, the original rules still apply:

• 100% gain exclusion for stock acquired after September 27, 2010
• QSBS gain exclusion is capped at the greater of (1) $10 million per taxpayer, per issuing corporation, or (2) 10x the taxpayer’s basis in the stock (generally, a taxpayer’s basis will equal the amount paid for the applicable QSBS shares)
• Requires a taxpayer to have held the QSBS for more than five years prior to the applicable sale or exchange

For QSBS acquired after July 4, 2025, the rules change significantly:

• There is now a tiered QSBS gain-exclusion regime that introduces the following tiered gain-exclusion structure:

• QSBS gain-exclusion cap increased to $15 million per taxpayer, per issuer, with annual inflation adjustments
• Asset cap raised to $75 million (up from $50 million) and is also inflation-adjusted beginning in 2027

The limit is applied on a per-partner or per-stockholder basis if the QSBS is held through a partnership, LLC, or S corporation.

Example: An investment fund acquiring QSBS for $20 million may exclude up to the greater of $200 million or $15 million (if acquired post-July 4, 2025) for each of its partners or stockholders.

Taxpayer Requirements

A taxpayer must satisfy various requirements for stock to qualify for QSBS gain exclusion, which include the following:

• Must be a noncorporate taxpayer
• Must sell QSBS held for the applicable minimum period (must hold for at least three, four, or five years, depending on when the stock was issued)
• If the QSBS is sold before reaching the applicable holding period, it may still qualify for tax-deferred rollover treatment (if the sold stock has been held for more than six months), allowing the taxpayer to reinvest in other QSBS within 60 days of a sale

Corporate Requirements

To qualify as QSBS, the issuing corporation must meet the following (among other) conditions:

• Be a S. C corporation
• Issue actual stock (or an instrument treated as stock for federal income tax purposes) acquired in exchange for cash, property, or services
• SAFE instruments may qualify depending on, among other potential factors, structure and intent
• Aggregate gross assets of the issuing corporation must not exceed $50 million (or $75 million if the stock is acquired after July 4, 2025) through and immediately after the issuance
  • For purposes of this test, aggregate gross assets are generally measured by reference to a company’s tax basis in its assets rather than, for example, accounting book value
• Use 80% or more of its assets (by value) in a qualifying active business over substantially all of the taxpayer’s holding period
  • Certain businesses are excluded (e.g., finance, real estate, hospitality, professional services)
• No recent redemptions: Certain redemptions (repurchases) of stock by the issuing corporation, either prior to or after issuance, may disqualify the stock

Startup Considerations

Entity choice remains critical. QSBS benefits generally apply only to stock in a C corporation. While many startups begin as LLCs, it’s possible to convert to a C corporation and still qualify—but this requires careful planning. See this post for more information.

With the asset cap now $75 million, there is more flexibility for later-stage companies to qualify. Still, startups aiming for QSBS status should manage large capital raises and asset acquisitions carefully to avoid disqualification.

Want to Learn More?

If you’re a founder, investor, or startup advisor navigating QSBS eligibility, we’d be happy to help. Contact a member of the Perkins Coie Emerging Companies & Venture Capital team to learn how the updated QSBS rules may apply to your situation.