The qualified small business stock (QSBS) exemption offers a significant tax benefit to shareholders in qualified small businesses (QSB) who meet specific criteria and conditions. First enacted by Congress in 1993 to incentivize entrepreneurship and investment in small businesses, Section 1202 of the Internal Revenue Code (IRC) allows taxpayers who sell QSBS to defer or exclude part or all of their gain from federal taxable income, reducing (or even eliminating) their federal tax burden. At the state level, many states also offer a QSBS exemption, though not all.
In 2025, the One Big Beautiful Bill Act (OBBBA) revised certain rules to expand QSBS eligibility for stock issued after July 4, 2025, which included raising the asset cap, increasing the individual benefit cap, and phasing in the exemption starting at a three-year holding period.
In this article, we will review the requirements for both shareholders and businesses to qualify for the QSBS exclusion. We will also highlight strategies for maximizing this tax benefit by multiplying or “stacking” the exemption. A sample scenario will be followed throughout to show the impact of proper planning.
Who Can Use QSBS?
If you are a founder, early employee, or early investor holding equity in a C-Corp, you may be eligible for the QSBS tax exemption. However, there are a number of QSBS rules for both stockholders and small businesses. If the eligibility requirements are not met for “substantially all” of the stockholder’s holding period, QSB stock status can be lost.
QSBS Requirements
To receive favorable QSBS tax treatment, the following requirements must be met:
| Requirement | Specifics |
|---|---|
| 1. Company qualifies as a "small business" | • Structured as a taxable, domestic C-Corp • Corporation has less than $50 million gross assets immediately before and after it issues stock to the taxpayer ($75 million for stock issued after July 4, 2025, under OBBBA) |
| 2. Company is an active trade or business | • At least 80% of the company’s assets must be used in active business in an approved industry • Excluded industries include finance, banking, insurance, hospitality, farming, mining and exploration, law, engineering, architecture, accounting, health, consulting, and athletics |
| 3. Stock must be "original issuance" | • Taxpayer must acquire the stock directly from the issuing company and not through secondary purchase from another shareholder • Taxpayer may gift* the original issue stock to a family member, and the stock will still satisfy this requirement in the family member's ownership |
| 4. Taxpayer must have held the stock for at least 5 years prior to sale | • Holding period begins on the date of acquisition and ends on the date of sale • Stock received by gift will have a holding period that includes the holding period of the person making the gift • Stock issued after July 4, 2025, is subject to 3-, 4-, and 5-year holding periods for increasing exemptions under OBBBA |
*Selling the stock to a family member will disqualify future QSBS treatment because it is no longer considered original issue stock in the hands of the family member.
If the taxpayer holds shares that qualify for QSBS exemption, the next step is to determine how much gain they can exclude based on certain limitations outlined in IRC Section 1202.
How Much Gain Can Be Excluded
Acquisition Date Limitation
Over the years, Congress amended IRC Section 1202 several times to increase the percentage of total gain potentially eligible for exclusion. The following chart summarizes those changes.
| Date Taxpayer Acquired QSBS | % of Gain Potentially Excluded |
|---|---|
| Prior to Feb. 18, 2009 | 50% of gain* |
| Feb. 18, 2009 – Sept. 27, 2010 | 75% of gain* |
| Sept. 28, 2010, or later | 100% of gain* |
*Subject to ceiling on gain discussed in next section.
Note that under OBBBA, qualified small business stock issued after July 4, 2025, will receive a 50% exemption if held for 3 years, 75% exemption if held for 4 years, and 100% exemption if held for 5 years.
Example Scenario ‒ Part 1
A married taxpayer with two children starts a company in January 2010 and receives 1 million founder shares. The taxpayer receives an additional 250,000 shares in January 2011. The taxpayer makes an additional investment in the company in January 2012 and receives 250,000 shares at $1/share. The taxpayer believes she will sell her shares to a prospective buyer in a few years at $40/share. The taxpayer also has another QSB company she recently started that she plans to invest more time and capital into after selling her first company.
The following table shows that the taxpayer has $60 million in gain but is only eligible for up to $50 million QSBS exclusion based on the acquisition date limitation.
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| Date QSBS Acquired | # of Shares Acquired | Total Basis | Share Value at Date of Sale | Gain | % Cap | Gain Potentially Eligible for Exclusion |
|---|---|---|---|---|---|---|
| 1/1/2010 | 1 million | $0 | $40/share | $40 million | 75% | $30 million |
| 1/1/2011 | 250,000 | $0 | $40/share | $10 million | 100% | $10 million |
| 1/1/2012 | 250,000 | $0 | $40/share | $10 million | 100% | $10 million |
| Total: | $60 million | $50 million |
Exclusion Ceiling
Each taxpayer may only exclude the greater of (a) $10 million or (b) 10 times the taxpayer’s basis in the qualified small business stock. This limit applies per taxpayer, regardless of the total potential exclusion based on the acquisition dates of different QSBS tranches. For stock issued after July 4, 2025, OBBBA increased this benefit cap to $15 million.
Example Scenario ‒ Part 2
The table above shows the taxpayer has $50 million of gain potentially eligible for QSBS exclusion. However, the taxpayer is limited to the greater of (a) $10 million or (b) 10 times her $250,000 basis (i.e., $2.5 million). As a result of the exclusion ceiling, the taxpayer will have $10 million qualified small business stock exclusion for this sale without additional planning.
With advance planning, the taxpayer could make early infusions of capital in her company to build up her QSBS tax basis. This strategy may allow the taxpayer to take advantage of the 10 times basis ceiling, which could greatly exceed $10 million. It may also be possible for the taxpayer to sell a tranche of stock for which she has no basis and receive a $10 million QSBS exemption, and the next year sell a tranche of stock in which she has basis and use a 10 times basis QSBS exemption.
The 2025 OBBBA Changes
OBBBA’s expansion of the QSBS eligibility requirements means stock issued after July 4, 2025, follows a different set of rules than stock issued before that date. For qualified small business stock issued after July 4, 2025, the following changes apply:
- Tiered holding periods: 50% at 3 years, 75% at 4 years, 100% at 5 years
- Aggregate gross asset threshold raised to $75 million from $50 million (inflation-indexed from 2027)
- Per-issuer cap raised to $15 million from $10 million (inflation-indexed from 2027); the 10 times basis prong is unchanged
- Non-excluded gain on 3- and 4-year holds is taxed at 28% (plus possible 3.8% NIIT)
Stacking: Multiplying the Exemption
The ceiling that caps a taxpayer’s excludable gain at the greater of (a) $10 million or (b) 10 times the taxpayer’s basis in the QSBS is applied per taxpayer. This creates an opportunity to establish and fund certain types of trusts that may each qualify for their own QSBS exemption and be subject to a ceiling above and beyond that which limits the taxpayer in our example. The trusts must be irrevocable, non-grantor trusts, but may be structured in various ways, a few of which are outlined below.
- Trusts for Descendants: A taxpayer may create a trust for each of their descendants and fund each trust with QSBS prior to selling the company. When structured properly, each trust will qualify for an additional $10 million QSBS exemption on top of the taxpayer’s own QSBS exemption.
- Trusts for Spouse: IRC Section 1202 states that if a married couple files separate income tax returns, each spouse may only claim up to $5 million of QSBS exemption. Some interpret this to suggest that a married couple filing jointly may exclude $10 million in total, which would achieve the same result as filing separately, while others argue each spouse may claim a separate $10 million exclusion for up to $20 million of QSBS exemption, since IRC Section 1202 does not specifically address this filing status. A more conservative approach to achieving an effective $10 million exclusion for each spouse is for the taxpayer to create and fund an irrevocable trust that names the taxpayer’s spouse as a beneficiary (in addition to their descendants). This strategy creates a clearly distinct taxpayer, which may present a lower risk of challenge than claiming the same exclusion amount on a single income tax return for that married couple.
- Charitable Remainder Trust (CRT): Often used in pre-liquidity tax planning, this type of trust allows a taxpayer to receive a stream of payments annually for a set number of years or for their lifetime, pay the income taxes on the trust assets in small increments over time, and receive an income tax deduction in the year the taxpayer funds the trust. The taxpayer receives roughly 90% of the trust assets and growth back through the annual payments, and charity receives roughly the remaining 10% of the trust assets and growth when the trust terminates. This charitable remainder trust is considered a separate taxpayer and will receive its own $10 million QSBS exemption even though the taxpayer is the sole initial beneficiary. These trusts are typically designed to last many years to maximize tax-free growth within the trust and spread the tax due over the most tax years. However, in this context, the trust could be structured for only a short duration, allowing the taxpayer to benefit from QSBS stacking while still receiving the sale proceeds back within a relatively short timeframe.
Example Scenario ‒ Part 3
The taxpayer creates a charitable remainder trust with a 4-year term and funds it with $10 million worth of stock. The taxpayer receives a charitable income tax deduction of $1,000,070 in the first year that can partially reduce the federal income tax burden on sale proceeds not covered by QSBS exemption or other gains the taxpayer has for that tax year. The taxpayer receives annual payments from the trust for four years, amounting in total to approximately $9.5 million. Each of those payments to the taxpayer is generally subject to state-level income tax, if any, but is exempt from federal income tax because the trust qualifies for a QSBS exemption.*
*This assumes the 5.00% 7520 rate of June 2026, a 3% growth and 0% on trust portfolio assets, 45.11642% unitrust payout, and that all gain in the trust is attributable to the sale of QSBS.
Incomplete Gift Trusts
- Many taxpayers who live in states with a high state-level income tax have opted to create trusts in states that have no state-level income tax. If structured properly, these trusts are separate taxpayers, and the gains recognized on assets held inside the trust could defer or potentially avoid the imposition of state income tax, even though the taxpayer is a beneficiary of the trust. Some states like New York, and more recently, California, amended their state statutes to allow their state tax agencies to tax certain out-of-state trusts. While these changes have greatly impacted the ability to conduct state income tax planning, this trust structure remains an effective planning tool for QSBS stacking because the trust generally qualifies as a separate taxpayer.
Section 1045 Rollover
In 1997, Congress added a companion provision, IRC Section 1045, which allows for gain on the sale of one qualified small business to be reinvested in another qualified small business without paying federal income tax.
Rollover Requirements
| Date Taxpayer Acquired QSBS | % of Gain Potentially Excluded |
|---|---|
| Prior to Feb. 18, 2009 | 50% of gain* |
| Feb. 18, 2009 – Sept. 27, 2010 | 75% of gain* |
| Sept. 28, 2010, or later | 100% of gain* |
Rollover of Excess Gain After Stacking
In some cases, a taxpayer’s gain exceeds the available QSBS exclusion, even after implementing one or more of the QSBS stacking strategies discussed above. In that case, IRC Section 1045 presents the opportunity to reinvest those excess gains within 60 days of selling the QSBS in one or more qualified small businesses. The reinvestment may be made in businesses in which the taxpayer is either a founder or an outside investor.
Example Scenario Wrap-Up
After maximizing QSBS exemption through multiple stacking techniques, the taxpayer still has $10 million of taxable gain in excess of all QSBS exclusions available. She can invest some or all of that excess gain in her other qualified small business and/or any other qualified small business. The amount reinvested in the new qualified small business could potentially receive yet another QSBS exemption when later sold.
Putting It All Together
The taxpayer in our example started with $60 million of gain, of which $50 million was potentially eligible to be excluded from federal income taxes based on the dates she acquired the stock. However, without proper planning, the taxpayer would only have been able to exclude $10 million, and the remaining $50 million would have been fully subject to federal and state income tax. The table below clearly shows the power and importance of proper planning prior to selling QSBS.
| Date QSBS Acquired | # of Shares Acquired | Total Basis | Share Value at Date of Sale | Gain | % Cap | Gain Potentially Eligible for Exclusion |
|---|---|---|---|---|---|---|
| 1/1/2010 | 1 million | $0 | $40/share | $40 million | 75% | $30 million |
| 1/1/2011 | 250,000 | $0 | $40/share | $10 million | 100% | $10 million |
| 1/1/2012 | 250,000 | $0 | $40/share | $10 million | 100% | $10 million |
| Total: | $60 million | $50 million | ||||
| QSBS STACKING STRATEGIES | ||||||
| Strategy: | Reduction in Gain: | |||||
| Descendant's Trust (2) | ($20 million) | |||||
| Spousal Trust | ($10 million) | |||||
| Charitable Remainder Trust | ($10 million) | |||||
| Incomplete Gift Trust | ($10 million) | |||||
| Remaining Gain After Stacking: | $10 million | |||||
| Rollover to Qualified Small Business(es) | ($10 million) | |||||
| Final Taxable Gain: | $0 | |||||
Through a combination of QSBS exclusion stacking strategies and a Section 1045 rollover, the initial $60 million gain can be reduced to $0 in taxable gain.
QSBS Attestation
It is important to note that qualifying for QSBS status is not a one-time event. Instead, QSBS status must be maintained over time. A QSBS attestation letter, or qualification confirmation, confirms a company’s stock is eligible for QSBS tax benefits per IRS criteria. An attestation letter may be requested by different people for different reasons at different times, including:
- A founder prior to a fundraising round, liquidity event, or exit
- A potential investor prior to making a stock purchase
- An employee who owns options or shares planning for the future
QSBS in Exit Planning
As you can see through the example scenario, timing is everything. Strategic planning before a liquidity event is essential to reducing, or even potentially eliminating the federal capital gains tax on the sale proceeds, which could save the taxpayer millions of dollars.
In addition to maximizing potential QSBS benefits, there are a number of other important and often time-sensitive considerations for private stockholders. For instance, holding a concentrated stock position, where a single stock represents more than 10% to 20% of the portfolio value, can create undue risk. Because each shareholder’s situation, needs, and goals are different, QSBS is just one of many factors that need to be considered in the broader picture of an individual’s wealth and estate planning strategy.
FAQs
What is QSBS?
QSBS is a highly beneficial tax exemption for eligible investors in qualified small businesses. It allows them to defer or exclude up to 100% of federal capital gains tax from the sale of their QSB stock.
What are the critical QSBS exclusion dates?
The date the taxpayer acquired QSBS will determine the percentage of gain that can potentially be excluded:
- Prior to Feb. 18, 2009: 50% of gain
- Feb. 18, 2009 – Sept. 27, 2010: 75% of gain
- Sept. 28, 2010, or later: 100% of gain
- After July 4, 2025: if held for 3 years, 50%; if held for 4 years, 75%; if held for 5 years, 100%
How does QSBS work?
When an eligible shareholder sells their stock in a qualified small business, the QSBS tax exemption allows that shareholder to exclude 50%, 75%, or even 100% of capital gains, subject to certain statutory limits, depending on when the stock was issued and how long the stock was held. There are also multiple options for “stacking” the exemption to further reduce the tax burden at the time of sale.
How do I qualify for QSBS?
QSBS qualification depends on both the company and the taxpayer meeting certain criteria. Key requirements to be a qualified small business include being a C-Corp, having less than $50 million in gross assets immediately before and after issuing stock to the taxpayer ($75 million for stock issued after July 4, 2025, under OBBBA). For stockholders to be QSBS eligible, the stock must be “original issuance,” and they must have held the stock for at least 5 years prior to the sale (stock issued after July 4, 2025, is subject to 3-, 4-, and 5-year holding periods for increasing exemptions under OBBBA).
How much gain can I exclude?
With proper advance planning, you may be able to exclude up to 100% of gain, subject to applicable QSBS exclusion limits. The amount that can be excluded depends on several factors, including when the shares were acquired, how long they were held, and the shareholder’s tax basis in the stock.
What changed under OBBBA in 2025?
For stock issued after July 4, 2025, OBBBA raised the asset cap to $75 million and increased the individual benefit cap to $15 million. In addition, holding requirements were expanded to include a 50% exemption if held for 3 years, 75% exemption if held for 4 years, and 100% exemption if held for 5 years.
Does QSBS eliminate state tax?
No. IRC Section 1202 is a federal tax exemption, so applicable state capital gains tax may still apply depending on the state.
If you need help determining whether your shares qualify as QSBS, or with advance planning to minimize the tax burden of selling your QSBS, reach out to us today.
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