Most founders find out about the QSBS tax exclusion the week they're negotiating an acquisition, which is about three years too late to fix a mistake. Qualified Small Business Stock, under Section 1202 of the tax code, can let you exclude up to 100% of your federal capital gains tax on the sale of your equity. But you have to meet five specific conditions, and a law change in July 2025 rewrote how the clock and the cap work.
What QSBS actually is
QSBS is stock in a qualifying C-corporation that, if held long enough, lets a founder or early employee exclude federal capital gains tax on the sale, up to a cap. On a $10M exit, that's the difference between paying roughly $2M in federal capital gains tax and paying nothing.
The rule was already generous. The One Big Beautiful Bill Act, signed July 4, 2025, made it more generous for anyone issued stock after that date, and it's the single biggest change to Section 1202 since the exclusion was made permanent in 2010.
The 5 requirements to qualify
- Your company must be a U.S. C-corporation. LLCs and S-corps don't qualify. If you're taxed as a pass-through entity, this exclusion isn't available to you at all, no matter how long you hold.
- The company's gross assets can't exceed the threshold at the time your stock was issued. For stock issued before July 4, 2025, that limit is $50M. For stock issued after, it's $75M, indexed for inflation starting in 2027. This is measured at issuance, not at exit, so a company that grows past the threshold later doesn't retroactively disqualify stock issued earlier.
- At least 80% of the company's assets must be used in an active qualified trade or business. Certain categories are excluded outright, including law, accounting, consulting, health, financial services, banking, insurance, hospitality, and any business where the principal asset is the reputation or skill of its employees. Most product-led SaaS and tech companies clear this bar. Services-heavy or professional-services-adjacent businesses often don't.
- You must acquire the stock at original issuance. Buying shares on a secondary market from another shareholder doesn't count. You need to receive the stock directly from the corporation, whether that's through a founder's stock grant, an exercised option, or a direct investment.
- You must hold the stock for the required period before selling. This is where the 2025 law change matters most.
What changed in July 2025
Before the bill, there was one holding period and one outcome: five years, 100% exclusion, no partial credit for holding four years and eleven months. After July 4, 2025, stock issued from that date forward follows a tiered schedule instead.
Holding period: 3 years. Stock issued before July 4, 2025: 0% exclusion. Stock issued after July 4, 2025: 50% exclusion.
Holding period: 4 years. Stock issued before July 4, 2025: 0% exclusion. Stock issued after July 4, 2025: 75% exclusion.
Holding period: 5 years. Stock issued before July 4, 2025: 100% exclusion. Stock issued after July 4, 2025: 100% exclusion.
Gross asset cap at issuance: $50M for stock issued before July 4, 2025, versus $75M for stock issued after. Per-issuer gain cap: $10M or 10x basis before, $15M or 10x basis after.
The practical effect: if your stock was issued after the cutoff and you sell at year three instead of year five, you still exclude half your gain instead of none of it. Any gain that isn't excluded because you sold early gets taxed at 28% rather than the standard 20% long-term capital gains rate, so there's still a real cost to selling before the full five-year mark. But it's no longer all-or-nothing.
One detail that trips founders up: the new tiered schedule and higher caps only apply to stock issued after July 4, 2025. If your founder shares were issued in 2022 or 2023, you're still on the old five-year, $10M, all-or-nothing rules, even if you sell in 2027.
What this actually looks like in dollars
Say you hold $12M in QSBS gain, stock issued in 2026, and you sell at the four-year mark instead of waiting for five.
Old rules (pre-July 2025 stock): $0 excluded. Full $12M taxed at up to 20% federal, roughly $2.4M in tax.
New rules (post-July 2025 stock), selling at year four: 75% excluded, so $9M is tax-free. The remaining $3M is taxed at 28%, about $840,000. You still pay something for selling a year early, but the gap between waited and didn't wait just got a lot smaller.
What to do this week
Pull up your cap table and note the issuance date on your own founder shares, and on any option grants, against July 4, 2025. That single date determines which of the two rule sets you're under. If you don't know your issuance date offhand, your stock purchase agreement or option grant notice will have it.
Then talk to a CPA who has actually filed a QSBS exclusion before, not a generalist. The eligibility rules around qualified trade or business have enough gray area, especially for companies that blend product and services revenue, that a documented professional opinion is worth having in your file before you're mid-acquisition and every day matters.
Frequently asked questions
Does QSBS apply to LLCs? No. Only stock in a U.S. C-corporation qualifies. If your company is an LLC or S-corp, you'd need to convert to a C-corp, and the five-year clock for pre-conversion value typically doesn't count toward the holding period.
Can I get the QSBS exclusion on secondary sales? Generally no. The stock must be acquired directly from the company at original issuance. Shares bought from another shareholder on a secondary market usually don't qualify, with narrow exceptions for gifts and inheritance from a qualifying holder.
What happens if I sell before the 3-year mark? You get 0% exclusion under either rule set, and the full gain is taxed as an ordinary long-term or short-term capital gain depending on how long you held it.
Does the $75M asset cap apply to companies that already exceeded $50M before July 2025? The cap that applies is the one in effect on the date your specific shares were issued. Stock issued while the company was under $50M, before the bill, follows the old rules even if the company later grows past $50M.
Is QSBS automatic, or do I have to elect it? It's not automatic in the sense of paperwork, but it also isn't optional if you meet the requirements. You claim the exclusion when you report the sale on your tax return, typically on Form 8949, and the burden is on you to be able to document that the stock and the company met every requirement.
Do stock options count the same as founder shares for QSBS? The holding period for options starts when you exercise the option and receive actual shares, not when the option was granted. An option granted in 2024 but exercised in 2026 has a 2026 issuance date for QSBS purposes.