QSBS for Early-Stage Founders: A Tax Strategy Worth $15 Million

Mark Percival

Recent legislation has made Qualified Small Business Stock (QSBS) an even more powerful tax planning strategy for founders. The One Big Beautiful Bill Act of July 2025 has increased the potential federal tax exemption to $15 million, making this an essential consideration for any startup founder.

What is QSBS?

QSBS refers to Qualified Small Business Stock under Section 1202 of the tax code. The benefit allows founders to exclude substantial gains from federal capital gains taxes when they sell their qualified stock. While this is a federal benefit, it’s worth noting that state tax treatment varies, with states like California not recognizing these exemptions.

The New Rules (July 2025)

The One Big Beautiful Bill Act has significantly enhanced QSBS benefits for stock acquired after July 4, 2025:

• Reduced holding period: The minimum holding period has dropped from 5 years to just 3 years for partial benefits.
• Increased exclusion cap: The maximum exclusion has increased to $15 million (up from $10 million), with inflation adjustments starting in 2027.
• Higher asset threshold: Companies with up to $75 million in gross assets now qualify (up from $50 million).
• New tiered benefit structure:
  • 3 years: 50% exclusion of gains
  • 4 years: 75% exclusion of gains
  • 5+ years: 100% exclusion of gains

Who Qualifies?

QSBS benefits apply specifically to:

• C-corporations only (LLCs don’t qualify)
• Companies with less than $75 million in gross assets at the time of stock issuance
• Businesses where 80% of assets are used in qualified business activities
• Most early-stage tech startups easily meet these expanded criteria

How to Secure Your QSBS Benefits

Timing is critical:

• The QSBS clock starts at stock issuance, not vesting
• Different stock grants may have different qualification timelines

Proper documentation is essential:

• Use restricted common stock (standard founder equity structure)
• Maintain detailed records of issuance dates and company asset levels
• Consider filing an 83(b) election within 30 days of stock grant - while not required for QSBS, it’s almost always beneficial

Corporate structure matters:

• Start as a C-corp if possible, as LLC-to-C-corp conversion resets the QSBS clock

Critical Pitfalls to Avoid

The “redemption trap” is a major danger:

• Company redemptions greater than 5% of stock value over 24 months disqualify everyone’s QSBS
• With the new $15M+ potential benefit per founder, the stakes are higher than ever

Other critical pitfalls include:

• Missing 83(b) elections
• Exceeding the $75M threshold for future issuances
• Poor documentation that prevents proving QSBS eligibility
• Corporate reorganizations that restart the holding period clock

Action Items for Founders

1. Verify your C-corp structure and proper stock issuance
2. File 83(b) elections within 30 days of any equity grant
3. Maintain detailed equity records with multiple stock issuance dates
4. Consult tax counsel before any equity transactions
5. Plan carefully for founder departures to avoid the redemption trap
6. Consider the impact of shorter holding periods on your exit timing

Conclusion

With enhanced benefits of a $15M cap, shorter holding periods, and higher asset thresholds, QSBS planning has become even more foundational for C-corp startups.The ability to access meaningful benefits starting at just 3 years provides founders with faster liquidity options,but also makes it even more critical to get the structure right from day one.Working with startup counsel and tax advisors familiar with these new rules is highly recommended.

QSBS has existed since 1993, but the One Big Beautiful Bill Act of July 2025 enhanced it to a $15 million federal tax exemption for early-stage C-corp founders with reduced holding periods and increased exemption caps. This isn’t just tax optimization—it’s fundamental startup planning that can save millions in capital gains taxes on exit. For founders building C-corps with less than $75M in assets, getting this right from day one is essential.

What is QSBS?

Qualified Small Business Stock (QSBS) under Section 1202 of the Internal Revenue Code allows founders to exclude substantial gains from federal capital gains taxes. The benefit applies only to federal taxes (note that California doesn’t recognize QSBS), and the holding requirement is now as little as 3 years for partial benefits under the new rules.

The July 2025 Update: One Big Beautiful Bill Act

Key Changes for Stock Acquired After July 4, 2025

The new legislation represents the most significant enhancement to QSBS benefits in years:

• Reduced holding period: Minimum 3 years (down from 5)
• Increased exclusion cap: $15M (up from $10M), inflation-adjusted starting 2027
• Higher asset threshold: $75M gross assets (up from $50M), inflation-adjusted starting 2027

New Tiered Benefit Structure

The updated law creates a graduated benefit system:

This means founders can capture meaningful tax benefits in 3-4 years instead of waiting 5+ years.

Real Impact Example

Let’s say you founded your company in July 2025 and sell in July 2028 for $50M:

• Your gain: $50M - your initial investment (let’s say $10K in founder stock)
• QSBS exclusion: 50% of $15M = $7.5M tax-free
• Taxable gain: $42.5M instead of $50M
• Tax savings: ~$1.8M in federal taxes alone

Wait until July 2030 to sell, and the entire $15M gain is tax-free.

Qualification Requirements

Under the expanded criteria, even more startups qualify:

• C-corporation structure: LLCs don’t qualify (this is why C-corp vs LLC matters)
• $75M gross asset test: At time of stock issuance (up from $50M)
• Active business requirement: 80% of assets in qualified business activities
• Original issuance: Must acquire stock directly from the corporation

Most tech startups easily meet these expanded criteria.

Key Steps to Secure QSBS Benefits

Timing Matters More Than Ever

Issue founder stock early—the QSBS clock starts at stock issuance, not vesting.

Example timeline:

• Founded company in July 2025 → 50% benefits available July 2028, 100% July 2030
• Founded as LLC 2023, converted to C-corp 2025 → Clock resets to 2025

Proper Stock Issuance

• Restricted common stock: Standard founder equity structure
• Documentation: Keep detailed records of issuance dates and company asset levels
• 83(b) election: Not required for QSBS, but almost always beneficial
  • Must file within 30 days of stock grant
  • Avoids future tax on vesting
  • Aligns tax treatment with QSBS timing

Corporate Structure Considerations

Start as a C-corp if possible. LLC-to-C-corp conversion resets the QSBS clock entirely.

Major Pitfalls That Can Destroy QSBS

The Redemption Trap

The most dangerous pitfall: Company redemptions exceeding 5% of stock value over 24 months disqualify everyone’s QSBS.

Case Study: The $15M Mistake

Setup: Two 50/50 founders, amicable split after 16 months

The mistake: Company buys back 45% from departing founder

The result: Destroys QSBS for both founders

The cost: $15M+ in lost tax benefits per founder under new rules

Better Alternatives for Founder Departures

• Personal purchase: Remaining founder buys shares personally
• Forfeiture of unvested: Reclaim unvested shares (typically 60-70% after 16 months)
• Third-party sale: Departing founder sells to investors
• Reduced equity: Let them keep 5-10% rather than full buyout

Other Critical Pitfalls

• Missing 83(b) elections: Creates massive future tax bills
• Exceeding $75M threshold: Disqualifies future issuances
• Poor documentation: Can’t prove QSBS eligibility at exit
• Corporate reorganizations: May restart holding period clock

Your QSBS Action Plan

Immediate

1. Verify C-corp structure and proper stock issuance
2. File 83(b) elections within 30 days of any equity grant
3. Document everything: Keep detailed records of all stock issuances

Ongoing

1. Track company assets: Ensure you stay under $75M threshold
2. Monitor equity transactions: Consult counsel before any buybacks
3. Update cap table: Track different tranches with different qualification dates

Before Major Events

1. Founder departures: Plan carefully to avoid redemption trap
2. Equity transactions: Always consult tax counsel on QSBS implications
3. Corporate changes: Check if reorganizations affect QSBS timing

The Bottom Line

The enhanced QSBS benefits make this planning even more critical. QSBS planning is now foundational to every C-corp startup. Work with startup counsel and tax advisors familiar with the new rules.

The Usual Disclaimer - The information in this User Guide is provided solely for general educational purposes and is not intended as legal advice. This User Guide should not replace competent legal counsel from a licensed attorney in your state. 1984 and its affiliates expressly disclaim all responsibility for any consequences resulting from the use of this User Guide.

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