QSBS Requirements, What Your Startup Needs to Qualify

Shares qualify for the QSBS exclusion only when every test below is true. Five tests are about the company and three are about you, and all of them come from section 1202 of the Internal Revenue Code.

Miss one test and the exclusion is gone for those shares. If you held them more than a year, the gain is then taxed like any other long term gain, at a top rate of 20 percent under IRS Topic 409. The 3.8 percent net investment income tax can come on top once your income passes $200,000, or $250,000 on a joint return.

The date you got your shares decides which version of section 1202 applies, and four versions are still in force. Each one kept its own numbers when the law changed, so shares in the same company can sit under different rules. In the table, basis means what you paid for the shares.

The asset limit goes by the date the company issued the shares. The other columns go by the date you got them. A share issued on 4 July 2025 falls under the old rules, because the new law covers shares issued or acquired after that date.

The first two rows carry one more cost. The alternative minimum tax is a second tax sum some high earners must run. On those shares, you add back 7 percent of the gain you excluded. Shares acquired after 27 September 2010 owe nothing extra there.

This table is also why pages disagree. A guide that prints $50 million and $10 million without a date is describing the first three rows. It is right for a founder who got shares in 2019 and wrong for one who gets them this year.

For shares acquired after 4 July 2025, up to $15 million of gain on each company's shares can count toward the exclusion. Your basis is usually what you paid for the shares. If ten times the basis of the shares you sell is more than $15 million, that higher figure is your cap.

The cap limits how much gain counts, and your holding tier sets how much of that gain you exclude. With $20 million of gain after 3 years, $15 million counts and you exclude half of it, $7.5 million. Hold for 5 years and the full $15 million is excluded.

The tiers work on the gain that counts. Sell after 3 years and half of it is excluded. After 4 years it is three quarters, and after 5 years it is all of it. The part you do not exclude is taxed at a top rate of 28 percent, which is higher than the usual 20 percent top rate on long term gains.

The table assumes a founder in the top bracket who also owes the 3.8 percent net investment income tax. State income tax is separate, and California is covered further down.

The $15 million goes down by any gain from that company's shares that you counted toward it in past years. Gain on the same company's older shares, counted in the same year, comes off too. The cap rises with inflation for tax years that begin after 2026, and so does the $75 million asset limit. For shares acquired on or before 4 July 2025, the dollar cap is $10 million. A married person filing a separate return gets half of either amount.

The company must be a domestic C corporation on the day it issues your shares. It must stay one for substantially all of the time you own them. If it later elects to be an S corporation, that can break the test for shares it already issued. Shares issued while a company was an S corporation never qualify, even after it becomes a C corporation, because the test looks at the company on the issue date.

The $75 million test adds up the company's cash and the tax basis of its other assets. It does not use what investors say the company is worth. A startup valued at $500 million can still issue qualifying shares if its cash plus the tax basis of its other assets stays under the limit. Any subsidiary it owns more than half of is added in.

Money raised in the round counts. A company holding $30 million that raises $50 million would sit at $80 million right after the issue, so the new shares would fail. Shares issued earlier are safe, because the test is taken at each issue. Only shares issued after the company first passes $75 million miss out.

Property someone puts into the company counts at its market value on the day it goes in, not at its tax basis. That rule matters most when an LLC converts, which is covered below.

At least 80 percent of the company's assets, by value, must be used in a qualified business. Research and startup work count even before there is revenue. Cash the business needs for its running costs counts too, and so does money it plans to spend within 2 years on research or a bigger working budget.

Three more limits sit inside the 80 percent test, and they catch companies that are doing well and holding cash.

Section 1202(e)(3) shuts out whole kinds of business, whatever their size. These are the groups the law names.

The service groups describe a company that performs the service. A company that runs dental clinics performs health services. A company that sells scheduling software to dentists sells software, which is a different case. If your company sits near one of these lines, get a tax adviser's view in writing before you count on the exclusion.

Section 1202 blocks shares when the company buys back stock around the time it issues them. Two windows apply, and the second one reaches shares held by everyone.

This catches founders who sell a slice of their shares back to the company during a funding round. Shares issued to that founder within 2 years either side of the buyback can lose QSBS. Clear any buyback with your adviser before the company signs it.

Only a taxpayer that is not a corporation can use section 1202. That means people, trusts and estates. Shares held through a partnership, an S corporation or a fund work differently. The benefit passes on only to people who were owners when that entity bought the shares and stayed owners until it sold. Even then, the benefit is capped at the share of the entity they held when it bought.

The shares must come from the company itself, directly or through an underwriter (the bank that sells new shares in a public offering). You can pay cash, put in property other than stock, or receive them as pay for work you do for the company. Shares bought from a cofounder, an early employee or on a secondary market do not qualify in your hands.

Gifts and inheritances are the main exception. Shares you receive that way keep the giver's status and holding period.

The clock starts on the day you acquire the shares, and for founders that often turns on vesting. If your founder shares vest over time and you make no election, the clock for each slice starts only when that slice vests, under Treasury regulation 1.83-4.

Stock options work differently. You have no shares until you exercise, so the clock starts at exercise, not at the grant.

An LLC taxed as a partnership cannot issue QSBS, because section 1202 covers only stock in a C corporation. Membership units in an LLC taxed the default way never qualify.

An LLC can choose to be taxed as a C corporation by filing Form 8832. The IRS looked at this once, in private letter ruling 201636003 from 2016. It said stock is a matter of economic substance, not paper certificates. It ruled that shares which had passed through an LLC taxed as a C corporation met the QSBS definition, but it did not rule on whether the company passed the other tests.

A private ruling binds only the taxpayer who asked for it. Founders who want QSBS without that doubt form a corporation under state law.

Converting an LLC into a C corporation is allowed, and the shares you receive can qualify from the conversion date. Section 1202(i) sets two rules for shares you get in exchange for property, and together they decide what the conversion is worth.

The company must also pass the $75 million asset test at conversion, measured at the market value of what goes in. The market value rule cuts both ways, because it also raises the ten times cap. Here is one founder at two sale prices.

At $12 million the C corporation wins. Maya's whole gain fits under the $15 million cap, while the LLC path leaves the $5.95 million built up before conversion taxable. At $40 million the LLC path wins, because ten times her $6 million starting value gives a $60 million cap. At $40 million and the 23.8 percent top rate, that is about $5.94 million of federal tax on the C corporation path and about $1.42 million on the LLC path.

Two conditions come out of those numbers. The LLC path can only come out ahead when the company was worth more than $1.5 million at conversion, so that ten times its value beats $15 million. And the sale price has to beat $15 million plus that value, which is $21 million for Maya. It also costs time, because the 5 year clock starts later. If you plan to raise from venture investors, they will usually want the C corporation before they fund, which sets the timing for you. Our LLC to C corp conversion guide covers the filing, the cost and the EIN question.

An S corporation cannot issue QSBS either. Section 1202 needs a C corporation when the shares are issued and for substantially all of the time you hold them. So shares issued while the company had S status never qualify. If the company drops its S election, only shares it issues after that can qualify. Our C corp vs S corp guide covers what the switch costs in yearly tax.

If you want QSBS on your own shares, you must start with a C corporation. The day you form it is the cheapest time to get the setup right, and these four steps cover it.

You claim the QSBS exclusion on your own tax return for the year you sell, on Form 8949 and Schedule D. The Schedule D instructions set out the steps. Report the sale in Part II of Form 8949 as usual. Then enter code Q in column (f) and the excluded gain as a negative number in column (g).

If you excluded 50 or 75 percent, the taxed part goes on the 28 percent rate gain worksheet. Shares acquired on or before 27 September 2010 also add 7 percent of the exclusion to Form 6251, the alternative minimum tax form. Newer shares add nothing there, the new 50 and 75 percent tiers included. The 2025 instructions came out before any 3 or 4 year sale was possible, so read the ones for the year you sell.

Section 1045 lets you put off the tax on a sale of QSBS you held for more than 6 months. You must buy other QSBS within 60 days of the sale. You make the choice on your return by its due date, including extensions, with code R on Form 8949. Any sale money you do not reinvest is taxed now, and the new shares take a lower basis, so the tax is put off rather than cancelled.

Section 1202 is federal law, and each state decides whether to follow it. California does not. Its 2025 Schedule D (540) instructions tell residents to enter the whole gain. So a California founder can owe no federal tax on the sale and still owe state tax on all of it. The same instructions say California does not follow the section 1045 rollover either. If you live somewhere else, check your state's return instructions for a line that adds back the federal exclusion.