For founders and early investors building toward a meaningful liquidity event, tax is not just a compliance issue. It is a value preservation issue. The structure you put in place today can materially change how much of the eventual sale proceeds you actually keep.
Qualified Small Business Stock under Section 1202 is one of the most significant tools available in that conversation. When it applies, the federal tax savings can be substantial. Recent legislative changes effective July 4, 2025, made the rules more flexible and, in some cases, more favorable. At the same time, they raised the stakes. The benefit is powerful, but it is technical and highly fact dependent.
QSBS is not something you fix at exit. It is something you protect from formation through growth. The right questions need to be asked early and revisited as the company evolves.
Below is what founders, CFOs, and early investors should understand in 2026 and where thoughtful planning can make a meaningful difference.
What Is Qualified Small Business Stock?
QSBS allows eligible shareholders to exclude a significant portion, and in some cases all, of the gain from federal income tax when selling qualifying stock.
To qualify, several requirements must be met:
- Domestic C Corporation: The company must be a U.S. C corporation
- Original Issuance: Stock must be acquired directly, or through an underwriter from the corporation in exchange for money, property, or services (Certain transfers such as a gift or at death can carry QSBS status and holding period).
- Gross Asset Test: The corporation’s gross assets must not exceed $50 million immediately before or immediately after stock issuance. For post July 4, 2025 stock issued, this number is $75 million.
- Active Business Requirement: At least 80% of the corporation’s assets must be used in the active conduct of a qualified trade or business
- Holding Period: Historically, stock must be held for more than five years. For post July 4, 2025 stock issued, there is a tiered system of 3, 4, and 5 years offering different exclusion amounts.
If structured properly, the tax savings can be substantial.
What Changed Under the OBBB?
The One Big Beautiful Bill (OBBB), effective July 4, 2025, introduced several key enhancements for newly issued QSBS:
Tiered Holding Periods
For stock acquired after July 4, 2025:
- 3 years: 50% gain exclusion
- 4 years: 75% gain exclusion
- 5+ years: 100% gain exclusion
This creates flexibility for earlier liquidity events while preserving the full exclusion for long-term holders.
Increased Exclusion Cap
The lifetime gain exclusion cap increased from $10 million to $15 million per taxpayer (indexed for inflation for tax years after 2026), per issuer for QSBS acquired after July 4, 2025.
The general rule remains the greater of:
- $10 million (or $15 million for post-July 4, 2025, stock), or
- 10 times the taxpayer’s basis in the stock
AMT Relief
Gains excluded under Section 1202 for any stock issued after 2010 are not treated as Alternative Minimum Tax preference items, preserving the intended benefit.
Not Every Business Qualifies
Certain industries are excluded from QSBS treatment, including (but not limited to):
- Health, law, accounting, actuarial science
- Consulting and financial services
- Banking, insurance, financing, leasing
- Farming and extraction industries
- Hospitality businesses such as hotels and restaurants
- Businesses dependent on the reputation or skill of employees
Understanding whether your company’s activities fall within a qualified trade or business is critical. This analysis often requires deeper review than many founders expect.
Planning Considerations for Founders and Executives
QSBS is most effective when it is part of the strategy early, not a technical review two months before closing. For founders and finance leaders, the real work happens at formation, during capital raises, and when equity is issued.
These are the areas where we see proactive planning make a measurable difference.
- Entity Structure Decisions
Entity choice is foundational. QSBS applies to domestic C corporations. If a business begins as an LLC or S corporation and converts later, the timing of that conversion can affect eligibility and holding periods.
We often encourage founders to evaluate entity structure not only through an operational lens, but through an eventual exit lens. The question is not just what works today. It is whether today’s structure preserves flexibility for five years down the road.
- Monitoring the $50 Million Asset Threshold
The gross asset test is measured at the time stock is issued. That means funding rounds, acquisitions, and significant growth events can influence whether newly issued shares qualify.
For high growth companies, it is easy to cross thresholds quickly. A disciplined review before each significant issuance helps avoid unintentionally disqualifying future equity. This is especially important for companies scaling rapidly or preparing for institutional capital.
- Equity Compensation and 83(b) Elections
Equity compensation design often intersects with QSBS in ways that are overlooked.
In certain cases, restricted stock may qualify if a timely 83(b) election is filed. That election can start the holding period at grant rather than vesting. Missing the filing window can permanently affect eligibility.
For founders and key executives, these decisions should not be made in isolation. Coordination between tax, legal, and finance teams ensures that compensation strategy aligns with long term exit planning.
- Documentation and Diligence Readiness
QSBS qualification is fact driven. Investors and buyers increasingly request representations and documentation supporting eligibility during fundraising and exit transactions.
Maintaining clear records of asset levels at issuance, capitalization history, and how the business meets the active trade or business requirement reduces friction during diligence. It also provides confidence that the benefit will withstand scrutiny.
Strong documentation is not just defensive. It signals discipline.
- State Tax Considerations
Federal exclusion does not automatically mean state exclusion. While many states conform to federal QSBS rules, some do not. For founders in higher tax jurisdictions, the state level outcome can materially affect net proceeds.
Exit modeling should reflect both federal and state impact. In some cases, this influences residency planning, trust structures, or timing decisions well before a transaction.
QSBS planning is not about chasing a tax benefit. It is about protecting the value created over years of risk and investment. For founders and CFOs, the right approach is to integrate QSBS into broader capital and exit strategy discussions, rather than treating it as a stand alone technical issue.
Our role is to help clients see how today’s structural decisions affect tomorrow’s liquidity. When addressed early and revisited as the company grows, QSBS can remain an asset rather than becoming a missed opportunity.
Why QSBS Planning Matters More Than Ever
With higher exclusion caps and more flexible holding periods now in place for newly issued stock, QSBS has moved well beyond a technical tax provision. For the right company, it directly affects how exit value translates into personal wealth.
Founders building long term enterprise value, early employees taking meaningful equity risk, and investors structuring capital raises all have something at stake. The difference between qualifying and not qualifying can materially change after tax outcomes.
The challenge is that QSBS is unforgiving. Eligibility depends on entity structure, asset levels at issuance, business activity, holding periods, and consistent documentation. These are decisions made over time, not in the final quarter before a transaction. By the time a buyer is conducting diligence, structural issues are rarely reversible.
That is why QSBS belongs in strategic conversations early and revisited as the company evolves.
How To Prepare
With higher exclusion caps and more flexible holding periods now available for newly issued stock, QSBS is no longer a technical footnote in the tax code. It is a structural planning issue that can materially influence how exit value translates into retained wealth.
For founders building long term enterprise value, early employees taking real equity risk, and investors focused on after tax return, the stakes are tangible. The difference between qualifying and missing eligibility can be measured in millions.
The difficulty is not understanding the rule at exit. It is preserving eligibility through years of growth, funding rounds, compensation decisions, and operational change. QSBS is fact driven and time sensitive. Most mistakes happen quietly and surface only during diligence, when options are limited.
That is why this conversation belongs alongside capital strategy, equity design, and long-term wealth planning.
At YHB, our role is not to “apply” QSBS at the end. It is to help clients think several moves ahead. We work with founders, CFOs, and their legal advisors to pressure test structure, timing, and documentation before decisions are locked in. Sometimes that means confirming the path is sound. Other times it means adjusting early, while flexibility still exists.
QSBS is ultimately about stewardship. If you are building a company with the expectation of a meaningful exit, the right time to evaluate whether your structure supports that outcome is now, not when a buyer is at the table.
