QSBS and QSBS Stacking Explained: How It Works, Limits, and Eligibility

The Qualified Small Business Stock (QSBS) exemption is a federal tax break that can be especially valuable for startup founders, early investors, and equity-holding employees. When the rules are met, part—or sometimes all—of the gain from selling qualified stock can be excluded from federal capital gains tax.

For stock acquired after July 4, 2025, taxpayers may generally exclude up to $15 million of gain or 10 times their adjusted basis per issuer, per taxpayer — whichever is greater — if the shares meet QSBS rules.

QSBS rules may seem complex at first, but understanding how they work could make a real difference for anyone involved with qualified small business equity. This guide covers how the exemption works, what “QSBS stacking” means, who qualifies, and the limits and pitfalls to keep in mind.

📌 Also read: How to Invest in Startups With Your Solo 401k

What Is QSBS?

Qualified Small Business Stock (QSBS), also called Section 1202 stock, refers to shares issued by certain small businesses that meet strict federal requirements. When those requirements are met, part or all of the gain from selling the stock may be excluded from federal capital gains tax. This potential benefit makes QSBS especially relevant to people who acquire equity in young, high-growth companies.

For QSBS acquired after July 4, 2025, the exclusion phases in with time held:

Stock acquired on or before that date typically requires a five-year hold for exclusion.

Who May Be Affected by QSBS

✅ Small business owners issuing qualifying stock
✅ Startup founders and employees receiving equity
✅ Startup or venture investors acquiring shares in qualifying companies

How Much Could You Save in Taxes With QSBS?

The QSBS exclusion can potentially shelter a significant portion of gain from federal capital gains tax if certain requirements are met. For stock acquired after July 4, 2025, the per-issuer cap is generally the greater of $15 million of gain or 10 times your adjusted basis. Any gain above the Section 1202 limit is taxed under normal capital gains rules.

The exclusion percentage depends on when the stock was acquired and how long it has been held:

What About State Taxes?

QSBS is a federal exclusion, and state-level treatment varies. Many states conform to the federal rules, but some do not. For example, California and Pennsylvania currently do not allow the QSBS exclusion. Mississippi and Alabama also do not conform. Wisconsin conforms, and New Jersey has enacted conformity beginning with tax years starting in 2026. Always check current state rules.

QSBS Eligibility Requirements

To qualify for the QSBS exclusion, both the issuing company and the shareholders must meet strict requirements. Missing one can disqualify the stock from QSBS treatment.

Five Requirements for Small Businesses

Here are the requirements that must be satisfied by the issuing company:

✅ Original Issue Requirement

Stock must be acquired directly from the company in exchange for cash, property, or services. Secondary purchases do not qualify. Options, warrants, or convertible notes are not QSBS until exercised or converted into stock at original issuance. Founders’ stock and stock issued for services may qualify if all Section 1202 rules are met.

✅ US-Based Domestic C Corporations Only

The issuer must be a domestic C corporation. It must also meet Section 1202 requirements during substantially all of the shareholder’s holding period (including the active-business test).

✅ Active Business Requirement

The company must actively operate a qualified trade or business during the shareholder’s holding period. A holding company can qualify if it owns more than 50% of subsidiaries and complies with Section 1202 asset-use limits (such as portfolio securities ≤10% and non-business real estate ≤10%).

✅ Prohibited Industries

Certain industries do not qualify. These include health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial or brokerage services; banking, insurance, financing, leasing, investing; farming; mining; and operating hotels, motels, or restaurants.

✅ Small Business Requirement

For stock issued after July 4, 2025, the company’s gross assets must not exceed $75 million (formerly $50 million for earlier issuances). Options are not stock— they must be exercised while the issuer is within the cap to qualify.

Four Requirements for Shareholders

These rules apply to individuals, trusts, or pass-through entities seeking QSBS treatment:

✅ Holding Period

For stock acquired after July 4, 2025, the exclusion is 50% at three years, 75% at four years, and 100% at five years. The clock starts when the stock is acquired (for example, at exercise, not grant).

✅ No Corporate Holders

Corporations cannot claim the QSBS exclusion. Only individuals, trusts, and pass-through entities are eligible.

✅ Stock Only

Options, warrants, and notes do not qualify. However, stock received upon exercise or conversion can qualify if issued at original issuance and all Section 1202 requirements are met.

✅ Cap on Exclusion

For stock acquired after July 4, 2025, the limit is $15 million or 10 times basis per taxpayer per issuer (whichever is greater).

📝 Note: Timing matters. Exercising options or converting notes when the issuer is over the asset limit or when you’ve already missed the “original issue” requirement can disqualify the shares from QSBS treatment.

Hypothetical Example: How QSBS Can Work in Practice

Imagine an entrepreneur named Sarah who launches a tech company called Mapple. She invests $100,000 at the start and spends several years building the business.

After five years, Mapple’s value has grown to $10 million. Sarah decides to sell her shares and pursue a new venture.

Taxes Owed Without QSBS

Without QSBS, Sarah’s profit would be taxed as a long-term capital gain. Her gain would be the selling price minus her initial investment:

At a 20% federal long-term capital gains rate, her tax bill would be:

Taxes Saved With QSBS

If Sarah’s shares meet Section 1202 requirements and fall within her per-issuer cap (for stock acquired after July 4, 2025, the limit is $15 million or 10 times basis), she could potentially exclude 100% of the gain federally.

Since her $9,900,000 gain is below the QSBS limit, she may exclude the entire amount from federal capital gains tax:

Takeaway From This Example

This hypothetical scenario shows how QSBS can dramatically reduce or even eliminate federal capital gains tax on qualifying stock sales. Entrepreneurs and early investors who meet all the requirements can potentially retain far more of their proceeds when exiting a successful business.

QSBS Stacking

QSBS has a per-taxpayer, per-issuer limitation. The exclusion limit is the greater of the applicable dollar cap or 10 times the aggregate adjusted basis:

If your expected gain exceeds your per-issuer cap, you could potentially increase the exclusion using a strategy called QSBS stacking.

How QSBS Stacking Works

✅ Gift Shares to Another Taxpayer
You can gift QSBS shares to another individual, such as an adult child. The recipient (donee) has their own per-issuer limit, allowing additional gain to qualify for exclusion.

✅ Gift Shares to a Non-Grantor Trust
You can also gift shares to a non-grantor trust for a beneficiary. A non-grantor trust is treated as a separate taxpayer, so it can claim its own per-issuer limit. A grantor trust does not create a separate exclusion because it is treated as owned by you.

✏️ Hypothetical Example:

Imagine Sarah’s shares in Mapple are worth $30 million instead of $10 million.

Do Gifted Shares Require a New Holding Period?

The QSBS status and holding period generally carry over to the donee. For post-7/4/2025 acquisitions, the donee benefits from the 3/4/5-year thresholds using the original holding period. This means the gain exclusion can apply without restarting the clock.

QSBS for Employees

QSBS is often discussed in the context of founders and investors, but it can also be valuable for startup employees who hold equity in their company. The same rules and potential benefits apply.

Employees may be able to exclude up to their applicable per-issuer cap from federal capital gains tax:

State treatment varies. Some states conform to the QSBS exclusion, while others do not.

Key Points for Employees

✅ Confirm QSBS Eligibility

Ask your startup’s CFO whether the company’s stock qualifies for QSBS. Startups with less than $50 million in raised capital may qualify, but not always. While this shouldn’t be the main factor in choosing a job, it can have a significant tax impact.

✅ Holding Period Requirements

✅ Company Sale Before Meeting the Holding Period

You may be able to use a Section 1045 rollover if you’ve held the stock for more than six months and reinvest in replacement QSBS within 60 days. The holding period generally carries over. To achieve the full exclusion, you still need to meet the applicable 3/4/5-year threshold.

✅ QSBS Stacking Opportunities

Employees may also use QSBS stacking strategies. Each recipient (or trust) can claim their own per-issuer limit, currently $15 million or 10 times basis for post-July 4, 2025 stock.

📝 Note: Exercising options early, confirming your startup’s QSBS eligibility, and tracking holding periods can have a meaningful impact on the amount of capital gains you may exclude.

Wrapping It Up

QSBS can potentially provide meaningful federal capital gains tax savings for founders, investors, and employees who hold qualifying stock. Eligibility depends on both company and shareholder requirements, as well as holding periods.

Strategies like QSBS stacking or Section 1045 rollovers may help increase exclusions or defer gains. Employees should confirm their company’s QSBS status and consider the timing of option exercises to start the holding period.

Working with a qualified tax or legal professional could help ensure the rules are applied correctly and opportunities are considered.

📌 Learn about more tax hacks for business owners in our free guide:

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