QSBS Tax Benefits: Everything a Company Should Know

Private companies and early-stage startups require funding, for which they need to raise capital with the help of shareholders and investors. Congress created a tax law in the United States that provides several tax incentives to people who invest in these early-stage businesses. The U.S. government passed The Protecting Americans from Tax Hikes (PATH) Act, which provides a tax exemption for Qualified Small Business Stock (QSBS). With the help of the QSBS exemption, earnings from the sale of a particular type of stock are completely excluded from federal income tax.

Significant changes to QSBS rules took effect on July 5, 2025, substantially increasing the benefits available to qualifying investors and expanding eligibility for more companies.

This article focuses on QSBS eligibility rules, exclusions, benefits, types, and requirements.

What is QSBS?

Shares of a qualified small business (QSB), as described in Section 1202 of the Internal Revenue Code (IRC), are referred to as qualified small business stock (QSBS). A QSB is a domestic C corporation with gross assets that meet specific thresholds at the time of issuance or immediately after.

Updated Asset Thresholds

• Stock issued before July 5, 2025: Aggregate gross assets must not exceed $50 million
• Stock issued on or after July 5, 2025: Aggregate gross assets must not exceed $75 million (indexed for inflation beginning in 2027)

If a QSBS investor meets specific requirements, they might be eligible for substantial tax incentives. The QSBS tax treatment offers a break on capital gains tax when shareholders sell their shares, potentially providing up to 100% tax exemption on capital gains.

QSBS offering is a way to acquire initial or additional funding for qualified startups and existing private firms who seek to grow their operations and expand their business. It is used as a form of in-kind payment to pay employees for their services when cash flow is tight. QSBS is sometimes also used by these businesses to compensate their team members for contributing to the expansion and success of the company.

Why is QSBS important?

When specific requirements are met, shareholders who sell QSBS may exclude up to 100% of their capital gains from federal income tax. This powerful tax benefit allows  shareholders to realize substantial gains without federal tax liability on the excluded portion.

Updated Exclusion Limits

• For stock issued before July 5, 2025: Maximum exclusion: The greater of $10 million or 10 times the taxpayer’s basis in the stock
• For stock issued on or after July 5, 2025: Maximum exclusion: The greater of $15 million (indexed for inflation beginning in 2027) or 10 times the taxpayer’s basis in the stock

Example: If you invested $3 million in QSBS issued after July 5, 2025, you could potentially sell that stock for up to $30 million (10 times basis) five or more years later and pay no federal income tax on that gain. Even if your basis is smaller, you could still exclude up to $15 million in gains, potentially saving you over $5 million at current tax rates.

Both businesses and individuals must meet specific guidelines to qualify for this tax break.

How can you get QSBS stock?

To hold QSBS stocks, you must own shares of a company that qualifies as a QSB; this excludes owning options or any other securities in the company. Another condition to hold QSBS shares is that you must be an individual, a trust, or another type of pass-through business. Only after the exercise and conversion of options, warrants, or convertible debt into stock will your actual holdings become QSBS-eligible.

A shareholder must hold eligible shares for at least five years after receiving them to be eligible for the tax advantage. If you decide to sell your qualifying shares before the holding period is over, you can be liable for taxes on the sale of those shares. Shareholders may sell their QSBS-qualified shares once the five-year holding period is over and can qualify for up to 100% exemption on federal taxes from the capital gains made at the sale of the company. You can sell the stocks of private companies through tender offers (buyback events), bilateral secondary transactions, and IPO events, among other methods.

QSBS Rules and Eligibility for Business

For small companies to benefit from federal tax incentives, they must be set up in a particular way. The startup or private company must adhere to the following requirements to qualify for the QSBS tax treatment:

Business Type Requirements

• Companies engaged in manufacturing and creating products, such as new technology or widgets, are eligible for tax benefits. 
• Hospitality, personal services, finance, farming, and mining businesses are not eligible to be QSBs.

Asset Requirements

• For stock issued before July 5, 2025: The company’s gross assets should be less than $50 million
• For stock issued on or after July 5, 2025: The company’s gross assets should be less than $75 million (this threshold will be indexed for inflation beginning in 2027)

Other Requirements

• The shares must have been acquired by the investor from a US C corporation in return for goods, services, or cash.
• The acquisition must be after 1993 and the shares ought to be the first shares issued by the company.
• The investor must have owned the stock for a minimum of five years for the investor to benefit from the tax exemption.
• At least 80% of the assets must be used in the QSB’s active conduct of business.
• The stock must have been purchased by the investor at the time of original issuance, not on the secondary market.
• A corporation cannot be an investor. In such a case, the company won’t qualify for QSBS.

How does a 409a valuation affect QSBS?

After having previously qualified for QSBS certification, a corporation may be declared ineligible. This occurs due to the company’s 409A valuation changes and or not being accurate. Shareholders can use this time to use their grants to qualify for the QSBS. Thus, it is highly recommended for a company to get a 409A valuation done. The 409A valuation determines the cost of purchasing a company’s share. It is important to know the worth of your company’s share, without which you won’t be able to offer equity to investors and, thus, lose out on raising capital. So, without a 409A valuation, a company won’t qualify for the QSBS tax exemption.

Understanding the QSBS exclusion benefits is simplified for corporations and shareholders using the Eqvista platform for 409A assessments. Eqvista makes it easy for shareholders to keep track of potentially eligible shares. They can also estimate the minimum amount of time they’ll need to hold onto their shares before selling in order to qualify for the QSBS bonus.

QSBS tax exemption

The QSBS tax exemption offers a break on capital gains tax when shareholders sell their shares. The tax break might provide a 100% tax exemption on capital gains. 

Updated Exclusion Limits Based on Issuance Date

For QSBS issued before July 5, 2025:

• Maximum exclusion: The greater of $10 million or 10 times the taxpayer’s basis in the stock
• Any surplus earnings from the sale over that amount will be subject to ordinary capital gains rates of taxation

For QSBS issued on or after July 5, 2025

• Maximum exclusion: The greater of $15 million (indexed for inflation beginning in 2027) or 10 times the taxpayer’s basis in the stock
• This represents a 50% increase in the base exclusion amount
• Any gains exceeding this limit will be subject to ordinary capital gains rates of taxation

In addition to the cap, the timing of the acquisition of the QSBS shares can affect the tax benefit.

Requirements for QSBS tax benefits

Specific requirements need to be met to qualify for QSBS tax benefits, which depend on the date of purchase and the stock’s holding period. The requirements are as follows:

• 100% exemption of capital gains for QSBS bought after September 27, 2010. Capital gains are excluded at 100%, including exemptions from the AMT (alternative minimum tax) and NII (net investment income) tax.
• To qualify for the tax benefits, the business should be an American C corporation
• The securities issued by the QSB should be post-August 10, 1993
• The taxpayer must directly receive the stock from the company in exchange for cash, another type of property (not stock), or services (limited exceptions to this rule). Further, the stocks that the taxpayers receive are limited to a certain extent and cannot be freely traded in the secondary market

Asset threshold requirements

• For stock issued before July 5, 2025: From August 10, 1993, until the time the taxpayer’s stock is issued, the corporation’s total gross assets must have a tax basis that is less than $50 million at all times
• For stock issued on or after July 5, 2025: The corporation’s total gross assets must be less than $75 million (indexed for inflation beginning in 2027)

In some cases, QSBS treatment can retroactively be eliminated after redemption

How can startups qualify for QSBS?

Every startup and early-stage investor should be familiar with qualified small business stock or QSBS. With the help of this tax exemption, companies need not pay capital gains taxes to the federal government on selling their eligible shares. The startup or private company must adhere to the following requirements to qualify for the QSBS tax treatment:

Key Qualification Requirements

• Asset Threshold at Issuance:
  • Stock issued before July 5, 2025: Receive shares when the company has gross assets of $50 million or less
  • Stock issued on or after July 5, 2025: Receive shares when the company has gross assets of $75 million or less (indexed for inflation starting 2027)
• Corporate Structure: The Company must be set up as a C corporation
• Business Activity: Startups need to manufacture or create services (not involved in excluded industries like hospitality, personal services, finance, farming, or mining)
• Holding Period: Hold your stock for at least 5 years
• Original Issuance: Stock must be acquired directly from the company, not on the secondary market
• Active Business Use: At least 80% of company assets must be used in the active conduct of business.

Get a 409A valuation with Eqvista!

The QSBS tax benefits are a highly advantageous method to raise capital for an early-stage startup or a small private company. It works in favor of both the corporation as well as the investor backing the company. In the case of a small private company or an early-stage startup, you should get your 409A valuation done to offer your company’s equity to investors.

At Eqvista, with the help of qualified valuation experts and professionals, you can get a correct appraisal of your company’s private stock. Eqvista offers QSBS attestation services to help shareholders document and verify their QSBS eligibility. 

A QSBS attestation letter provides official confirmation that your company’s stock qualifies under Section 1202, which is crucial documentation for claiming the tax benefits when you sell your shares. This service ensures you have the proper evidence needed to support your QSBS tax exclusion claims with the IRS.

Start your journey of getting a 409A valuation and QSBS attestation with Eqvista today.