One of the Most Powerful Tax Breaks for Business Owners (That Many Miss)
Every so often, you hear about someone who sold their company and paid no federal capital gains tax.
It’s not magic. And it’s not a loophole.
It’s often something called Qualified Small Business Stock (QSBS) under Section 1202 of the tax code.
When structured correctly, QSBS can allow founders, early employees, and certain investors to exclude a significant portion — sometimes even 100% — of the gain when they sell stock in a qualifying small C corporation.
Here’s what that actually means.
What Is QSBS?
In simple terms, QSBS is stock in a qualifying U.S. C corporation that meets a specific set of rules.
If the stock qualifies and you hold it for more than five years, you may be able to exclude up to:
$10 million / $15 million of gain, or
10× your basis in the stock
(Whichever is greater, applied per company, per taxpayer.)
The intent behind the rule is straightforward:
Congress wanted to encourage investment in growing operating businesses structured as C corporations.
Not Every Small Business Qualifies
This is where things get nuanced.
For stock to qualify as QSBS:
The company must be a U.S. C corporation
It must have had $50 million or less in gross assets at the time the stock was issued
At least 80% of its assets must be used in an active trade or business
And here’s the part that surprises many people—some industries are excluded.
Professional services (like law, accounting, consulting, and many financial services), banking, insurance, and certain hospitality businesses often don’t qualify — even if they’re small.
Structure alone isn’t enough. The business activity matters.
How Do People End Up With QSBS?
There are typically three paths:
1. Founders
If you formed (or early on converted to) a C corporation and received founder shares, those shares may qualify — assuming the company met the requirements at the time.
2. Employees With Equity
Restricted stock or exercised options can qualify, too.
In some cases, filing an 83(b) election early can meaningfully improve the outcome by starting the five-year clock sooner.
3. Early-Stage Investors
Angel or seed investors who purchase newly issued shares directly from the company may also qualify — as long as they meet the holding period and other requirements.
One important caveat:
Buying shares from another shareholder (a secondary purchase) generally does not qualify.
The Five-Year Rule
The stock must generally be held for more than five years to access the exclusion.
That timing requirement drives a lot of planning conversations — especially when a company is approaching a potential sale.
Where Planning Gets Powerful: Gifting Strategies
One of the most compelling features of QSBS is that the exclusion can potentially be multiplied across taxpayers.
For example:
Gifting shares to adult children
Transferring shares to properly structured non-grantor trusts
Coordinating ownership between spouses
Each separate taxpayer may be eligible for their own exclusion, subject to the per-issuer limitations.
That can dramatically increase the amount of gain excluded in the right circumstances.
Timing is critical, though. Transfers typically need to happen well before a liquidity event to avoid IRS scrutiny.
Should a Business Choose a C Corporation for QSBS?
Sometimes — yes.
Even with the possibility of double taxation, Section 1202 can outweigh that cost when a company expects:
Significant growth
A future exit
Substantial equity appreciation
But it’s not automatic. The decision needs to factor in cash flow, reinvestment plans, state tax treatment, and long-term goals.
A Few Common Pitfalls
QSBS is powerful — but technical.
Issues we often see include:
Operating in an excluded industry
Poor documentation of original stock issuance
Stock redemptions that unintentionally break qualification
Waiting too long to plan before a sale
And importantly:
Section 1202 applies to stock sales, not necessarily to asset sales at the company level.
QSBS remains one of the most powerful tax planning tools available to founders, early employees, and early-stage investors in qualifying C corporations.
With the expanded $10 million / $15 million exclusion now available for shares acquired after July 4, 2025, the opportunity is even more meaningful — especially when paired with thoughtful estate and gifting strategies.
But this is not something to evaluate at the finish line.
The biggest benefits typically come from planning early, documenting carefully, and revisiting the structure as the business grows.
If you think QSBS might apply to you — or your company — it’s worth reviewing well before a liquidity event is on the table.
Will