QSBS planning before and after your founder exit

What qualifies as QSBS

Qualified small business stock (QSBS) is stock issued by a domestic C corporation that meets a specific set of requirements at the time of issuance and throughout the shareholder's holding period. The requirements are not complicated to state, but each one must be satisfied:

• C corporation. The issuing entity must be a domestic C corporation at the time of issuance and during substantially all of the holding period. S corporations, LLCs, and partnerships do not issue QSBS—though a conversion to C-corp before issuance or as part of a restructuring can preserve eligibility in some cases.
• Original issuance. The stock must be acquired at original issuance in exchange for money, property, or services. Stock purchased on the secondary market does not qualify.
• Gross assets test. The corporation's aggregate gross assets must be within the applicable threshold immediately before and after issuance. For stock issued on or before July 4, 2025, the threshold was $50 million.¹ For stock issued after that date, the OBBBA raised the threshold to $75 million.²
• Active business requirement. The company must be engaged in a qualified trade or business during substantially all of the shareholder's holding period. Excluded businesses include finance, insurance, leasing, real estate, farming, hospitality, law, health, consulting, engineering, architecture, and certain other service fields.¹
• Non-corporate shareholder. The exclusion is available to non-corporate taxpayers: individuals, trusts, and estates. Stock held by a corporation does not qualify for the exclusion.

How the holding period affects your exclusion

The percentage of gain you can exclude from federal tax depends on when your stock was issued and how long you hold it. The rules changed significantly with the One Big Beautiful Bill Act (OBBBA), signed in July 2025.²

Stock issued on or before July 4, 2025 continues to be governed by the pre-OBBBA rules: a five-year holding period is required for the 100% exclusion. There is no partial exclusion at three or four years for this stock. The per-taxpayer, per-issuer exclusion limit for this stock is $10 million or ten times your adjusted basis in the stock, whichever is greater.¹

Stock issued after July 4, 2025 gains access to the new tiered structure under OBBBA:

• Three-year hold: 50% of eligible gain excluded from federal tax
• Four-year hold: 75% of eligible gain excluded
• Five-year hold: 100% of eligible gain excluded

The per-taxpayer, per-issuer exclusion limit for post-OBBBA stock is $15 million (indexed for inflation), or ten times adjusted basis, whichever is greater.²

The 28% rate on unexcluded gain

If you sell stock issued after July 4, 2025 after holding it for three or four years, the excluded portion is removed from your taxable income as before. The portion that is not excluded, however, is taxed at 28%—not at the standard long-term capital gains rate of 15% or 20% that would otherwise apply to most long-term gain.³ This means an early exit at three years is not simply "a 50% exclusion at a lower rate"—the tax on the remaining half is higher than it would be without the Section 1202 election. Run the comparison with your tax professional before assuming a partial exclusion is advantageous in your situation.

The per-issuer limit and planning for larger exits

The $15 million per-taxpayer, per-issuer exclusion limit applies to each combination of taxpayer and issuing company. Founders with larger expected exits have historically used several techniques to expand the effective coverage:

• Gifting before exit. Transferring qualifying shares to family members or trusts (each of whom is a separate taxpayer) before a sale or liquidity event can allow multiple parties to each claim the exclusion. The transferred shares generally retain their QSBS character if the gift is made before the sale.⁴
• Early-stage diversification of stock issuances. Founders who participated in multiple distinct financing rounds, or who received stock at different times across restructurings, may have different eligibility dates and basis lots. Each lot is analyzed separately.
• Entity structure. Pass-through entities that hold QSBS (such as a partnership or S-corp that converts) have specific rules for how the exclusion flows to individual partners or shareholders. The analysis is fact-specific.

Whether any of these strategies is appropriate in your situation depends on your deal structure, timing, and family circumstances. Discuss these questions with a qualified tax attorney or CPA before a letter of intent is signed.

State tax conformity: a significant variable

Section 1202 is a federal provision. States are not required to conform to it, and several do not. California is the most prominent example: California does not recognize the federal QSBS exclusion, and founders in California owe California income tax on the full gain that is excluded at the federal level.⁵ Other states may partially conform, fully conform, or fully exclude the benefit. If you live in a high-income-tax state, the effective benefit of QSBS is meaningfully lower than the federal exclusion alone would suggest. Model the combined federal-plus-state liability with your CPA.

What QSBS planning looks like in a post-exit family office context

If your stock qualified and you have already exited, the planning conversation shifts. The excluded gain does not need to be reinvested or held in any particular form to preserve its exclusion—the gain simply disappears from your federal taxable income. What comes next is investment and estate planning around the proceeds that are actually taxable, plus the after-tax cash you received.

Several questions come up consistently in post-exit planning:

• How do taxable proceeds interact with any retained equity, rollover interest, or earnout that is still outstanding?
• How should liquidity from the excluded gain be invested differently, if at all, than proceeds that were fully taxed?
• If you gifted shares before exit, what is now each recipient's situation, and how is the new wealth coordinated with your own?
• If a large enough exclusion reduced your federal taxable income substantially in the year of sale, how do you plan estimated payments and investments in subsequent years when ordinary income resumes?

None of these is a reason to delay the conversation. Use the proceeds planning worksheet to separate the different components of your post-exit picture before bringing it to an advisor.

Sources & further reading

Source pages reviewed September 2026. Content reflects the OBBBA changes effective July 4, 2025 for newly issued stock; pre-OBBBA rules remain in effect for stock issued on or before that date. This page does not constitute tax advice. QSBS eligibility is fact-specific; work with a qualified tax professional.

1. IRS Publication 550: Investment Income and Expenses — Section 1202
2. McLane Middleton: OBBBA Changes to the QSBS Regime under Section 1202
3. MasterCPE: Section 1202 QSBS in 2026 — the 28% rate trap and OBBBA rules
4. Carta: Qualified Small Business Stock (QSBS) Explained
5. YHB CPAs: QSBS — What Business Owners Need to Know in 2026
6. Keystone: QSBS Eligibility — Complete Requirements Guide for 2026