QSBS Explained: How Founders and Investors Can Save Millions in Taxes
If you’ve founded or invested in a startup — especially in tech, media, or consumer brands — there’s one tax incentive you should absolutely understand: Qualified Small Business Stock, or QSBS.
QSBS isn’t a loophole. It’s a legitimate, congressionally created benefit that can completely eliminate federal capital gains taxes — up to $10 million or 10x your investment, whichever is greater. But to qualify, your company and your stock must meet very specific criteria.
What Is QSBS?
Qualified Small Business Stock refers to shares issued by a C corporation that meets certain requirements under Section 1202 of the Internal Revenue Code. If you hold those shares for at least five years, the gain from selling them can be excluded from federal income tax.
In short: if your company qualifies and you plan correctly, you could exit without paying federal capital gains tax on the first $10 million in profit.
Example:
You invest $100,000 in a qualifying C-corp. Five years later, you sell your shares for $3 million. The $2.9 million in gains could be entirely tax-free.
Who Qualifies for QSBS?
Both founders and early investors can qualify — but only if:
The company is a C corporation (not an LLC, S-corp, or partnership).
The company’s gross assets were $50 million or less when the stock was issued.
At least 80% of the company’s assets are used in an active trade or business (not investing or holding real estate).
The stock was originally issued — meaning you got it directly from the company, not by purchasing it from another shareholder.
Why It Matters That You’re a C-Corp
QSBS only applies to C corporations. That’s because the benefit was designed to encourage investment in small businesses that can scale — particularly those that intend to take outside funding.
If you’re an LLC or S-corp, you can’t issue QSBS. You can, however, convert to a C-corp early enough that new shares qualify going forward. Timing matters — if you wait until just before a major round or exit, you might miss out on millions in potential tax savings.
QSBS in Practice: Founders, Investors, and Early Employees
Founders: The shares you receive at formation can qualify as QSBS if the company is a C-corp from the start.
Investors: Angel and venture investors can also qualify if they receive original-issue stock.
Employees: If you’re compensated in stock (rather than options exercised later), you might also benefit — but timing and documentation are key.
This is why clean incorporation and early legal structuring matter so much. The QSBS clock starts the moment stock is issued, not when you first join the company.
When QSBS Doesn’t Apply
QSBS isn’t universal. It doesn’t apply if your company:
Is structured as an S-corp, LLC, or partnership
Operates primarily in excluded industries (like finance, law, hospitality, or real estate)
Has assets exceeding $50 million at the time of stock issuance
However, if you’re in media, technology, consumer products, or entertainment — industries focused on creative IP and scalability — your company likely qualifies.
Why Founders Should Care Early
Most founders focus on cap tables, valuations, and fundraising — but ignore tax structure until it’s too late. Setting up your company as a C-corp and maintaining QSBS eligibility can lead to transformative tax advantages later on.
Even if you’re years away from an exit, you can start the clock now. Those five years go faster than you think.
At WADR Law
We help founders and investors understand how to structure their entities to take advantage of tax-efficient strategies like QSBS — while staying compliant with securities, corporate, and investor regulations.
If you’re forming a company or preparing for a raise, talk to us before you issue stock. The right structure today could mean millions saved later.