Qualified Small Business Stock (QSBS) offers one of the most powerful tax incentives for entrepreneurs, investors, and employees in the United States and has been made even more powerful following the passage of the One Big Beautiful Bill Act (OBBBA). Under Internal Revenue Code § 1202, noncorporate taxpayers may exclude a significant portion—or even all—of the capital gain realized from the sale of QSBS, provided certain requirements are met. The primary beneficiaries of this incentive are business owners who are also shareholders and investors.

Although the details of QSBS are complex, this overview highlights recent changes from the OBBBA and key planning opportunities and pitfalls for investors to consider. Cerity Partners advisors are available to help you navigate these updates and explore how QSBS may fit into your broader investment strategy.

What is QSBS?

In a nutshell, QSBS refers to stock in a domestic C corporation that meets specific requirements at the time of issuance and during the shareholder’s holding period. The main requirements are:

  • Original issuance: The stock must be acquired at its original issuance, either directly from the corporation in exchange for money, property (other than stock), or as compensation for services (excluding services as an underwriter).
  • Qualified small business: At the time of issuance, the corporation’s aggregate gross assets, not valuation, must not exceed $50 million. This includes cash and the adjusted basis of other property, with contributed property measured at fair market value at the time of contribution.
    • OBBBA increased the $50 million asset test to $75 million for stock issued after July 4, 2025.
  • Active business requirement: During substantially all of the taxpayer’s holding period, at least 80% of the corporation’s assets (by value) must be used in the active conduct of one or more qualified trades or businesses. There is an exception for new or startup C corporations with lower thresholds for the first two years of operation.
  • Qualified trade or business:
    • Generally, startups and companies in technology, manufacturing, and product development as well as service companies involved in the skilled trades tend to benefit the most from QSBS.
    • Certain businesses are excluded, such as those involving health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset is the reputation or skill of one or more employees. Also excluded are banking, insurance, financing, leasing, investing, farming, extraction businesses, and businesses operating hotels, motels, or restaurants.

The QSBS gain exclusion

For shareholders and investors, the main benefit of QSBS is the exclusion of capital gain from federal income tax upon sale, subject to certain limits that have changed based on the OBBBA.

Percentage exclusion and per-issuer limitation: The exclusion percentage and the exclusion limitation amount depend on when the stock was acquired and how long it was held. As shown in the table below, the passage of the OBBBA has changed these percentages and limitations, making them much more advantageous.

 Pre-OBBBAPost-OBBBA
Amount of gain eligible for exclusion$10 million ($5 million for married filing separately) or 10 times basis$15 million ($7.5 million for married filing separately) or 10 times basis  
100% exclusion100% for stock acquired after September 27, 2010, and held for five years100% for stock acquired after July 4, 2025, and held for five years  
75% exclusion75% for stock acquired after February 17, 2009, and before September 28, 2010, and held for five years  75% for stock acquired after July 4, 2025, and held for four years
50% exclusion50% for stock acquired after August 10, 1993, and before February 18, 2009, and held for five years50% for stock acquired after July 4, 2025, and held for three years

As an example, suppose a shareholder acquires QSBS prior to July 5, 2025, in a single corporation and later sells it after holding it for more than five years. If the taxpayer’s basis in the stock is $1 million, the maximum gain exclusion is the greater of:

  • $10 million (for stock acquired before the applicable date), or
  • $10 million (10 × $1 million basis).

If the taxpayer sells additional QSBS in the same corporation in later years, the $10 million limit is reduced by the amount of gain previously excluded for that corporation.

Planning opportunities

1. Gifting and estate planning

  • QSBS can be gifted to family members and certain trusts. Each donor or trust is treated as a separate taxpayer, eligible for their own separate exclusion depending on the date the QSBS was originally acquired or 10x original basis known as “stacking.”
  • Gifts and bequests retain the QSBS status and holding period, allowing for significant estate and income tax planning benefits. Also, gifts of the stock do not run afoul of the original issuance rule.

2. Rollover of gain (Section 1045)

  • If QSBS is sold before the required holding period, gain can be deferred by rolling the proceeds into new QSBS within 60 days. The holding period of the original QSBS tacks onto the replacement stock.

3. Entity conversion

  • Partnerships and LLCs can convert to C corporations (often via a tax-free Section 351 exchange) to issue QSBS. The holding period for QSBS starts at the date of conversion, not the date the partnership interest was acquired.

4. Stock options

  • Employees with stock options should consider exercising early to start the five-year holding period for QSBS, provided the company meets the requirements at the time of exercise.

Pitfalls and cautions

  • Secondary purchases: Buying QSBS from another shareholder (rather than from the corporation) generally disqualifies the stock from QSBS treatment.
  • Disqualifying businesses: Many service businesses and other excluded activities do not qualify for QSBS.
  • State tax treatment: Not all states conform to the federal QSBS exclusion. For example, California and Pennsylvania do not allow the exclusion, while most other states do at this time.
  • Documentation: The corporation and shareholders must maintain records proving the corporation’s QSBS such as original issuance documents, financial statements showing gross assets and the type(s) of business activity the corporation is engaged in. Lack of documentation can result in loss of the exclusion.

Pass-through entities: These entities can acquire, hold, and sell QSBS. However, for an individual owner or member of the pass-through entity to receive the QSBS benefit, they must have been an owner or member of the entity when the shares were acquired and continue to be an owner or member throughout the entire period that the entity holds the QSBS.

Discussion points at different business milestones

Startup phase

There are many entity types to choose from, and many advisors, lawyers, friends, accountants, and media outlets generally have their preferred choice. Now, with QSBS being upgraded and expanded, the choice of a C corporation should rank toward the top—assuming the type of business would qualify for QSBS and it makes sense for the overall goals of the business and owners. We recommend discussing entity choice with the full team of advisors, including accountants and attorneys, to ensure thorough consideration of all angles and aspects.

Established business but unsure of QSBS qualification

If the business has a five-plus-year horizon before selling, there are some planning opportunities that merit consideration in order to achieve the benefit of the QSBS gain exclusion. This requires careful and methodical steps to undertake a conversion of the business to a qualifying C corporation, but it can be done successfully by having a coordinated strategy executed by a team of advisors, attorneys, and accountants.

Selling or already sold

Determining if the business owner, shareholder, investor, qualifies for the gain exclusion is consequential. If the business sells for $10 million, the seller(s) will incur a $2 million capital gain tax if the business doesn’t qualify for the QSBS gain exclusion. Confirming and documenting the QSBS is therefore of enormous consequence. The seller’s accountant must document the exclusion properly on the tax return through Form 8949 and Schedule D. If the sale otherwise qualifies but for the requisite holding period, planning a Section 1045 rollover is particularly important as the 60-day rollover window closes quickly.

Conclusion

QSBS offers a unique and substantial tax benefit for founders, investors, and employees in qualifying small businesses. With proper planning, taxpayers can exclude millions of dollars of gain from federal income tax, multiply the benefit through gifting strategies, and defer gain through rollovers. However, careful attention to the requirements, documentation, and planning strategies is essential to maximize the benefit of QSBS. Reach out to your Cerity Partners advisor to learn more. If you are not yet a client, we invite you to request an introduction with our concierge to explore your objectives and be matched to the right financial advisor for your unique needs.

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