Your startup shares could increase by $15 million and you could potentially owe $0 in federal capital gains tax.
That is the potential benefit of Qualified Small Business Stock, commonly known as QSBS.
However, simply working for a startup does not mean your shares qualify. There are specific requirements related to the company, when you acquired your shares and how you acquired them.
The hardest part is often proving that those requirements were met years later when the company is finally sold or goes public.
What Is QSBS?
QSBS is stock in certain small C corporations that may qualify for a federal capital gains tax exclusion.
To qualify, the shares generally must have been acquired directly from the company in exchange for money, property or services. Buying shares from another employee or investor usually does not count because that is not an original issuance from the company.
The company must also operate an eligible active business. Certain service-based industries are excluded, including health, law, accounting, consulting, financial services, banking, insurance, investing, hotels and restaurants.
When Is the Company's Size Measured?
The company must be below a specific gross-asset limit before and immediately after your shares are issued.
The limit is:
- $50 million for stock issued on or before July 4, 2025
- $75 million for stock issued after July 4, 2025
This does not refer to the company's valuation. A startup could be valued at $1 billion and still potentially be below the QSBS asset limit. On the other hand, a company with a much lower valuation could fail the test after receiving a large amount of cash from a funding round.
Gross assets generally include the company's cash plus the adjusted tax basis of its other property.
Assume a startup has $25 million of gross assets and then raises another $75 million. Shares issued before the funding round may qualify, while shares issued afterward may not. Even shares issued as part of the funding round could fail if the new cash causes the company to exceed the limit immediately after the issuance.
Having shares before a major funding round is therefore a positive sign — but it is not definitive proof.
Which Date Applies to Your Shares?
This depends on what you received.
If a founder purchased restricted stock on June 1, 2025, the shares were acquired before July 4, 2025. Those shares would generally remain under the older QSBS rules.
If an employee received stock options in 2023 but did not exercise them until 2026, the option grant date generally does not start the QSBS clock. An option is not stock. The employee generally acquires stock when the option is exercised and actual shares are issued.
In that example, the shares would be acquired after July 4, 2025 and may qualify for the newer rules. However, the company must satisfy the $75 million gross-asset test when the employee exercises, not when the option was originally granted.
That creates an important planning consideration. Exercising options earlier could potentially start the QSBS holding period while the company is still below the asset limit. But exercising also requires cash, can create taxes and exposes the employee to the risk that the private shares never become liquid.
For restricted stock that is still subject to vesting, a timely 83(b) election may allow the tax holding period to begin when the shares are transferred instead of when they vest.
What Changed on July 4, 2025?
Stock acquired on or before July 4, 2025 generally must be held for more than five years before any QSBS exclusion becomes available.
For qualifying stock acquired after July 4, 2025, the potential exclusion is phased in:
- Held for at least three years: 50% of eligible gain
- Held for at least four years: 75% of eligible gain
- Held for at least five years: 100% of eligible gain
The new law also increased the fixed exclusion limit from $10 million to $15 million for qualifying stock acquired after July 4, 2025.
What Does "$15 Million or 10× Basis" Mean?
The exclusion limit is generally the greater of:
- $15 million, or
- 10 times your adjusted basis in the qualifying stock sold
Assume an employee exercises 100,000 options at $1 per share. The employee pays $100,000 to exercise. Ten times that basis is $1 million. Because $15 million is greater than $1 million, the fixed $15 million limit would generally be more valuable. This is common for founders and early employees because their shares usually have a very low purchase or exercise price.
Now assume an investor purchases newly issued qualifying shares directly from the company for $2 million. Ten times the investor's basis would be $20 million. Because $20 million is greater than $15 million, the 10× basis limit could potentially provide a larger exclusion. The 10× rule is therefore more likely to help an investor making a large direct investment than an employee exercising low-priced options.
These limits generally apply per taxpayer, per company, and can be reduced by QSBS gain previously excluded from that same company.
How Do You Actually Know if Your Shares Qualify?
Do not rely on the company's valuation or someone in the office saying the shares "should qualify."
Keep the following records for every block of shares:
- Stock grant or purchase agreement
- Option exercise confirmation
- Stock certificate or cap-table statement
- Form 3921 for an ISO exercise
- Proof of an 83(b) election, if applicable
- The exact date the shares were issued
- The number of shares and purchase price
- Information about major funding rounds
You should also ask the company's finance or legal team: Can the company provide a written QSBS representation confirming whether it believes the shares issued to me on this date met the requirements of Section 1202?
Ideally, that confirmation would address whether the company was a domestic C corporation, whether the shares were acquired at original issuance, whether the company satisfied the gross-asset test and whether it operated a qualifying active business.
Financial presentations and company meetings can provide useful clues. Pay attention to funding rounds, cash on the balance sheet, acquisitions and major changes in the company's business. However, these are still only clues. A formal letter from the company's attorney or tax advisor is much stronger than an informal email from HR.
Save everything somewhere outside your company email. You may need these records long after you leave the company.
Don't Forget About State Taxes
QSBS is a federal tax benefit. Each state decides whether it will follow the federal exclusion.
New York currently generally conforms to the federal QSBS rules. This means properly excluded federal gain is generally also excluded from New York State, and typically New York City, taxable income.
But on the other hand, some states like California do not conform. Someone living in California could qualify for a full federal QSBS exclusion but still owe California tax on the entire gain. For example, a $10 million qualifying gain could create $0 of federal capital gains tax while still producing up to approximately $1.33 million of California tax at the state's highest marginal rate.
Your state of residence when the shares are sold can therefore make a major difference. State laws can also change during a three-, four- or five-year holding period, so state treatment should be reviewed before any tender offer, acquisition or other sale.
The Bottom Line
Do not wait until your company is acquired or goes public to ask whether your shares qualify for QSBS.
By that point, you may no longer have access to the attorneys, financial records or company information needed to support the exclusion.
Track each block of shares when it is issued, request written confirmation from the company and keep your own records.
With millions of dollars in potential tax savings on the line, "I think my shares qualify" is not enough.
