The Qualified Small Business Stock (QSBS) exemption is one of the most powerful tax benefits available to high-income earners, yet most investors—and even many financial advisors—remain unaware of its potential. Under Section 1202 of the IRS code, this provision can completely eliminate capital gains taxes from qualifying startup investments.

What is QSBS and How Does It Work?

QSBS is designed to encourage investment in small, growing companies by allowing investors to exclude capital gains from the sale of certain small business stocks. This tax exemption allows qualifying small business investors to exclude either $10 million or 10 times their original investment from capital gains taxes—whichever is greater—as long as they hold the stock for at least five years. ($15 million or 10 times their original investment with a tiered approach starting on the third year for QSBS purchased after July 4, 2025).

Gains from QSBS that don’t meet the requirements to qualify for the exclusion are subject to a maximum 28% capital gains rate, compared to the usual long-term capital gains tax rate of up to 20%.

The exemption is remarkably comprehensive. Excluded gains are not subject to federal income tax, the alternative minimum tax (AMT), or the 3.8% net investment income tax (NIIT).

Real-World QSBS Example

If you invested $200,000 in a qualifying tech startup and it grew to $15 million, you'd pay zero federal taxes on $10 million of that gain. The remaining $5 million would be subject to standard capital gains treatment. Conversely, if you invested $2 million and it grew to $15 million, you could exclude all $13 million in gains because it falls under the "10 times your basis" rule.

How Much Can You Exclude with QSBS?

The maximum benefit for QSBS acquired before July 4, 2026 is either $10 million or 10 times your original investment, whichever is greater.

The exclusion percentage depends on when you acquired the stock:

• 50% exclusion for stock acquired between 1993 and February 17, 2009
• 75% exclusion for stock acquired between February 18, 2009, and September 27, 2010
• 100% exclusion for stock acquired between September 27, 2010 and July 4, 2025
• 100% exclusion for stock acquired after July 4, 2025, with a maximum benefit of either $15 million or 10 times your original investment, whichever is greater.

What Investments Qualify for QSBS Treatment?

For shares purchased before July 4, 2026 to qualify, you must own issued shares (not options) in a C corporation that had under $50 million in gross assets when the stock was issued. The specific IRS criteria include:

• C Corporation Structure: Must be a domestic C corporation, not an LLC or S Corporation
• Asset Threshold: Company must have gross assets under $50 million when stock was issued (not company valuation)
• Original Issue: You must acquire stock at original issue, not from secondary markets
• Five-Year Holding Period: Stock must be held for more than five years for full benefit
• Active Business Requirement: Company must use at least 80% of assets in active business operations
• Qualified Business Activities: Cannot be passive holding companies, financial services, or certain professional services

For shares purchased after July 4, 2026, these criteria apply, except the asset threshold rises to $75 million, and the holding period requirements have a tiered system:

• 50% exclusion after 3 years
• 75% exclusion after 4 years
• 100% exclusion after 5+ years

Who Can Take Advantage of QSBS?

Startup Founders and Early Employees

Founder stock typically qualifies for QSBS treatment, assuming all business requirements are met. Early-stage employees who exercise stock options while the company remains under the $50 million asset threshold can also benefit.

Key Insight: Options themselves don't qualify as QSBS—only executed shares count. This makes timing crucial for startup employees considering when to exercise their options.

When Should You Exercise Stock Options for QSBS?

If your company is approaching the $50 million asset threshold, exercising options becomes time-sensitive. Once a company crosses this threshold, it's no longer QSBS eligible and there's no way to go back.

Early exercising—if your plan allows it—lets you exercise unvested shares before losing QSBS eligibility. While this requires upfront cash and carries forfeiture risk if you leave the company before vesting, it can lock in QSBS treatment for your entire grant.

QSBS eligibility is a factor to consider when deciding when to exercise stock options, but it’s a good idea to keep your larger wealth plan, liquidity needs, diversification preferences, and your confidence in the company’s success in mind when making this decision. 

• Someone holding options with a QSBS eligibility window about to close, who does not have immediate liquidity needs, and is confident about their company’s prospects, might benefit from exercising while the options are still QSBS eligible. 
• For someone who needs a large portion of their assets to remain liquid (perhaps someone looking to buy a home soon) or prioritizes diversification, QSBS tax benefits may not be worth it.

State Tax Considerations for QSBS

While QSBS provides federal tax exemption, some states don't recognize the exclusion. Investors residing in these states at the time of sale would still pay state taxes on QSBS capital gains:

• Alabama
• California
• Mississippi
• New Jersey
• Pennsylvania
• Hawaii
• Puerto Rico

California's 13.3% top tax rate means even QSBS-qualified gains can face significant state-level taxation.

Common QSBS Misconceptions and Planning Strategies

"I Have QSBS Shares, So I Won't Pay Any Taxes"

This assumes federal-only taxation and full eligibility. Many investors discover state tax obligations or partial qualification issues too late.

"My Company Valuation is Over $50 Million, So My Stock Won’t Qualify"

The asset test uses gross assets, not company valuation—these can be vastly different numbers. Always confirm the actual asset level with your company during 409A valuations.

QSBS Rollover Strategy Under Section 1045

If you sell QSBS shares before meeting the five-year holding requirement, you can roll proceeds into a new QSBS-eligible entity under Section 1045. This rollover must occur within 60 days and allows you to continue the holding period clock toward full tax exemption.

The challenge: The new company must meet all QSBS requirements, including C corporation status, asset thresholds, and qualified business activities.

How Range Helps Members Optimize QSBS Strategy

When someone joins Range with private company equity, we immediately assess whether their shares qualify for QSBS treatment, if they've exercised options that would qualify, and whether they have the cash flow to exercise before losing eligibility. We help members identify when to sell for optimal tax treatment, and weigh the benefits of early exercising, if that's an option.

Our approach includes:

• QSBS Eligibility Assessment: Determining which equity grants qualify
• Exercise Timing Strategy: Modeling the financial impact of exercising options before QSBS eligibility expires
• State Tax Planning: Coordinating federal QSBS benefits with state tax implications
• Rollover Opportunities: Identifying qualified reinvestment options under Section 1045

Frequently Asked Questions About QSBS

Should I Exercise My Startup Stock Options Now or Wait?

This depends on your company's asset level, your cash flow situation, and your conviction in the company's future. If the company is approaching $50 million in assets, you may have to make this decision sooner.

How Do I Know If My Company Qualifies for QSBS?

Check your grant documents first. If QSBS eligibility is still unclear, ask your company directly during their next 409A valuation process. They should know their gross asset level relative to the $50 million threshold.

Can I Use QSBS Benefits in a Roth IRA?

No, QSBS benefits apply only to taxable accounts. However, the tax-free growth potential of QSBS in a taxable account can exceed Roth IRA benefits, especially for high-growth companies where you might exclude $10 million or more in gains.

What Happens If I Leave My Company Before My Options Vest?

If you exercised options early, the company would often repurchase the exercised but unvested shares at your original strike price. This is why early exercising requires strong conviction in both the company's prospects and your employment stability.

Taking Action on QSBS

To claim QSBS benefits, you'll need to file Form 8949 when selling qualified shares. Given the complexity of QSBS rules and the potential for significant tax savings, working with experienced tax professionals is essential.

The QSBS exemption represents one of the few opportunities to achieve tax-free investment growth outside retirement accounts. For startup employees and founders, understanding and optimizing QSBS treatment can mean the difference between paying hundreds of thousands in taxes or keeping those gains entirely.

Range specializes in helping high-income earners navigate complex equity compensation strategies, including QSBS optimization. Schedule a demo to discuss how QSBS might fit into your overall tax and investment strategy.

Related Resources

• "Big Beautiful Bill" Boosts QSBS Benefits for Startup Employees and Founders
• My company gave me stock options. How do they work?
• What should I know about Alternative Minimum Tax (AMT)?
• Five Reasons You Should Graduate From DIY to a CPA or Tax Professional
• Range Equity Compensation Calculator
• Tax Planning Services at Range