The tax break that could save you millions

The tax break that could save you millions. Here’s how not to mess it up.

If you qualify for Qualified Small Business Stock (QSBS) treatment under Section 1202 of the Internal Revenue Code, you could:

• Pay no federal capital gains tax on up to $10 million per stockholder or exclude 10 times your stock basis, whichever is greater
• Stack the benefit across founders, family members, or trusts to exclude even more than $10 million
• And if you start as an LLC and convert to a C-Corp before hitting $50 million in assets, your total exclusion could reach up to $499 million

This is the biggest tax break in America—and many founders don’t even know how easily they can accidentally lose it.

Who qualifies?

To qualify, the stock must be:

• Issued by a U.S. C-Corp with under $50 million in assets at the time of issuance
• Acquired directly from the company in exchange for money, property, or services
• Held for at least 5 years
• Issued by a company engaged in a qualified active business (not services, finance, or real estate)

Top 5 Ways Founders Accidentally Lose QSBS

1. Not being a C-Corp or converting too late

QSBS doesn’t apply to LLCs or S-Corps. If you convert to a C-Corp, your QSBS clock starts at conversion—and it must be done perfectly before your company hits $50 million in assets.

VC Eric Bahn shared he lost out on QSBS when he exited his startup because he never converted his startup from an LLC. “Enough to make me cry.”

2. Not holding shares for 5 years

You must hold QSBS stock for at least 5 years from the date it’s issued.

If you operate as an LLC for 3 years, convert to a C-Corp, and sell after 4 more years—QSBS is lost. The clock starts at conversion.

3. Exceeding the $50M asset limit

If your company has more than $50M in gross assets before or immediately after issuing stock, that stock is not QSBS-eligible.

This is why early stock grants should happen before a major funding round or revenue spike.

4. Repurchasing stock the wrong way

To preserve QSBS, both of these must be true:

A. The company hasn’t repurchased more than 2% of the taxpayer’s shares (or over $10K in value) in the 2 years before or after issuance

B. The company hasn’t repurchased more than 5% of total outstanding stock (by value) from its stockholders in the 1-year window before or after issuing QSBS

Example: A company buys back 6% of its stock from a departed co-founder for $150K. The repurchase happens one year after the co-founder leaves and doesn’t fall under any exception like retirement or termination. Six months later, the company issues stock to a new employee and several investors. Because the repurchase exceeded 5% and occurred within the critical window, that new stock may not qualify for QSBS.

5. Too much cash or investments can kill QSBS (especially after year 2)

To qualify for QSBS, your company must pass the 80% active business test—meaning at least 80% of its assets must be used in the active conduct of business.

In the first two years, most cash and investments can count as active if they’re earmarked for working capital or R&D.

Once your company has been operating for over two years, the test gets stricter:

• No more than 50% of your total assets can be cash or investment assets under the working capital exception
• If that 50% threshold is exceeded, no more than 10% of your total assets can be in portfolio stock (e.g., money market funds or equity in companies you don’t control)

Raise $10M and don’t deploy it—by year 3, you could fail the 80% active business test and lose QSBS.

Don’t leave millions on the table.

Download the Ultimate QSBS Checklist to audit your eligibility before your next raise or stock grant.