QSBS: The Tax Break Every Tech Founder Should Know
by Malik Amine
If you're building a tech company, there's one tax benefit that could save you millions when you exit: Qualified Small Business Stock (QSBS).
Most founders I meet have heard of it. Few actually understand how to maximize it.
What is QSBS?
QSBS is a section of the tax code (Section 1202) that allows you to exclude up to $10 million (or 10x your basis, whichever is greater) of capital gains from federal taxes when you sell stock in a qualified small business.
That's zero federal tax on up to $10 million of gains.
For a founder who exits for $50 million and owns 20% of the company, that's potentially $2.38 million in federal tax savings.
The Requirements
Not every startup qualifies. Here's what you need:
1. C-Corporation Status
Your company must be a C-corp when the stock is issued. LLCs don't qualify (but can convert).
2. Gross Assets Under $50M
Your company must have less than $50 million in assets immediately after issuing the stock. This means your early shares are more valuable than later ones for QSBS purposes.
3. Active Business Requirement
At least 80% of your company's assets must be used in an active trade or business. No real estate or financial services.
4. 5-Year Holding Period
You must hold the stock for at least 5 years before selling to get the full benefit.
Why This Matters for Funding
Here's where most founders mess up: dilution resets your QSBS clock.
Let's say you issue yourself 1 million shares at founding. Five years later, you're about to exit. Great, right?
Not if you raised a Series A in year 3 and the board authorized new shares that pushed the company's assets over $50 million. Those new shares don't qualify.
Planning Strategies
Get Your Stock Early
The earlier you receive shares, the more likely they qualify. Founder shares issued at formation almost always qualify.
Track the $50M Threshold
Before each funding round, calculate your gross assets. If you're approaching $50 million, consider:
- Delaying the raise
- Structuring it differently
- Timing it after key employees receive their grants
Consider QSBS Trusts
You can gift QSBS shares to family members, and they get their own $10 million exclusion. A married couple with two kids could potentially exclude $40 million.
Document Everything
Keep records of when shares were issued and the company's gross assets at that time. You'll need this for your tax return.
The California Problem
One major caveat: California doesn't recognize QSBS.
If you live in California, you'll still owe state taxes (13.3% on gains over $1 million). But federal savings alone make QSBS incredibly valuable.
Some founders move to tax-free states like Texas or Florida before selling to avoid this.
Common Mistakes
Mistake 1: Waiting Too Long to Issue Stock
Early employees who join after the Series A might not get QSBS treatment. Issue shares early when possible.
Mistake 2: Converting to an LLC
Once you convert from a C-corp to an LLC, your QSBS benefit disappears. Talk to a tax advisor first.
Mistake 3: Not Planning for AMT
Exercising ISOs (Incentive Stock Options) can trigger Alternative Minimum Tax, which complicates QSBS planning.
The Bottom Line
QSBS is one of the most founder-friendly parts of the tax code, but it requires planning years in advance.
If you're pre-Series A and haven't thought about this yet, talk to a CPA who specializes in startups. The decisions you make today will determine how much you keep when you exit.
And if you're already past the $50 million threshold? There are still strategies to maximize what qualifies. Don't assume you've missed out.
Have questions about QSBS or equity compensation? Book a call and let's talk through your specific situation.