Money Talk with Malik | Financial Planning for Builders

Key Takeaways

Qualified Small Business Stock (QSBS) under Section 1202 lets you exclude up to $10 million in capital gains (or 10x your basis, whichever is greater) when you sell startup stock
You must hold the stock for at least 5 years to qualify
The company must be a C-corp with under $50 million in assets when you acquire the stock
Serial founders can stack QSBS benefits across multiple companies (separate $10M exclusion for each)
Getting this wrong costs founders millions in unnecessary capital gains taxes

I've worked with three serial founders in the past two years who sold companies and paid millions more in taxes than they needed to. All of them qualified for QSBS (Qualified Small Business Stock) treatment under Section 1202 of the tax code, but either they didn't know about it, or their CPA didn't structure it correctly.

One founder sold his fintech company for $18 million. His gain was $15 million. Without QSBS, he owed about $3 million in federal capital gains tax (20% rate). With QSBS, he could have excluded $10 million of that gain and owed tax on only $5 million. That's a $2 million tax savings he left on the table.

Let me explain how QSBS works and how serial entrepreneurs can use it across multiple exits.

What Is QSBS and Why Does It Exist?

QSBS stands for Qualified Small Business Stock. It's a tax break created in 1993 (and expanded in 2010) to encourage investment in small businesses. Under Section 1202, if you hold stock in a qualified small business for at least 5 years, you can exclude up to $10 million in capital gains (or 10x your cost basis, whichever is greater) when you sell.

That means if you're a founder or early employee and you sell your stock for a $12 million gain, you pay ZERO federal tax on the first $10 million. You only pay capital gains tax on the remaining $2 million.

The tax savings are massive. At the 20% long-term capital gains rate, excluding $10 million saves you $2 million in federal taxes. Some states (like California) don't recognize QSBS, so you'd still owe state tax, but the federal savings alone make this worth planning for.

What Are the Requirements to Qualify for QSBS?

Not all startup stock qualifies. Here are the rules (straight from IRS Section 1202):

1. The company must be a C-corporation

LLCs, S-corps, and partnerships don't qualify. If you're a founder setting up a new company, structure it as a C-corp from day one if you want QSBS treatment later.

Common mistake: Founders start as an LLC for simplicity, then convert to a C-corp before raising VC money. The problem? Your QSBS holding period starts when you acquire stock AS A C-CORP, not when you founded the LLC. So you lose years of holding period.

What to do: If you're serious about building a venture-backed company, start as a C-corp (Delaware is standard).

2. The company must have under $50 million in gross assets when you acquire the stock

This is measured at the time you receive your stock (at founding, or when you exercise options, or when restricted stock is granted).

Example: You join a startup at Series A when it's valued at $30 million (gross assets under $50M). You get stock options. Later, the company raises a Series B and is valued at $200 million. You exercise your options after the Series B. Do you still qualify for QSBS?

Answer: No. The company had over $50M in assets when you exercised, so the stock doesn't qualify. You should have exercised BEFORE the Series B.

This is a trap for employees at fast-growing startups. You need to exercise options while the company is still under $50M in gross assets, even if that means paying AMT or coming up with cash.

3. You must hold the stock for at least 5 years

The clock starts when you ACQUIRE the stock (for founders, that's when you get your shares at formation; for employees, it's when you exercise your options or when restricted stock is granted).

If you sell before 5 years, you don't qualify for QSBS. Period.

Common mistake: Founders sell in an M&A deal 4 years after founding. They miss QSBS by a few months and lose millions in tax savings. If the acquirer had been willing to wait 6 more months, the tax benefit would have been worth structuring the deal around.

4. The company must be in a qualified business

Most tech startups qualify, but there are exclusions. You can't get QSBS for:

Law firms, accounting firms, consulting firms
Financial services (banking, investing, brokerage)
Hospitality (hotels, restaurants)
Farming
Oil and gas extraction

Good news for tech founders: SaaS companies, fintech platforms, AI startups, e-commerce, and most other tech businesses qualify.

5. You must acquire the stock directly from the company (not from another shareholder)

If you buy stock from another shareholder (secondary market), it doesn't qualify for QSBS. You must get it directly from the company (at founding, through option exercises, or through a stock grant).

How Can Serial Founders Stack QSBS Across Multiple Companies?

Here's where it gets interesting. The $10 million exclusion is per company, per taxpayer. If you're a serial founder who exits three companies, you can exclude up to $10 million in gains from EACH exit.

Real example: Cynthia Chen (Kikoff founder) had three fintech unicorns before her current company. If each of those exits qualified for QSBS, she could have excluded up to $30 million in capital gains across all three (assuming she held for 5+ years each time).

Strategy for serial founders:

Start each new company as a C-corp (even if it's just you in the beginning).
File an 83(b) election immediately when you grant yourself founder stock (pay tax on nearly zero value).
Hold for at least 5 years before selling (structure M&A deals around this if needed).
Repeat with the next company.

If you do this right, you can shield tens of millions of dollars in capital gains over a career.

What About the 10x Basis Rule?

QSBS has an alternative exclusion: instead of $10 million, you can exclude 10x your cost basis, whichever is GREATER.

Example: You invest $2 million in your own startup (you put in cash for your shares). Five years later, you sell for $30 million (gain of $28 million). Under the $10M cap, you'd exclude $10M and owe tax on $18M. But under the 10x rule, you can exclude $20 million (10x your $2M basis), so you only owe tax on $8M.

This is great for founders who put significant cash into their companies early on.

What Are the State Tax Implications of QSBS?

This is where it gets tricky. QSBS is a federal tax break. Some states recognize it, some don't.

States that DO recognize QSBS:

Most states follow federal tax treatment

States that DO NOT recognize QSBS:

California (charges 13.3% on the full gain, no exclusion)
New Jersey
Alabama
A few others

If you live in California and sell stock with a $10M gain, you'll pay zero federal tax (thanks to QSBS) but still owe $1.33 million in California state tax.

Strategy: Some founders move to a no-income-tax state (Texas, Florida, Nevada, Washington) before selling. But you need to establish residency BEFORE the liquidity event, or California will argue you moved solely for tax avoidance. This requires documentation: apartment lease, utility bills, gym membership, voter registration, spending at least 183 days per year in the new state.

I've seen founders save over $1 million by moving to Texas a year before their exit. But I've also seen California audit people and claw back taxes when the move wasn't legitimate. Don't mess around with this. Work with a tax attorney if you're planning a move.

Can You Lose QSBS Status After You Qualify?

Yes. If the company redeems stock (buys back shares from shareholders) in certain ways, it can disqualify everyone's QSBS. The IRS has strict rules about redemptions.

Safe rule: Keep total redemptions under 2% of the company's stock value per year (measured by fair market value). If you go above that, you risk losing QSBS for everyone.

This matters for founders doing secondary sales (selling some shares to investors before an exit to get liquidity). If the company buys back shares as part of that transaction, it could blow up QSBS for all shareholders.

What to do: Work with a startup lawyer who understands QSBS. Make sure any secondary sales or redemptions are structured to preserve QSBS status.

Summary

QSBS is one of the most valuable tax breaks for founders and early employees, but it requires planning. Here's what serial entrepreneurs need to remember:

Structure each new company as a C-corp from day one
Hold stock for at least 5 years before selling
Make sure gross assets are under $50M when you acquire stock (matters for option exercises)
File 83(b) elections immediately when you get founder stock
Stack the $10M exclusion across multiple exits (it's per company)
Consider moving to a tax-friendly state before a big exit (but do it right)

The difference between knowing these rules and not knowing them is millions of dollars. If you're building a company right now and planning for an exit in 5+ years, talk to a CPA who specializes in QSBS. This is not the time to use your cousin who does tax returns for W-2 employees.

Sources:

IRS Section 1202 (Qualified Small Business Stock)
Case studies from serial founders (names changed for privacy)

QSBS: The $10M Tax Break Serial Founders Keep Missing