Qualified Small Business Stock (QSBS) Explained
Qualified small business stock (QSBS)
Authors:
Michael Sechuga, JD, CPA, Holli Heiles Pandol
Read time: 12 minutes
Published date: 18 February 2026
Understand the qualified small business requirements and how to take advantage of QSBS tax treatment for eligible stock options.
What is qualified small business stock (QSBS)?
The qualified small business stock (QSBS) exclusion is a U.S. tax benefit that applies to eligible shareholders of a qualified small business (QSB). The QSBS tax exclusion is set forth in Section 1202 of the U.S. Internal Revenue Code (IRC), and allows founders and investors to potentially exclude up to 100% of federal capital gains tax on the sale of qualified stock held for over five years, if all the required conditions are met.
In 2025, new legislation expanded QSBS eligibility by raising the asset cap from $50 million to $75 million, increasing the individual benefit cap from $10 million to $15 million, and phasing in the benefit (50% capital gains tax exclusion for a three-year holding period, 75% exclusion for four years, 100% after five years). These changes only apply to shares issued after July 4, 2025.
Originally enacted as part of the Omnibus Budget Reconciliation Act of 1993, QSBS was designed to encourage investment in small businesses by rewarding entrepreneurs, early employees, and investors for taking the financial risk to build and fund new companies. Because founding, investing in, and working for a startup can be riskier by nature, the QSBS exclusion helps encourage people to take that risk. For anyone involved in a startup, understanding QSBS is an essential part of the journey, as Carta and industry groups like the NVCA actively work to protect QSBS at the federal level.
What are the requirements for QSBS?
To secure this significant tax break, both the company issuing the stock and the shareholder receiving it must meet a specific set of rules. The rules can be broken down into two main categories:
- Issuing company requirements: The corporation must be a qualified small business.
- Shareholder requirements: The individual must meet specific criteria in how and when they acquire and hold the stock.
While the QSBS requirements are detailed, they are manageable, especially when you plan for them from the very beginning of your company's life. Getting these details right from day one can prevent major headaches and lost opportunities years down the road.
Qualified small business (QSB) rules for eligibility
For a company's shares to be considered qualified small business stock, the issuing corporation itself must meet several criteria at the time the stock is issued:
C corporation structure: The company must be incorporated as a domestic C corporation in the U.S.
- Stock from an S corporation or an LLC does not qualify unless the company converts its legal structure to a C corp before issuing the shares.
Gross assets test: The company's aggregate gross assets are $75 million or less at all times before and immediately after the equity was issued.
Active business requirement: At least 80% of a company's assets must be used in the active conduct of a qualified trade or business. Excluded business types are determined by the IRS.
Stock issued by a company that no longer meets the QSB requirements may not qualify as QSBS.
2025 QSBS expansion: Main differences in eligibility requirements
| Company Gross Asset Limit | Shareholder Tax Benefit Cap | Share Holding Period |
|---|---|---|
| $50 million (before and immediately after equity issuance) | Up to $10 million (or 10x the share cost basis, whichever is greater) | Minimum of five years for 100% capital gains tax exclusion |
| $75 million (before and immediately after equity issuance) | Up to $15 million (or 10x the share cost basis, whichever is greater) | Minimum of three years, benefits phased in: 50% after 3 years, 75% after 4 years, 100% after 5 years |
Qualified small business stock (QSBS) rules for eligibility for shareholders
Eligible shareholder: The stock must be held by a non-corporate taxpayer.
Original issuance: You must have acquired the stock directly from the company at its original issuance.
QSBS holding period requirements
For shares issued on or after July 4, 2025, you must hold eligible stock for at least three years in order to qualify for QSBS tax benefits. Benefits are phased in, with a 50% capital gains tax exclusion for a three-year holding period, a 75% exclusion for a four-year holding period, and full exclusion up to 100% when eligible stock is held for five years.
QSBS tax treatment and benefits
Generally speaking, if you acquired QSBS-eligible stock after September 27, 2010, you can exclude up to 100% of the qualified gain. If you acquired the eligible stock before September 26, 2010, you can exclude a smaller percentage of the qualified gain.
QSBS location eligibility
Since QSBS is an amendment to the U.S. tax code, only employees who are U.S. taxpayers can take advantage of this federal income tax benefit.
Some states do not conform to the federal rule, presenting potential eligibility issues.
Frequently asked questions about QSBS
Does the QSBS exclusion apply to state taxes?
- The QSBS exclusion is a federal tax benefit, and its treatment at the state level varies.
Can an LLC or S-corp issue QSBS?
- No, only a C corporation can issue QSBS.
What is a Section 1045 rollover?
- A tax provision allowing a shareholder to sell their QSBS and defer paying capital gains tax by reinvesting into another QSBS opportunity.
The founder's guide to QSBS
Download our free guide to learn more about QSBS benefits, rules, and best practices—including how to take advantage of the QSBS tax exclusion and business actions that impact QSBS eligibility.
Author: Michael Sechuga, JD, CPA
Michael Sechuga is a Senior Technical Manager at Carta, guiding companies through QSBS qualification.
Author: Holli Heiles Pandol
Holli Heiles Pandol is Carta’s Policy Counsel.