QSBS For Startup Founders
Qualified Small Business Stock (QSBS) remains one of the most powerful yet underutilized tax incentives available to startup founders. At QSBSrollover.com, our goal is to simplify this area of the tax code and help founders make informed decisions around formation, liquidity events, and exits.
Starting QSBS
Founders are typically the first individuals in a company to hold QSBS. When a C Corporation is formed and initial equity is issued, most legal counsel or formation platforms will advise founders to make an 83(b) election. This election accelerates the recognition of ownership and starts the five-year QSBS holding period immediately. There is essentially no earlier point at which anyone can receive QSBS-eligible shares than a company’s founding team.
Once the company is established, the presumption is that its operations qualify under the QSBS “qualified trade or business” requirement. However, certain industries are excluded by statute. Real estate firms, investment companies, law practices, and consultancies generally do not qualify. Founders in these areas should confirm their eligibility with a tax professional before assuming QSBS treatment applies.
QSBS for Startup Founders Video
As a business matures, founders may have opportunities to sell a portion of their holdings in secondary transactions, particularly during oversubscribed funding rounds at the Series A or B stages. In many cases, those shares will not have met the five-year holding requirement, which would normally disqualify the gain from QSBS treatment.
The primary method to preserve QSBS eligibility in this situation is through a QSBS Rollover, also referred to as a Section 1045 rollover. This provision allows a founder to reinvest proceeds from the sale of qualified stock into new QSBS-eligible stock within 60 days. By doing so, the investor effectively continues the original holding-period clock, maintaining potential eligibility for future exclusion of capital gains.
QSBS 5 Year Holding Period
If a founder holds QSBS for at least five years before an exit, the tax benefits can be substantial. The law permits exclusion of up to $10 million in capital gains from federal income tax. For example, a founder realizing an $8 million gain after six years would owe no federal income tax on that amount and, in many cases, would also be exempt from state income tax. In states such as New York, this can reduce a combined federal-and-state tax burden of roughly 37 percent to zero—a savings of $2.4 million to $3.5 million depending on location.
The $10 million exclusion applies per taxpayer, per company. For larger exits, this creates an opportunity to extend the benefit through an additional QSBS rollover. Consider a founder exiting for $18 million after seven years. The first $10 million may qualify for the original QSBS exclusion, while the remaining $8 million could be reinvested into a new qualified corporation. If that new stock also meets the five-year requirement, the entire $18 million in gains could ultimately be tax-free.
QSBS History and Planning Outcomes
For much of its history, QSBS was viewed as an obscure or limited incentive. Earlier versions of the law were less favorable, and as a result, relatively few advisors developed deep expertise in the area. However, several legislative updates over the past fifteen years have significantly improved its effectiveness, creating meaningful opportunities for founders and early-stage investors.
With proper planning, QSBS can materially alter a founder’s long-term financial outcome. It enables greater liquidity flexibility, supports reinvestment into new ventures, and helps preserve capital within the entrepreneurial ecosystem.
At QSBSrollover.com, our team focuses exclusively on this segment of the tax code. Whether you are structuring an early-stage company, preparing for a secondary sale, or evaluating the implications of an acquisition, we can help determine eligibility and identify strategies for maximizing the QSBS benefit.
For further information or a review of your specific situation, visit QSBSrollover.com or contact me directly at brady@qsbsrollover.com.
