Written by: David Cooper
Why this matters: Qualified Small Business Stock (QSBS) offers one of the most powerful tax benefits available to business owners and investors: the potential to exclude millions of dollars in capital gains from tax. But taking advantage of QSBS isn’t automatic. The structure of your business, the timing of incorporation, and the way you hold stock all determine whether you qualify. Recent changes under the One Big Beautiful Bill (OBBB) expanded opportunities, but they also make planning with your tax advisor from the very beginning more critical than ever.
Key Takeaways:
- The timing of when you incorporate as a C-corporation matters—your holding period and eligibility clock starts when stock is issued, not when the business begins operating.
- Changes under OBBB expanded benefits, including a shorter holding period for partial exclusions and higher asset and exclusion thresholds.
- Early consultation with a tax advisor can prevent costly missteps—like missing out on millions in tax-free gains due to entity choice or timing.
- QSBS is most beneficial when planning is aligned with growth expectations, funding strategies, and exit timelines.
Why Planning Early Matters
As our team has seen firsthand, the biggest risk with QSBS is not the complexity of the rules—it’s missing the window of opportunity. In two recent client cases, businesses that began as LLCs later converted to C-corporations, but too late. One missed the five-year holding requirement by less than a year. Another had grown so quickly that by the time it incorporated, its valuation exceeded the $50 million limit (now $75 million under OBBB). In both cases, millions in potential tax-free gain were lost.
These scenarios highlight the core message: when you become a C-corporation matters. If incorporation happens after substantial growth or too close to a potential sale, eligibility for QSBS may be lost.
Recent Changes Under the One Big Beautiful Bill (OBBB)
Legislation passed as part of the OBBB in 2025 expanded QSBS opportunities:
- Partial exclusions sooner: Investors acquiring stock directly from a QSBS after July 4, 2025, can now receive a 50% exclusion after three years, with phased increases leading to 100% at five years (previously only available at the five-year mark).
- Higher asset threshold: For stock issued after July 4, 2025, the gross asset cap for qualifying as a small business increased from $50 million to $75 million.
- Higher per-taxpayer cap: The lifetime exclusion per Qualified Small Business Corporation (issuer) cap rose from $10 million to $15 million for QSBS acquired after July 4, 2025.
These adjustments create more flexibility for founders and investors. They also mean that even companies experiencing rapid growth have a larger window of opportunity to plan and qualify.
The Role of Your Tax Advisor
QSBS rules aren’t intuitive. For example:
- Forming an LLC and later converting doesn’t “backdate” your holding period—you must start the QSBS holding period clock when C-corp stock is issued.
- The stock must be acquired directly from the corporation.
- Not all industries qualify (healthcare, law, accounting, financial services, insurance, banking, athletics, and hospitality are excluded).
- Loss utilization strategies in early years may conflict with QSBS planning.
A tax advisor can help weigh these trade-offs. In some cases, it may make sense to accept early-year losses in a pass-through entity. In others, starting as a C-corp may be worth it to secure long-term benefits, especially when federal C-corporation rates (21%) are lower than individual rates (up to 37%)
Planning conversations should start as soon as a business is formed or when a new investment is considered. An upfront investment of time and cost to understand QSBS can prevent multi-million-dollar surprises later.
When to Start the Conversation
- Founders: If you believe your idea has high-growth potential, consider QSBS eligibility before forming your entity.
- Investors: Evaluate QSBS qualification as part of due diligence—this can tip the scales when comparing opportunities.
- Businesses nearing $50–$75 million in assets: Timing is critical. Incorporating before crossing the threshold may preserve eligibility.
- Those anticipating an exit in under five years: The new phased-in exclusions may still provide meaningful tax savings.
Final Thought
QSBS planning isn’t about memorizing the technical details—it’s about avoiding costly mistakes by structuring your business the right way from the start. The opportunity is significant: millions of dollars in potential tax-free gains. But it requires foresight. If you’re launching, investing in, or growing a business, the most valuable move you can make is to bring your tax advisor into the conversation early.
FAQ: Qualified Small Business Stock
How do I know if a stock is qualified for small business?
Only stock issued by a domestic C-corporation that meets the gross asset and active business requirements may qualify. Stock acquired from third parties does not.
What businesses are not QSBS eligible?
Exclusions include professional services such as health, law, accounting, athletics, financial services, insurance, banking, and hospitality.
Does the period operating as an LLC before incorporating count toward the holding period?
No. The clock starts when stock is issued by a C-corporation, not when the LLC began operations.
What are the benefits of QSBS?
Depending on the investment, holding period, and when the stock was acquired, the greater of up to $15 million—or 10 times your basis—of capital gains can be excluded from federal tax. With OBBB, partial exclusions are available after three years.
How long do I need to hold QSBS?
Full exclusion requires a five-year holding period, but for QSBS stock acquired after July 4, 2025, partial exclusions begin after three years.
Can an S corporation qualify?
No. Only C-corporation stock may qualify.