- Qualified small business stock (QSBS)
- What is qualified small business stock (QSBS)?
- What are the requirements for QSBS?
- Qualified small business (QSB) rules for eligibility
- The 2025 QSBS expansion: Main differences in eligibility requirements
- Qualified small business stock (QSBS) rules for eligibility for shareholders
- QSBS holding period requirements
- QSBS tax treatment and benefits
- QSBS location eligibility
- How QSBS is handled in investor rights agreements
- How to maintain QSBS eligibility and avoid common pitfalls
- How to prove your QSBS eligibility
- How to use QSBS to build your company
- Frequently asked questions about QSBS
- The founder's guide to QSBS
What is qualified small business stock (QSBS)?
The qualified small business stock (QSBS) exclusion is a U.S. tax benefit under Section 1202 of the Internal Revenue Code (IRC) that 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 required conditions are met.
In 2025, Congress passed H.R. 1, the One Big Beautiful Bill Act, which 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Originally enacted as part of the Omnibus Budget Reconciliation Act of 1993, QSBS was designed to encourage investment in small businesses by rewarding entrepreneurs, early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. It remains one of the most powerful tax incentives available to startup founders, employees, and investors. Carta and industry groups like the National Venture Capital Association (NVCA) actively work to protect QSBS at the federal level.
Note: The following article is intended to be a general summary of QSBS. We strongly recommend talking to a tax advisor before making any decisions about exercising or selling any equity.
What are the requirements for QSBS?
Both the company issuing the stock and the shareholder receiving it must meet a specific set of rules. The first set of rules applies to the issuing company itself, defining what makes it a qualified small business. The second set applies to the individual shareholder, outlining how and when they must acquire and hold the stock to be eligible for the tax benefit.
Qualified small business (QSB) rules for eligibility
For a company's shares to be considered qualified small business stock, the issuing corporation must meet several criteria at the time the stock is issued. These rules are designed to ensure the tax benefit goes to the types of small, growing businesses it was intended to support.
A company is known as a qualified small business when it meets the below qualification requirements:
C corporation structure: The company must be incorporated as a domestic C corporation in the U.S. This means 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. For shares issued before July 4, 2025, the gross assets threshold is $50 million.
Active business requirement: At least 80% of a company's assets must be used in the active conduct of a qualified trade or business. Assets held passively, such as investments, do not count toward this threshold. Excluded business types are determined by the IRS and include companies that:
Perform services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, or financial services
Rely on an employee or owner's reputation
Produce products, such as fossil fuels or mining, for which percentage depletion can be claimed
Operate a hotel, motel, restaurant, or similar business
Are a farming business
Stock issued by a company that no longer meets the QSB requirements may not qualify as QSBS. For a full list of requirements, see IRS's Pub. 550 or Section 1202.
If your company uses Carta for QSBS attestation, you can see which shares are eligible for the QSBS exclusion today, as well as which shares will be eligible for tax benefits after the required holding period, within your Carta account.
The 2025 QSBS expansion: Main differences in eligibility requirements
For shares issued before July 4, 2025 | For shares issued on or after July 4, 2025 | |
Company gross asset limit | $50 million (before and immediately after equity issuance) | $75 million (before and immediately after equity issuance) |
Share holding period to be eligible for tax benefits | Minimum of five years for 100% capital gains tax exclusion (for shares acquired on or after September 27, 2010). Shareholders who acquired eligible shares before September 26, 2010 can exclude up to 50% or 75% of the qualified gain, depending on the acquisition date. A portion of the gains may be subject to the alternative minimum tax (AMT). | Minimum of three years, after which the benefits are phased in: 3 years: 50% exclusion; 4 years: 75% exclusion; 5 years: 100% exclusion |
Shareholder tax benefit cap | Up to $10 million (or 10x the share cost basis, whichever is greater) | Up to $15 million (or 10x the share cost basis, whichever is greater) |
QSBS attestation letter
A QSBS attestation letter documents your company's QSB status under IRS guidelines to support the eligibility of your shares. Carta is the only provider that delivers both:
A company-level summary for due diligence and internal compliance purposes
Individualized shareholder letters that can be used to support personal tax filings
Annual QSBS attestation helps to ensure founders, employees, and investors have reliable documentation if their QSBS benefit is ever reviewed or questioned.
What can cause QSB disqualification for companies
Certain actions can disqualify a company's QSB status, affecting all shareholders' ability to gain the exclusion:
Share repurchases: If share repurchases, also called redemptions, exceed a certain threshold, shares issued one year prior to and one year after the buyback may be disqualified.
Cash management of investments: Investing company assets into non-cash deposit instruments, like corporate bonds or money market funds, with liquidity terms more than 24 months could impact QSBS eligibility depending on the amount and company age.
Business model changes: If your company changed its business model and began to perform non-qualifying activities, your QSBS status may be affected.
Exceeding asset threshold: Acquisitions, fundraising rounds, licensing agreements, and inventory can cause a company to exceed the $75 million* gross asset threshold. Companies often lose their QSB status after raising multiple funding rounds for this reason. (For shares issued prior to July 4, 2025, the asset limit is $50 million.)*
The “substantially all” trap: It is a common misconception that QSBS is a set-it-and-forget-it benefit. Under Section 1202, a company must satisfy the active business requirements for “substantially all” of a shareholder's holding period. If a company fails these tests, perhaps by holding too much cash or pivoting to an excluded service industry, for a significant window of time, the stock may permanently lose its QSBS status. This is why annual attestation is critical. Waiting until an exit to review eligibility is often too late to correct issues that occurred years prior.
Qualified small business stock (QSBS) rules for eligibility for shareholders
In addition to the company-level rules, there are requirements that apply to the person or entity holding the stock.
Eligible shareholder: The stock must be held by a non-corporate taxpayer. This includes individuals, trusts, and pass-through entities.
Original issuance: You must have acquired the stock directly from the company at its original issuance. This means you cannot buy shares from another shareholder on a secondary market and have them qualify. Stock received from exercising stock options (including ISOs and NSOs), warrants, or convertible debt like a SAFE is considered acquired at original issuance.
Once you hold the stock, confirm whether your company is a QSB, as defined by the IRS and outlined above.
QSBS holding period requirements
For shares issued on or after July 4, 2025, you must hold eligible stock for at least three years 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, provided all conditions are met.
If you hold eligible shares, you may be subject to tax liabilities on the sale of those shares if you decide to sell before the holding period has been completed. Tender offers (buyback events), bilateral secondary transactions, and IPO events are all common liquidity events that allow you to sell private company stock.
Carta Equity Advisory offers 1:1 sessions with an equity tax advisor and QSBS tax filing guidance for startup employees. Find out how Carta can help your team make informed decisions on their equity.
QSBS tax treatment and benefits
When you sell shares, gains are typically subject to either short- or long-term capital gains rates. Short-term capital gains rates can reach as high as 37%, and long-term capital gains rates can be as high as 20%. QSBS status can reduce that federal rate to 0%. Excluded QSBS gains are also not subject to the 3.8% net investment income tax (NIIT), which can otherwise apply to investment income for higher earners. However, the tax benefits differ depending on when the QSBS shares were acquired.
If you acquired QSBS-eligible stock after September 27, 2010, you can exclude up to 100% of the qualified gain.Your gain is calculated against your tax basis in the shares, which is typically what you paid at original issuance. If you acquired the eligible stock before September 26, 2010, you can exclude a smaller percentage of the qualified gain—either 50% or 75%, depending on the acquisition date, and a portion of the gains may be subject to the alternative minimum tax (AMT).
Shareholders can claim the entire amount of eligible gains in one year, or spread it out over multiple years. If a shareholder works for or invests in multiple companies that qualify, they may independently claim the tax benefit for shares in each company.
QSBS location eligibility
Since QSBS is an amendment to the U.S. tax code, only employees who are U.S. taxpayers can claim this federal income tax benefit. And while many state jurisdictions conform to the federal tax code for state taxes, some states do not.
As of today, if you (the shareholder of company stock) are a resident in one of the following states or territories, you are not eligible for the QSBS tax exclusion at the state level:
Alabama
California
Mississippi
Pennsylvania
Puerto Rico
Hawaii and Massachusetts partially conform with the QSBS tax exclusion. The requirements vary based on the state of incorporation (for the company) and the state of residency (for the shareholder).
→ Learn more about QSBS stacking and packing
How QSBS is handled in investor rights agreements
While QSBS allows employees to exclude up to $15 million in federal capital gains, it can help investors save even more. QSBS protects up to 10x their investment from long-term capital gains taxes, or $15 million, whichever is greater. For example, an investor who put in $15 million could avoid paying federal capital gains tax on up to $150 million.
Investors have a direct stake in ensuring the companies they back maintain QSBS eligibility. Investor rights agreements (IRAs) are central to this. The National Venture Capital Association provides an IRA template, used as the industry standard by many law firms, that states a company will take reasonable actions to maintain QSBS eligibility and, if requested, send the required information to claim QSBS to investors.
With Carta QSBS attestation, you'll get the annual QSBS eligibility review, attestation letter, and ongoing guidance you need to meet investor rights agreement requirements.
How to maintain QSBS eligibility and avoid common pitfalls
Qualifying for QSBS is not a one-time event. The benefit can be lost if statutory requirements are not continuously met for "substantially all" of the shareholder's holding period, as required by Section 1202. As a company grows, raises capital, and evolves its business, certain actions can unintentionally disqualify its stock.
Here are some of the most common disqualifying events to watch for:
If the company no longer meets QSBS requirements (such as changing business models) during a substantial portion of your holding period, future QSBS claims could be at risk.
In mergers or acquisitions, eligibility may be preserved in some cases (for example, through tax-free share exchanges), but outcomes can vary, and you may need to track “tacked” holding periods or face limitations on the exclusion.
QSBS can generally only be transferred without losing its status through gift, inheritance, divorce, or from a partnership to its partners. Any other type of transfer will typically result in the loss of QSBS eligibility.
→ Learn how to preserve QSBS eligibility through a Section 1045 rollover
How to prove your QSBS eligibility
The responsibility for proving that shares qualify for the QSBS tax exclusion rests with the taxpayer. Years after receiving stock, tracking down historical financial records, board consents, and the data needed to prove every requirement was met can be difficult. This administrative burden can be a significant barrier to claiming the benefit you've earned, leading to a situation where taxpayers fail to claim benefits they’ve earned.
Because eligibility must be maintained over time, a single letter at the time of issuance isn't enough. Companies should perform a QSBS eligibility review and refresh their attestation letter at least once per year, as well as after major events like large financings, stock repurchases, or business model changes.
These annual letters create a paper trail of the company's status. This helps shareholders and tax advisors substantiate claims and allows the company to address potential eligibility gaps before they violate the "substantially all" requirement.
For companies like Luminary Cloud, providing this documentation was key to helping employees see the real value of their equity. The attestation letter gave them the confidence that their shares had a potential upside that larger companies couldn't match.
Having this letter from an independent third party like Carta gives shareholders the documentation they need to confidently claim the tax benefit.
How to use QSBS to build your company
QSBS is not just a tax break. Founders who plan for it early can use it as a competitive edge in both fundraising and hiring.
Attracting investors: Angel investors and VCs actively seek out QSBS-eligible companies because the exclusion improves their potential returns. Presenting a company that is QSBS-ready with clean documentation signals professionalism and organization, making the company a more attractive investment.
Hiring and retaining talent: QSBS can strengthen your equity package. For early employees, the potential for tax-free gains on their startup equity can matter more than a higher salary at a larger company. The prospect of tax-free gains gives startups a concrete edge when competing for talent against larger employers.
Startup Mezcalum is a perfect example of this strategy in action. By working with Carta to structure the company correctly from the start, Mezcalum was able to benefit its investors, founders, and employees, making its equity more valuable for everyone involved.
To learn how Carta can help you track eligibility and maximize your tax benefits, request a demo of Carta’s QSBS solution today.
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. Some states conform to the federal rule, while others, like California, do not offer a similar exclusion. Consult a tax professional for state-specific guidance.
Can an LLC or S-corp issue QSBS?
No, only a C corporation can issue QSBS. If your company is currently an LLC or an S corporation, it must convert to a C corp before issuing the stock for it to be eligible.
What is a Section 1045 rollover?
A Section 1045 rollover is a related tax provision that allows a shareholder to sell their QSBS and defer paying capital gains tax. This is possible if they reinvest the proceeds into another QSBS opportunity within a specific timeframe.
What is the Section 1202 exclusion?
Under IRC Section 1202, eligible shareholders can exclude up to 100% of federal capital gains on qualified Section 1202 stock held long enough to qualify.
What is the 80% rule for QSBS?
At least 80% of the company's assets must be used in the active conduct of a qualified trade or business.
The founder's guide to QSBS
Download the 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.
DISCLOSURE: This communication is on behalf of eShares, Inc. dba Carta, Inc. ("Carta"). This communication is for informational purposes only, and contains general information only. Carta is not, by means of this communication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein. © 2026 Carta. All rights reserved. Reproduction prohibited.
