Hold stock in a private company? Expanded Qualified Small Business Stock (QSBS) rules could increase your tax savings

Qualified Small Business Stock (QSBS) has long been one of the most valuable tax incentives available to people who own shares in U.S. small businesses or startups such as founders, early equity employees, and investors. The idea behind it is simple: if you build and invest in U.S. small businesses the tax code offers a reward for the financial risks and “sweat equity” taken if the business succeeds. When QSBS applies, a taxpayer may be able to exclude a substantial portion of federal capital gains tax when selling shares—often translating into millions of dollars of after-tax benefit.

After July 4, 2025, important expansions widened both the size and flexibility of the QSBS exclusion. Understanding how these new rules interact with prior law is essential for tax planning, liquidity event strategy, and long-term wealth planning—particularly for those who expect to eventually sell their shares in a private secondary sale, merger/acquisition, or public offering.

Do your shares qualify for the QSBS tax break?

Before considering the new rules, the first step is determining whether your shares qualify, as the basic rules to qualify have not changed.

In general, stock must be issued by a U.S. C corporation in exchange for cash, property (other than stock) or services. Secondary market purchases generally do not qualify. The company must also meet certain size limits when the shares are issued, and at least 80% of its assets must be used to actively operate the business rather than primarily being held for investment purposes.

The QSBS new rules—bigger and earlier tax breaks

While the qualification rules remain largely the same, the benefits themselves have expanded—both in size and flexibility.

Historically, QSBS operated under a strict five-year holding requirement. If shares were sold even a few days before the five-year mark, the exclusion generally did not apply, unless a 1045 rollover was applied within a stringent 60-day rollover to another QSBS eligible company.

The One Big Beautiful Bill Act introduced a parallel set of enhanced QSBS rules for newly acquired stock. For shares issued after July 4, 2025, a new tiered system allows shareholders to claim partial exclusions as early as year three, along with a higher dollar cap and a larger asset threshold for qualifying companies.

QSBS Rules: Before vs. After July 4, 2025

QSBS is enhanced and more forgiving with shorter holding periods and available to more stockholders to participate in a liquidity event earlier, allowing them to benefit from realizing personal life and financial goals sooner. As a result, planning around the QSBS exclusion becomes even more important—including strategies that can multiply the benefit across multiple taxpayers, such as spouses or properly structured non-grantor trusts.

Both sets of tax rules may apply to those holding shares pre- and post-July 2025

These enhancements also introduce additional complexity. Shareholders who have already utilized the maximum $10 million QSBS capital gains exclusion under the prior rules can participate in an additional $5 million of exclusion for shares acquired after July 4, 2025. In addition, for individuals with equity compensation from a QSBS-qualified company that was granted but not exercised before July 4, 2025, their newly acquired shares may qualify for the expanded QSBS exclusion after this date.

As a result, two sets of QSBS rules apply depending on when shares were acquired. Meaning, a single shareholder can hold multiple blocks of shares in the same company with different QSBS treatments.

For example, a founder might have early common stock issued years ago, additional shares issued later, equity issued as part of a financing round, and shares acquired through option exercises—each with its own issuance date and therefore its own set of QSBS rules. As a result, careful recordkeeping is no longer optional; it is the foundation of optimizing the benefit.

Example: How the new rules could affect a $20M exit¹

• Initial investment/cost basis: $500,000
• Company sale value: $20,000,000
• Total capital gain/spread: $19,500,000
• Federal capital gains tax rate: 31.8% (28% + 3.8% NIIT)

Under the new rules, a shareholder who exits after three years in this example could realize more than $3.81 million in federal tax savings—compared to no benefit under the prior rules, which required a full five-year holding period. Even at five years, the higher exclusion can still increase after-tax proceeds by more than $1.5 million compared to the old QSBS rules.

Common mistakes that can cost you the QSBS tax break

Despite the expanded benefits, there are still several common pitfalls to avoid that still hold true.

Make sure your company actually qualifies

QSBS qualifications still begin at the company level. Certain categories of businesses remain excluded, including many professional service and financial businesses. In today’s economy, however, eligibility is not always obvious from a company’s label alone. Some modern business models can sit in gray areas that require careful analysis. Assuming qualification without reviewing the underlying activities can create unpleasant surprises later.

The holding period trips up many shareholders

Even when the company qualifies, one of the most common issues is the holding period—the length of time you have owned your shares. Failing to track types of equity owned and monitoring changing values and tax considerations, in addition to failing to have an exercise strategy over equity options or grant awards, strong record-keeping of when shares were acquired, and personal shareholder holding period can lead to unpleasant and surprising tax consequences.

For employees and founders with equity compensation, timing is frequently misunderstood. The QSBS clock generally begins when stock is actually owned—after an option is exercised, or a convertible instrument converts—not when options are granted, not when they vest, and not when someone starts working at the company. As a result, “I’ve been here for five years” is not the same as “I’ve held QSBS for five years.” If the company is sold sooner than expected, that difference can have significant tax consequences.

Some states don’t recognize the QSBS tax break

State taxation is another common source of surprise. QSBS is a federal tax incentive. Some states fully conform, meaning no state income tax levied, which further increases the overall tax benefit. However, not every state conforms, meaning gains excluded at the federal level may still be taxed at the state level. For individuals living in high-tax or nonconforming states, a strong federal outcome can still result in a meaningful state tax bill. Modeling both systems side by side is essential, particularly when considering timing decisions, trust strategies, or potential relocation.

Certain transactions can disqualify your QSBS shares

Corporate and personal transactions can unintentionally undermine eligibility. Stock redemptions or repurchases—often used to simplify a company’s cap tables—can affect qualification if not structured carefully.

How to make the most of the QSBS tax break

Start planning before a liquidity event

To capture the full QSBS benefit, planning needs to start before a transaction is underway. With both the original and expanded QSBS rules potentially applying to different shares, effective planning requires proactive documentation and thoughtful structuring of equity decisions on an ongoing basis.

In practice, this means keeping track of when shares are issued, monitoring company growth and valuation, and understanding how changes, such as new financing rounds or rising 409A valuations (the company’s fair market value), can affect the cost of exercising options and the related tax impact.

Know when your shares were issued

Shareholders should identify when each block of equity was issued and understand which rules apply to each. This allows founders and boards to make more informed decisions about future equity issuance and structure and to monitor how close the company is to the applicable size threshold.

Make sure your shares meet the holding period

Once the applicable QSBS rules are determined, the next step is meeting the required holding period. Each block of shares must satisfy its own holding period, which now includes three-, four-, and five-year milestones under the new rules. Employees should factor timing and valuations when they exercise their options into planning, since it determines when the QSBS holding period begins.

Plan for early exits and preserving the QSBS benefits

If a company is sold before a full holding period is met, there may still be ways to preserve the tax benefit.

In a stock-for-stock transaction, where QSBS is exchanged for shares of the acquiring company, your original holding period generally carries over to the new shares. This means the QSBS clock can continue running, potentially allowing you to qualify for the full exclusion when those shares are sold in the future—even if the acquiring company itself is not a qualified small business.

If the transaction includes cash, Section 1045 rollover planning remains an important tool. Shareholders with a partial or full cash acquisition who have held QSBS for at least six months may defer gain by reinvesting the proceeds in a new QSBS within 60 days, potentially preserving the opportunity to qualify for exclusion later. In these transactions, your original holding period carries over to the new shares, allowing the QSBS clock to continue. However, the QSBS benefit is limited to the gain that existed at the time of the exchange. If the shares are later sold after meeting the five-year holding requirement (including your original holding period), you may still qualify for the QSBS exclusion, but only on that original built-in gain. This strategy can be useful for investors facing fund-driven exits outside their control.

Align federal and state tax planning with your broader estate strategy

Because QSBS is a federal tax benefit, its impact can vary depending on state tax treatment and overall wealth planning goals. Coordinating federal and state tax projections—and aligning QSBS decisions with estate and trust planning—can help ensure the full federal tax benefit is realized. There may be additional state income tax benefits that may be achieved as well. This is particularly important for shareholders considering timing decisions, transfers, or multi-state residency.

Consider gifting and estate planning strategies that expand the QSBS exclusion

QSBS stacking is another tax planning strategy used by founders and investors to multiply the $10 million or $15 million capital gains exclusion. It involves gifting QSBS-eligible shares to family members or specialized trusts before a sale, allowing each recipient to claim their own separate exclusion, thereby shielding more family wealth from federal (and some state) taxes. Trust structures, such as Delaware Directed Trusts, can play an important role to help achieve these tax and estate planning goals.

Turning opportunity into results

Taken together, these considerations underscore that QSBS planning is an ongoing process, not a one-time decision and requires strategic personal planning. The QSBS expansion significantly increases the potential after-tax value of a successful exit, but capturing that value depends on disciplined tracking, timing, and alignment with your overall financial goals. With thoughtful planning, QSBS can be one of the most powerful tools for enhancing after-tax proceeds. Without it, the opportunity can be reduced, or lost entirely.

At Fiduciary Trust International, we help clients navigate their options to maximize the benefits of the QSBS exclusion and coordinate with the appropriate professionals to support a well-executed strategy.

 

 

 

1. In this example, the $15 million exclusion cap is shown in nominal dollars (i.e., it is not adjusted for inflation). The tax figures are calculated by taking total capital gain (sale proceeds minus cost basis), subtracting the applicable QSBS exclusion to determine taxable gain, and then applying a 31.8% total federal capital gains tax rate (28% + 3.8% NIIT) to that taxable gain. As of 2027 and thereafter the $15 million federal capital gain tax exclusion limit and the $75 million asset threshold will be indexed for inflation.