You founded a tech company. You worked 80 hours a week for years.
Finally, Google acquires your startup for $15 Million.
You are celebrating, until your accountant mentions the 23.8% Federal Capital Gains Tax. That's over $3.5 Million gone.
But wait. If you structured your company correctly, you might owe the IRS exactly $0.
This miracle is called QSBS (Qualified Small Business Stock) under Section 1202 of the tax code. It is the single biggest tax break for entrepreneurs in America.
Disclaimer: QSBS rules are extremely complex and were recently updated in July 2025. This article is for informational purposes only. Consult a tax attorney specializing in Section 1202.
Sold Your Startup for Millions?
1. What Is the QSBS Exemption? (Section 1202)
To encourage investment in small businesses, the US government offers a massive reward.
If your stock qualifies as QSBS, you can exclude 100% of your capital gains from federal taxes.
🆕 2025 Law Update (The "OBBBA" Act)
Under the One Big Beautiful Bill Act signed on July 4, 2025, the rules have improved for stock acquired after this date:
- Higher Limit: Exclusion increased from $10 Million to $15 Million.
- Larger Cap: Company asset limit raised from $50 Million to $75 Million.
- Faster Vesting: You now get a partial 50% exclusion after just 3 years (previously 0%).
(Note: For stock acquired before July 2025, the old $10M limit and strict 5-year wait still apply.)
Crucial Warning: While federal tax is $0, some states (California, New Jersey, Pennsylvania) do NOT honor this federal break and will still tax you.
2. The "Must-Have" Checklist
Not every startup stock qualifies. You must meet ALL these criteria:
✅ The 5 Golden Rules
- It Must be a C-Corporation: Stocks from LLCs or S-Corps do NOT qualify. (Most VC-backed startups are Delaware C-Corps for this reason).
- Original Issuance: You must have bought the stock directly from the company (not from another shareholder).
- The Asset Cap: Company assets must be under $75 Million (or $50M for older stock) at the time of issuance.
- Active Business: The company must make things or provide services. (Excluded: Banking, Hotels, Restaurants, Farming, and Law Firms).
- Holding Period: Generally 5 years for 100% tax-free status.
3. The "83(b) Election" Trap (Don't Miss This!)
If your stock has "vesting" (e.g., you earn it over 4 years), your 5-year QSBS clock does NOT start when you join.
⚠️ The 30-Day Deadline
To start the clock immediately, you MUST file an "83(b) Election" with the IRS within 30 days of receiving your stock.
If you miss this 30-day window, you might have to wait years longer to sell tax-free. There are no exceptions for being late.
4. What If You Sell Early? (Section 1045)
If your company gets bought out after only 2 years, do you lose the tax break?
Not necessarily.
You can use Section 1045 (QSBS Rollover).
This allows you to take your profit and reinvest it into another qualified small business stock within 60 days. This keeps your "QSBS clock" ticking until you hit the 5-year mark.
5. Why "LLC vs. C-Corp" Matters
Many founders start as an LLC to avoid "double taxation."
However, if you plan to have a massive exit, starting as an LLC is a mistake because LLC interests are never QSBS.
If you convert an LLC to a C-Corp later, only the appreciation after the conversion counts. You might lose years of tax-free gains.
The $15 Million Reward for Patience
QSBS is the government's way of saying "Thank you for taking a risk."
If you are joining a startup today, ask the founder: "Is this stock QSBS qualified?"
If you are founding a company, talk to a lawyer about incorporating as a C-Corp and filing your 83(b) Election immediately.
Action Plan:
- Check your stock purchase agreement. Is the entity a C-Corp?
- Did you file your 83(b)? If you received stock recently, do it TODAY.
- Redemption Warning: Do not sell your stock back to the company. Significant "Buybacks" can disqualify QSBS status for all shareholders.
Helpful Resources:
IRS Instructions for Schedule D (Section 1202)
Investopedia: Qualified Small Business Stock (QSBS)
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