Qualified Small Business Stock (QSBS) is stock in a qualifying US C corporation that can be excluded from federal capital gains tax under Section 1202 of the tax code. Hold it long enough and you can exclude gains up to the greater of $15 million ($10 million for stock issued on or before July 4, 2025) or 10 times your basis, per company. For startup employees, the way in is exercising options while the company still qualifies.

Below: the requirements, how the rules differ by issue date, how long you need to hold, and a worked example showing what QSBS is worth.

QSBS Requirements

• Domestic C corporation. The company must be a US C corp. LLCs and S corps don't qualify.
• Original issuance. You must acquire the stock directly from the company. Exercising stock options counts. Buying shares on the secondary market doesn't.
• Gross assets of $75 million or less. The company's aggregate gross assets must be at or below $75 million ($50 million for stock issued on or before July 4, 2025) before and immediately after your stock is issued.
• Active, qualifying business. At least 80% of the company's assets must be used in a qualified trade or business. Fields like finance, banking, insurance, law, consulting, health, hospitality, and farming are excluded.
• Individual holder. The stock must be held by an individual or certain pass-through entities, not a corporation.
• Holding period. At least 3 years for a partial exclusion on stock issued after July 4, 2025, or 5 years for the full exclusion (and for any exclusion on older stock).

Gross Assets, Not Valuation

The most common QSBS mistake is assuming a company's valuation decides eligibility. It doesn't. The test is aggregate gross assets: roughly the company's cash plus the tax basis of its other assets. A startup valued at $500 million that has raised $40 million may still qualify. A company that raises a $100 million round will likely push its gross assets over the limit, and stock issued after that point won't qualify, no matter the valuation.

Stock you already hold isn't disqualified when the company later grows past the threshold. That's why timing your exercise before a large fundraise can matter so much. Many companies will confirm whether they currently meet the gross asset test if you ask.

QSBS Rules by Issue Date

QSBS rules depend on when your stock was issued. Stock issued after July 4, 2025 follows the rules set by the One Big Beautiful Bill Act. Stock issued on or before that date follows the prior rules.

On a partial exclusion, the portion of the gain that isn't excluded is taxed at a higher rate than standard long-term capital gains, so the 5-year hold is still the target where you can manage it.

How QSBS Works for Startup Employees

Options aren't QSBS. The stock you get by exercising them can be. When you exercise ISOs or NSOs in a qualifying company, the shares you receive can qualify, and your holding period starts on the exercise date, not the grant date.

Earlier is usually better. Exercising while the company is small does three things at once: it locks in QSBS eligibility before a large fundraise can push gross assets over the limit, it starts your holding period, and it typically keeps your exercise cost and taxable spread low. Early exercise with an 83(b) election can start the clock even before your options vest.

You don't need to exercise everything. Exercising part of your grant while the company qualifies, and the rest later, still captures QSBS on the shares you exercised early.

QSBS Example: What It's Worth

Three employees each hold 100,000 NSOs with a $0.50 strike price at a startup with well under $75 million in gross assets. The 409A value is also $0.50, so exercising today costs $50,000 and creates no taxable spread.

• Employee A exercises now, while the company qualifies. Cost: $50,000.
• Employee B exercises after a large Series B pushes the company's gross assets past the limit and the 409A rises to $1.50. Cost: $50,000 plus about $40,000 in tax on the $100,000 spread.
• Employee C waits and exercises at the exit.

More than five years later, the company goes public and all three sell at $20.50 per share ($2.05 million).

Simplified for illustration: it ignores state tax, the 3.8% Net Investment Income Tax, and the time value of the cash A and B tied up. The takeaway still holds. Long-term capital gains put Employee B $380,000 ahead of C. QSBS put Employee A another $420,000 ahead of B, on the same shares and the same exit.

State Taxes and QSBS

QSBS is a federal exclusion. California doesn't conform and taxes the full gain, and a handful of other states don't fully follow it either. Check your state's rules, and be careful with a move timed around an exit: states can scrutinize whether a change of residency was genuine.

How to Exercise While Your Company Still Qualifies

QSBS rewards exercising early, and the exercise cost is usually what stops people. ESO Fund can help. Exercise your stock options and cover the taxes with no interest, no out-of-pocket cost, and no personal risk if the company fails. Your shares, your upside.

If you're at an early-stage company that may still meet the gross asset test, the window can close with the next big round. ESO Fund has worked with employees at 700+ venture-backed companies since 2012. See if you qualify, and see our stock option taxes guide for how QSBS fits with ISO and NSO tax planning.

This guide is for educational purposes and isn't tax advice. QSBS rules are complex; confirm eligibility with a tax professional.

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Written by Jordan Long, CMO at ESO Fund