QSBS Eligibility Requirements: Is Your Business Qualified?

Quick Overview

Qualified Small Business Stock (QSBS) can provide founders, investors, and employees with significant tax benefits—but only if your business meets specific eligibility requirements. This article breaks down the key criteria your company must satisfy to qualify for QSBS treatment under Section 1202, including business structure, asset limits, industry requirements, and holding periods. Not sure if you qualify? Take our quick eligibility quiz to find out in minutes.

The Core QSBS Eligibility Requirements

When I talk to founders about tax planning, one of the first questions I ask is whether their company qualifies for QSBS benefits. The difference can mean millions in tax savings, but many entrepreneurs are surprised to learn that not all startups automatically qualify.

Section 1202 of the Internal Revenue Code sets out several specific requirements that must ALL be met. Let's break them down one by one:

1. C-Corporation Status

First and most importantly, your company must be a domestic C-Corporation. This is non-negotiable.

LLCs, S-Corporations, and partnerships do not qualify for QSBS treatment. If you're currently operating as an LLC or other pass-through entity, you'll need to convert to a C-Corporation to start the QSBS qualification clock.

When we founded Trust & Will, we incorporated as a C-Corp from day one, which proved to be a wise decision as the company grew. It’s common for investors to make being a C-Corp a requirement for investment. If you plan on raising capital, forming a C-Corp from the get go is a common strategy. 

Pro Tip: If you're converting from an LLC to a C-Corporation, the conversion date becomes your QSBS clock start date as long as you purchase and hold your equity when you convert - file those 83(b) elections! This means you'll need to hold the stock for 5 years from the conversion date, not from your original LLC formation date.

2. Gross Asset Limitation

Your company's aggregate gross assets must not exceed $50 million before and immediately after the stock issuance.

This means:

• Prior to the issuance, the company's gross assets (generally the sum of cash and the adjusted basis of property) must be $50 million or less

• Immediately after the issuance, the company's gross assets must still be $50 million or less

This limit applies at the time the stock is issued, not when it's sold. So your company can grow well beyond $50 million after stock issuance and still qualify for QSBS treatment.

For example, many unicorn founders who started with less than $50 million in assets still qualify for QSBS benefits on their original shares, even though their companies are now valued at billions.

An important distinction here is that the $50m limit is in assets, NOT valuation. You can raise a $20m round, at a $100m valuation and your stock can still qualify, as long as you don’t have more than $50m in gross assets (in your bank accounts or the sum value of your tangible property). 

3. Original Issuance Requirement

You must acquire the stock at its original issuance, directly from the company, in exchange for:

• Money

• Property (excluding stock)

• Services

Stock purchased on secondary markets or from other shareholders generally doesn't qualify. However, there are exceptions for gifts, inheritances, certain distributions from partnerships, and specific tax-free transactions where the "original issuance" status can transfer.

This is why founders, early employees, and initial investors are the ones who typically benefit most from QSBS—they receive their shares directly from the company.

4. Active Business Requirement

At least 80% of the corporation's assets (by value) must be used in the "active conduct" of one or more qualified trades or businesses during substantially all of your holding period.

This excludes companies that are primarily:

• Holding investments

• Managing real estate

• Sitting on large cash reserves without active business operations

The IRS looks at how assets are being used, not just what they are. A tech company with significant cash reserves can still qualify if those reserves are held for expanding operations rather than for investment purposes.

This also means that you can’t invest a large portion of your cash reserve (generally 15% or more) into the stock market or buying other assets like crypto. This can be tempting when your company raises a large round and has an excess cash reserve, but it's best to sit on it or park in a HYSA.

5. Qualified Trade or Business

Not all business types qualify for QSBS treatment. Section 1202(e)(3) specifically excludes:

• Professional services (law, medicine, accounting, consulting, financial services, etc.)

• Banking, insurance, financing, leasing, or investing businesses

• Farming operations

• Mining and natural resource businesses

• Hospitality businesses like hotels and restaurants

• Businesses where the reputation or skill of employees is the principal asset

Technology companies, manufacturing businesses, and retail operations typically qualify. This is one reason why tech startups have been among the biggest beneficiaries of the QSBS provisions.

6. Five-Year Holding Period

To receive the full QSBS exclusion benefit, you must hold the stock for at least 5 years before selling.

If you sell before the 5-year mark, you generally lose the QSBS benefits. However, there are certain exceptions where you can roll over the gain into other QSBS within 60 days and preserve the tax benefits.

Remember that the holding period is transferable—if you gift QSBS to a family member or trust after holding it for 3 years, they only need to hold it for 2 more years to reach the 5-year threshold.

Common Eligibility Questions

"What if my company has significant intellectual property but few tangible assets?"

Intellectual property counts toward your "active business" assets. Many tech companies with substantial IP but minimal physical assets still easily meet the 80% active business requirement.

"Can I qualify if I received stock options or RSUs?"

Stock acquired through the exercise of options or settlement of RSUs can qualify as QSBS, provided the underlying stock meets all the requirements and you receive the actual shares (not cash) at exercise.

"Does each round of funding restart the 5-year clock?"

No, each stock issuance has its own 5-year clock. Your Series A shares might qualify while your later Series C shares are still in their holding period. It all depends on when you actually acquired the stock, not when the option to buy the stock was granted to you. 

“Are my stock options QSBS eligible?”

The holding period begins when you acquire the stock typically by purchasing it outright, not when the option to buy is granted to you. This is an important distinction many founders and early employees overlook, thinking that their options will be QSBS eligible as soon as they exercise them. This is not the case. The 5 year clock starts when you exercise the option and acquire the shares. 

"What if I'm in a borderline industry?"

The distinction between qualified and non-qualified businesses can sometimes be blurry. For example, a software company that provides financial services might need careful analysis to determine if it qualifies. This is where professional guidance is crucial.

Check Your Eligibility

Not sure if your business qualifies for QSBS benefits? We've built a handy eligibility quiz that walks you through all the requirements step by step. In just a few minutes, you can determine if your business is likely to qualify and identify any potential issues that might need addressing.

Establishing your eligibility early in your business journey can help you make strategic decisions about your corporate structure, financing, and operations to maximize your QSBS benefits down the road.

Key Takeaways

• Your business must be a domestic C-Corporation with gross assets under $50 million at stock issuance

• The stock must be originally issued directly from the company

• At least 80% of assets must be used in "active business" operations

• Certain industries like professional services, finance, and hospitality don't qualify

• You must hold the stock for at least 5 years to get the full benefit

• Each stock issuance has its own separate eligibility analysis

• The holding period is transferable to gifts or inherited shares

• Take our eligibility quiz to quickly determine if your business qualifies

Disclaimer

Tax laws are complex and constantly evolving. While this article provides general information about QSBS eligibility requirements, it should not be considered legal or tax advice. Each situation is unique, and tax treatment can vary based on individual circumstances. Always consult with qualified tax and legal professionals before making decisions based on the information provided here.

Ready to determine if your business qualifies for QSBS benefits? Take our quick eligibility quiz at Promissory to find out, then start planning your QSBS strategy. Our platform streamlines the entire QSBS process from legal document creation to trust custody in Nevada and even valuation of private company assets—all in one platform for a fraction of the cost of traditional attorney services. Create an account today and maximize your future wealth.