Do My Startup Shares Qualify for 0% Capital Gains Tax Under Qualified Small Business Stock (QSBS) Law?
- Marcel Miu, CFA, CFP®
- Sep 18
- 6 min read
Updated: Nov 21
TL;DR
Yes, your startup shares could potentially qualify for a 0% federal capital gains tax on gains up to $15 million or 10 times your cost basis. This benefit falls under the Qualified Small Business Stock (QSBS) rules (Section 1202). To qualify, you must own stock (i.e., exercise your stock options) directly from a U.S. C-Corporation with less than $75 million in gross assets at the time of issue, hold it for over five years (for the full exclusion), and the company must operate in an eligible industry.
While the tax benefits of QSBS can be significant, eligibility is complex and subject to strict IRS requirements. Not all startup stock qualifies.
Case Study: The $700,000 Tax Bill That “Vanished”
For illustrative purposes only. This example does not represent actual client experiences or guarantee future results.
Let's talk about "Alex." Alex worked at a startup and exercised 75,000 stock options over the years. When the company had a major exit, Alex's stake was worth $2 million. It was the moment many startup employees dream of.
Then reality hit.
The potential federal tax bill was nearly $700,000. However, because Alex had unknowingly met a series of specific requirements, a part of the tax code called Section 1202 (QSBS) came into play. Under these specific circumstances, Alex was eligible to exclude the capital gains from federal taxes.
Paying zero capital gains tax on your equity gains is possible, but it is not automatic.
This post will walk you through how to determine if your shares might qualify for this benefit. We will cover the steps needed to pursue this tax advantage. You can also explore our webinar on QSBS for a more detailed discussion.
How Do I Know If My Shares Qualify?
You must generally meet a 5-point test. Your shares meet the requirements only if the company is a "qualified small business" with assets under a specific cap when you exercise your options or are granted stock. You also must hold the actual stock, not just the options, for five years (for the full exclusion).
The rules are strict. Aiming for a 0% tax rate requires careful planning and adherence to regulations. Missing a requirement could result in the disqualification of the tax benefit. This visual breaks down the journey from qualification to potential tax-free gains.
Is the Company a "Qualified Business"?
Your company's main revenue must come from a qualified trade or business, like technology, manufacturing, or retail.
It must be an active U.S. C-Corporation. Service-based businesses, like financial services, hospitality, farming, and consulting, are generally not eligible. The table here provides a breakdown of eligible vs. ineligible industries.
Did the Company Meet the Asset Test When I Got My Stock?
The rules have become more generous as of July 2025. For "Legacy" shares issued before the new law, the company's gross assets must have been below $50 million. For shares issued after the new law, the cap is $75 million (indexed to inflation).
This test applies immediately before and after you receive your stock. If you acquire shares via stock options, this applies on your exercise date. Note that a company's valuation is not the same as its gross assets. A company with a high valuation could still have qualifying book assets, as shown below. New cash from a funding round counts, so the timing of your exercise is critical.
Do I Own Stock or Just Options?
You must own the stock directly!! The 5-year holding period for QSBS does not start until you exercise your stock options and officially own the shares.
Waiting to exercise may impact your ability to qualify if the company grows beyond the asset cap. While exercising early can start your holding period clock, it also involves upfront costs and investment risk. This strategy should be weighed carefully against the potential tax benefits.
What Happens If My Company Is Acquired Before 5 Years?
You do not necessarily lose the benefit, but the outcome depends on the deal structure. In a stock-for-stock acquisition with another QSBS-qualified company, your holding period and QSBS status may "tack on." In a cash-out deal, you may lose the benefit unless you execute a Section 1045 rollover.
The implications of each deal type are outlined in the table below. In a stock-for-stock acquisition, if the acquirer is not QSBS-eligible, your tax-free gain is generally frozen at its value on the merger day. Future growth would likely be taxable. The new rules add complexity for partial holds.
How Do I Prove My Shares are QSBS-Eligible?
Documentation is crucial for substantiating your claim in the event of an IRS audit. We recommend creating a "QSBS Vault" with specific records from the time of exercise through the eventual sale.
The burden of proof is on you, the taxpayer. Without appropriate records, the IRS may deny your claim. The framework here shows what records are generally required. An effective way to support your claim is to have your company's finance or legal team complete an attestation checklist before you acquire your shares.
Attestation Checklist to send to CFO / Head of Finance / Legal: Click here
FAQs
What is the difference between Legacy and new QSBS rules?
The new law increased the asset cap from $50 million to a $75 million inflation-adjusted cap. It also raised the gain exclusion cap to $15 million and allows for partial benefits after three and four-year holds. Legacy shares generally require a full five-year hold.
Can I roll over QSBS gains if I sell before 5 years?
Yes, Section 1045 of the tax code allows you to defer the gain by rolling the proceeds into another QSBS-eligible stock within 60 days of the sale. This strategy can preserve the tax benefit if you leave a company early, but it involves strict timelines and investment risks.
What is "QSBS stacking"?
This is an advanced strategy where shares are gifted to multiple irrevocable trusts. While this may allow for "stacking" multiple exclusions, it is a complex area of tax law that is subject to high scrutiny. This strategy requires guidance from qualified legal and tax professionals.
What states do not conform to federal QSBS rules?
Be aware of state taxes. Several states, including California, Pennsylvania, and New Jersey, do not follow the federal QSBS exclusion and may tax your gains at state income tax rates, even if they are exempt from federal taxes.
Your Next Steps
Here is how to take action and determine your QSBS strategy.
Take the Gut Check. First, ask yourself if the risk and illiquidity are appropriate for your situation. Can you afford the cash to exercise and potentially pay Alternative Minimum Tax (AMT)? Can you lock up this money for 3-5 years?
Verify Eligibility with Your Company. Send a formal questionnaire to your company's CFO, controller, or legal department. Obtaining a signed attestation letter acts as strong evidence of eligibility.
Attestation Checklist to send to CFO / Head of Finance / Legal: Click here
Create Your QSBS Vault. Organize your documents now. Use a file-retention framework to save every key document, from your exercise confirmation and 83(b) election receipt to the company's 409A valuation.
Model Your Exercise Strategy. The timing of your exercise is a critical decision. A common approach involves weighing the trade-off between the cash outlay now versus the potential for future tax benefits.
Don't Potentially Leave Millions on the Table
Navigating QSBS rules is complex, but the potential payoff can be significant. Proactive planning is key to capturing these benefits. This means verifying eligibility, documenting your holdings, and strategically timing your stock option exercise.
If you hold equity in a startup that might be QSBS-eligible, the stakes are too high to guess. Let's build a clear strategy together. Schedule a consultation to model your potential tax savings and create your QSBS action plan.
This blog is for educational purposes only and should not be taken as individual advice
Simplify Wealth Planning
Fast-Tracking Work Optional For Tech Pros | Turn Your Stock Comp Into Wealth, Cut Taxes & Live Life Your Way | Flat Fees Starting at $3k - Not Based On How Much Money You Have
Marcel Miu, CFA and CFP is the Founder and Lead Wealth Planner at Simplify Wealth Planning. Simplify Wealth Planning is dedicated to helping tech professionals master their money and achieve their financial goals.
Disclosures
Simplify Wealth Planning, LLC (“SWP”) is a registered investment adviser in Texas and in other jurisdictions where exempt; registration does not imply a certain level of skill or training.
If this blog refers to any client scenario, case study, projection or other illustrative figure: such examples are hypothetical and based on composite client situations. Results are for informational purposes only, are not guarantees of future outcomes, and rely on assumptions specific to the scenario (e.g., age, time horizon, tax rate, portfolio allocation). Full methodology, risks and limitations are available upon request.
Past performance is not indicative of future results. This message should not be construed as individualized investment, tax or legal advice, and all information is provided “as-is,” without warranty.
The material and discussions are for informational purposes only. These do not constitute investment advice and is not intended as an endorsement for any specific investment.
The information presented in this blog is the opinion of Simplify Wealth Planning and does not reflect the view of any other person or entity. The information provided is believed to be from reliable sources, but no liability is accepted for any inaccuracies.
We recommend consulting with your independent legal, tax, and financial advisors before making any decisions based on the information from this blog or any of the resources we provide herewithin (models, etc).
