Small Business Stock (QSBS) After the 2025 Tax Law

If you are starting a company or investing in one, the choices you make now can decide how much tax you pay on a sale years from now. The federal exclusion for qualified small business stock, usually called QSBS, can take millions of dollars of gain off your return. The July 2025 tax law made it faster and larger for new stock.

The new rules apply to stock acquired at original issue after July 4, 2025. Stock acquired earlier keeps the old rules. Here is what changed, what did not, and what we would document from the first day.

What changed for new stock

For stock acquired after July 4, 2025, the benefit no longer requires a five-year wait. Stock held at least three years qualifies for a 50 percent exclusion, at least four years for 75 percent, and five years or more for 100 percent. The cap on qualifying gain from one company rises from $10 million to $15 million, or 10 times your basis in the stock if that is larger. The company's gross assets can now be as high as $75 million when the stock is issued, up from $50 million. Starting in 2027, both the $15 million cap and the $75 million limit rise with inflation.

The early tiers are less generous than they look. The taxable part of the gain at three or four years is taxed at up to 28 percent, not the usual 20 percent long-term rate. One piece of good news: excluded gain at any tier does not count toward the alternative minimum tax.

What stays the same for older stock

Stock acquired on or before July 4, 2025 keeps the old rules. For stock acquired after September 27, 2010, that means a 100 percent exclusion after more than five years, a cap of $10 million or 10 times basis, and a $50 million gross asset test at issuance. If you own older and newer shares of the same company, the two caps interact, so the order in which you sell can matter.

The core requirements still apply

The stock must come from a domestic C corporation, and you must acquire it at original issue, directly from the company, in exchange for money, other property or services. Shares bought from another shareholder do not qualify. During substantially all of your holding period, at least 80 percent of the company's assets must be used in an active qualified business.

Many fields are excluded, including health, law, engineering, architecture, accounting, consulting, financial services, athletics and the performing arts, along with banking, investing, farming, and hotels and restaurants. Insurance, brokerage, financing, leasing, actuarial work, and mining or oil and gas production are excluded too. So is any business whose main asset is the reputation or skill of its employees.

Choosing an entity for a new venture

QSBS is available only for C corporation stock, and that is a real trade-off. A C corporation pays federal tax on its profits at 21 percent, plus California's 8.84 percent, and owners pay tax again on dividends. An LLC or S corporation avoids that second layer while the business runs. For a company that plans to reinvest its profits and sell at a large gain, the exclusion can outweigh the corporate tax. For a business that will pay out its profits every year, it often does not. We run the numbers both ways.

Converting later is possible, but timing matters. When an LLC taxed as a partnership becomes a C corporation, the QSBS clock starts on the conversion date, and the stock's QSBS basis is the fair market value of the business at that time. Growth before conversion is not excluded, and that value counts toward the $75 million test. If you held the LLC interest before July 5, 2025, the old rules may apply to the new stock. S corporation stock issued while the S election was in effect never qualifies, even after the election ends. Restructuring an S corporation to create qualifying stock can work, but it requires legal documents, so work with an attorney while we handle the tax side.

Rollovers, gifts and trusts

If you sell QSBS you have held more than six months, section 1045 lets you defer the gain by buying new qualifying stock within 60 days. The 2025 law did not change that rule. The replacement stock takes the original shares' start date, so rolling over shares acquired on or before July 4, 2025 generally keeps you under the old rules.

Gifts keep QSBS status, and the person who receives the stock takes over your holding period. Some families give shares to trusts so that more than one taxpayer can claim the cap. Those plans turn on trust drafting and anti-abuse rules, so they belong with an estate planning attorney; we handle the tax side.

California does not follow QSBS

California has no QSBS exclusion and no section 1045 rollover. It taxes capital gains as ordinary income, so a resident who owes no federal tax on a qualifying sale can still owe California tax on the entire gain. For founders here, QSBS is a federal benefit only, and the entity decision should reflect that.

Records to keep from the first day

A QSBS claim is proven with paperwork, often years after the fact. Keep the company's balance sheet as of each stock issuance, showing gross assets before and right after the money came in. Keep subscription agreements, board approvals and proof of payment for every issuance. If founder shares vest over time, a section 83(b) election filed within 30 days after the shares are issued to you starts the clock on the issue date; without it, each vesting date starts a new clock. Track any stock the company buys back, because redemptions near an issuance can disqualify shares. If you invest through a SAFE or a convertible note, the clock may not start until it converts into stock. If you are an investor, ask the company to confirm in writing that it met the tests when your shares were issued.

Book a planning call

If you are forming a company or investing in one, talk with us before the documents are signed. Book a time with our team at calendly.com/kirkcole/15-minute-meeting.

This article is general information, not tax advice for your situation. Tax rules change, and the right move depends on your facts.