For startup founders, few tax incentives are as powerful, or as overlooked, as Qualified Small Business Stock (QSBS). If your startup qualifies and you structure things right from the beginning, you could exclude up to 100% of capital gains taxes on your exit. But the benefits come with strict rules, and the window to qualify starts from day one.

Here’s a deep dive into how QSBS works, who qualifies, and why it should be part of your long-term tax and exit planning strategy.
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What Is QSBS?

Qualified Small Business Stock (Section 1202 stock) is a tax exemption available under the U.S. Internal Revenue Code. If certain criteria are met, founders and early investors can exclude up to $10 million, or 10x the original investment, in capital gains from federal taxes when they sell their shares.

This provision is designed to reward and incentivize investment in high-risk, early-stage businesses.
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Why It Matters for Founders

If you’re planning for a significant liquidity event, acquisition, secondary sale, or IPO, the QSBS exclusion can dramatically change your personal financial outcome. Instead of giving away 20%+ of your gains to federal taxes, you could walk away with 100% of your eligible gains tax-free.

For a $5M–$10M exit, the difference can be life-changing.
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Key Requirements for QSBS Eligibility

To benefit from QSBS, both the company and the shareholder must meet several requirements:
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✅ For the Company:

• Must be a U.S. C-Corporation (not an LLC, S-Corp, or foreign entity)
• Gross assets must be under $50 million at the time of and immediately after the stock issuance
• Must be an active business (not an investment company or holding company)
• Must operate in a qualified industry (excludes finance, professional services, and hospitality)
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✅ For the Shareholder:

• Must acquire the shares directly from the company (not via secondary market)
• Must hold the shares for at least 5 years
• Must be a non-corporate taxpayer (individuals, trusts, etc.)
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Timing Is Everything

QSBS eligibility starts from the moment your shares are issued, not later in your company’s journey. That’s why it’s critical to structure your business correctly early on, especially when it comes to:

• Choosing the right entity type
• Documenting stock issuance properly
• Tracking capital contributions and valuations
• Ensuring compliance with the $50M asset test
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Any missteps in these areas can cost you the exemption later — even if your business otherwise qualifies.
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Common Mistakes Founders Make

• Forming as an LLC or S-Corp and converting too late
• Failing to document stock issuances properly
• Not holding shares for 5 years before a liquidity event
• Misunderstanding what counts as “active business” or qualified industries
• Overlooking the asset test after a large funding round
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Planning Ahead Pays Off

Savvy founders work with legal and financial advisors to plan around QSBS from day one. If you’re still pre-seed or seed stage, there’s time to get it right. If you’re post-Series A or preparing for an exit, it’s worth reviewing your structure now to see what options remain. This is where tax strategy becomes part of your overall startup roadmap, not just a last-minute concern at exit.
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Don’t leave your QSBS eligibility to chance

At Lazo, we help early-stage startups structure as C-Corps, track asset thresholds, and document equity grants properly, all to ensure your shares qualify under Section 1202. Whether you're just forming your company or reviewing your readiness for a future exit, our experts can guide you through the right steps to secure your QSBS tax exemption.
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