We talk to founders regularly who have heard of QSBS, know the $15 million number, and have mentally checked that box. Most of them haven't thought through how many things have to go right between now and an exit for that benefit to hold.
A poorly timed stock redemption. A business model shift that edges into a restricted industry. New shares issued after the company's balance sheet crossed a threshold nobody was watching. Each of these can disqualify equity that looked clean the day it was issued, and in most cases, nobody catches it until the term sheet is already signed.
The OBBBA changed the rules significantly in July 2025, and the new structure creates real planning opportunities for founders who are paying attention. We put together a video that walks through what the current rules require, where eligibility breaks down, and how the stacking strategies that can multiply the benefit are supposed to work.
If you have equity you expect to be worth something significant, watch it before your next funding round.
If you sold your company tomorrow, do you know what you'd owe in taxes? Most founders think they do. They've heard about QSBS and they know the $15 million number and they filed it away as something their lawyer is handling. What they're usually missing is how many things have to go right for that benefit to hold and how fast it disappears when one of them doesn't.
I'm Dan Magier, a Partner and Managing Director at Next Capital Management. This video covers what QSBS requires where founders run astray and why the gap between having this benefit and preserving it is wider than expected. Qualified small business stock known as Section 1202 of the tax code is one of the most significant tax benefits available to company founders.
If your equity qualifies and you've held it long enough, you may be able to exclude a substantial portion of your gain from federal capital gains tax entirely. Here's how the numbers work under current law. And yes, the exact calendar date dictates your entire strategy.
For stock issued after July 4th, 2025, the game has changed. Your lifetime exclusion cap is now $15 million or 10 times your adjusted basis. Under these new rules, you no longer have to wait a rigid five years to see a benefit.
The law now offers a graduated schedule. Hold for three years and 50% of your gain may be excluded. Hold for four years and that rises to 75%.
And if you cross the five-year mark, you can potentially exclude 100% of your gain up to the cap. But those early exits come with a catch. The unexcluded portion of your gain is taxed at a 28% rate.
And when you add the net investment income tax, your effective federal rate looks more like 15.9% for a three-year hold. That rate drops to just under 8% for a four-year hold. It's a massive discount compared to a standard asset sale.
But the math is complex. For stock issued before that July 2025 cutoff, the old rules apply. That means a strict $10 million cap and an all or nothing five-year hold with no partial credit.
The most common mistake I see founders make with QSBS is assumption. Founders who built venture-backed C-corporations assume they qualify. Sometimes they do, but other times something shifted along the way and nobody caught it.
Take the gross asset test. For stock issued under the current rules, your company's gross assets at the time of issuance had to be under $75 million. For older stock, that limit was $50 million.
But here's the trap. That limit is based on the tax basis of the assets on your balance sheet. Your company's market valuation does not change this number.
A significant capital raise or acquisition of a small competitor can push your balance sheet over that threshold in a few weeks. If new shares are issued after that limit is crossed, including through option exercises, those specific shares may not qualify. This means early employees are often hit the hardest.
The gross asset test is just one place this comes apart. At least 80% of the company's assets also need to be deployed in a qualified business throughout the entire holding period. And that requirement has to hold for as long as you own the stock.
Certain industries are explicitly excluded from QSBS, such as law, health, financial services, and consulting. Shifting your direction to target a new market is a normal part of scaling a business. If that new revenue stream pushes your company into one of these restricted categories, it can completely eliminate the tax exemption on your shares.
Then there's the redemption trap. If the company repurchases stock from any shareholder within a certain window, generally one year before or one year after a new issuance, that single transaction can disqualify the new shares for everyone on the cap table. Founders frequently use redemptions to clean up messy cap tables or to provide quick liquidity to a departing executive.
It rarely occurs to anyone in the room that it might affect the next funding round. We're going to spend an entire video on this topic because the list of ways founders lose eligibility is long. Stacking, which in my opinion is the part most people miss.
Protecting your own shares is the foundation, but Section 1202 goes further than a lot of founders realize. There's a gifting provision built into the law that allows you to transfer qualified stock to another person or entity. And when you do, that recipient gets their own separate $15 million exclusion on top of yours.
Imagine a founder who sets up three independent trusts before a sale, creating one for their spouse and one for each of their two children. The family now has four distinct exclusions. That means the total federal tax exclusion could climb from $15 million to $60 million.
The final outcome depends on your timeline and the exact legal structure. The timeline for this type of gifting is critical. It works best in the early stages of your company when the share value is still low.
Gifting shares at a low valuation means you use very little of your lifetime gift tax exemption. If you wait until a term sheet is already on the table, the shares are worth far more, which limits your options. This type of planning requires active coordination between your legal counsel and your wealth advisor from the beginning.
All that trust planning assumes the federal exclusion is the whole story. And for most founders it is, but QSBS is a federal benefit and each state sets their own rules on whether they recognize it. The majority of states conform to the federal treatment, but California does not.
A California-based founder may owe state capital gains tax on gain that is fully excluded at the federal level. New Jersey recently changed course and now conforms for tax years starting in 2026. Check with your attorney to ensure that you comply with your state's requirements.
For founders in non-conforming states, the federal savings are still worth protecting. A full exclusion on a $15 million gain at a 23.8% federal rate is a substantial number, but the tax picture looks different than it might appear on paper and you should know it before you plan around it. Founders getting the most from QSBS are treating it as an ongoing coordination problem.
Every funding round, every cap table change and every shift in business model is a moment when something can go right or wrong. In many cases, the people who would catch an issue are not talking to each other in real time. The attorney drafts the redemption agreement and the CPA finds out about it a year later during tax prep.
By then the damage is done. In the next videos in this series, we'll discuss ways founders lose eligibility and how to use a rollover strategy to carry the benefit into your next venture. If you have equity that you expect to be worth something significant at exit, understand where you stand before your next move, not after it.
At Next Capital, we work with founders on this kind of planning and you can connect with us through the link below.