The Most Powerful Tax Break in America

I’ve spent the last two years of my life diving deep into the wild world of tax optimization.

And I’ve learnt some very powerful things.

At last count, we use 26 (!) different strategies at my startup to bring down the taxes business owners pay.

But amongst all of these strategies, there is one specific tax break that is bigger than pretty much everything else combined.

The four magic letters are QSBS and this tax break can literally save startup investors, employees and founders tens of millions of dollars of taxes.

This article will break down:

• How QSBS works and what a startup founder needs to do to make their business eligible for it

• How to use QSBS to get the largest possible tax break

• How certain startup founders are multiplying the QSBS limit from $10M to many tens of millions of dollars (or in one case $100M+)

• What steps you can take if your startup ends up selling before the 5-year mark

• How QSBS works for startup employees and investors

Let’s get into it.

Table of Contents

• Overview

  • How QSBS Works

• QSBS Requirements

  • Active C-Corporation

  • The Asset Test

  • Qualified Trade or Business

  • Not Accidentally Blowing Up QSBS Status

• QSBS Rollover

  • If you get paid cash

  • If you get paid stock in the acquiring company

• QSBS Stacking

  • Gifting Shares to Friends and Family

  • Trusts That Multiply QSBS

• QSBS Conversions

  • QSBS Packing: The $500M Tax Break

• How to Think About QSBS

  • QSBS for Founders

  • QSBS for Investors

  • QSBS for Employees

Overview

QSBS is the single most generous tax break in America today as it allows you to pay no federal taxes on the greater of:

• $10M in gains

• 10 times what you paid for your shares

Because this benefit is so large and so generous, as a startup founder you want to be very careful to not accidentally blow up QSBS status.

Doing this would hurt just not you, but every single other shareholder in the business and can be an incredibly costly mistake.

Once you set your business up correctly, QSBS is mostly a waiting game as you have to wait five years for your shares to be eligible. If the business ends up selling before then, you can do a Section 1045 rollover to keep your QSBS clock ticking.

When the business starts growing and it’s likely that your company will be worth a lot of money, you should look into gifting shares to family members and setting up trusts to “stack” or multiply your QSBS limit.

To visualize how powerful this tax break is, consider this range of outcomes for a founder who owns 20% of her business and sells her company at different price points:

If they are in a state with no state income tax or in any of the 40+ states that respect QSBS, your take-home is the same as the numbers above.

How QSBS Works

We’ll discuss the specific requirements to qualify for QSBS in the next section, but generally speaking here is how you set yourself up for this tax break:

• Buy shares from your company (which needs to be a C-Corp) — typically, every founder does this at incorporation.

• Hold these shares for a period of 5 years before selling them.

• This automatically qualifies you for a $10M federal tax exemption or 10 times what you paid for the shares (whichever is greater).

• 40+ states also either follow QSBS legislation or have no state taxes so you would also owe no state taxes.

  • Here’s a list of states that do NOT respect QSBS tax treatment, where you’d still owe STATE taxes: California, Alabama, Mississippi, Pennsylvania, New Jersey, and Puerto Rico. Hawaii and Massachusetts offer partial eligibility.

You typically do not need a QSBS attestation letter or to do anything specific to get QSBS. It’s just something you note while filing your taxes, similar to not paying taxes on capital gains when you sell your primary residence.

In a later section, we’ll talk about how this QSBS limit applies per shareholder and how you can multiply this. But for now let’s dive into the specific requirements of QSBS.

QSBS Requirements

Understanding QSBS qualification can be slightly tricky, since it’s set up to be less about what to do versus what to avoid.

By default, your startup will likely automatically qualify unless you accidentally trip it up.

After you sell your shares, it’s a stance your accountant or tax preparer needs to take proactively. You do not need to apply for it — you file your taxes indicating that you are taking the QSBS exclusion

I cannot give you legal or tax advice but I do know several founders that will be aggressive in taking this stance because of how high stakes this decision tends to be.

But here are the official requirements:

Active C-Corporation

The business must be an active C-Corporation in the United States.

To be clear, the word actively implies you cannot get the QSBS clock ticking on a holding company that does nothing at the time.

If you have an LLC or an S-Corp or a different type of business structure, you would need to convert to a C-Corp to qualify for QSBS. Your 5-year clock would only start from the date of conversion and not from when you started the business.

Most startups are set up as C-Corps already for a myriad of other reasons, so most people tend to be good here.

The Asset Test

The company must have gross assets of $50M or less at all times before and during the time the equity was issued.

Assets refer to the cash, property and other assets held by the business. This does NOT refer to the valuation at which you raise money.

Most startups have a lot of time during which they can still qualify. The point at which it flips for most businesses is when they raise a very large mega round to take them over the $50M in assets.

As an example, if your business has $10M+ in the bank and you raise a large $40M Series B, the stock issued after the Series B would not qualify.

However, once a stock retains QSBS eligibility, it does not lose this even as the business grows past $50M in assets. The stock remains qualified and even if you end up transferring it to a trust or a family member, it does not lose its QSBS status.

If you are a startup employee, it’s worth enquiring before joining a new job if the stock issued is likely to be QSBS qualified.

Qualified Trade or Business

At least 80% of the company’s assets must be in a “qualified trade or business”.

What is NOT a qualified trade or business?

• Services businesses

  Most services businesses are excluded from QSBS qualification. This includes, but is not limited to services related to health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, finance, banking, insurance, leasing, investing, or brokerage.

• Rely on an employee or owner’s reputation

  If the business largely exists to capitalize on the reputation of a single person, it likely will not qualify.

• Farming Business. Operating a hotel, motel, restaurant or a similar business. Oil and gas businesses.

  Self explanatory

I will however reiterate — at the end of the day, QSBS is a stance your tax professional needs to take and there are a lot of businesses that could sort of qualify, where you may choose to take the stance that QSBS is applicable.

The most common scenario is a tech-enabled services businesses where there isn’t a clear line between the product and the service.

I’d be very, very careful before making any kind of official QSBS attestation to investors on a qualifying business because for a lot of businesses, it’s hard to know for sure.

Not Accidentally Blowing Up QSBS Status

In addition to those requirements, there are sadly a multitude of ways you can accidentally blow up your QSBS status.

Doing this is nothing short of catastrophic typically — as you not just hurt yourself, but you also hurt every single investor and employee that is also a shareholder.

If you are a foreign founder of a Delaware C-Corp (like lots of YC companies), this is a section you should pay special attention to because other stakeholders in your business will likely care quite a lot about this.

Here are things to avoid without checking with legal or tax counsel:

• Repurchasing shares from departing employees, cofounders or other stakeholders

  If you are buying back shares from employees that own a significant chunk, have counsel check this will not blow up your QSBS status. This can sometimes adversely affect QSBS status for the entire business.

  Typically, repurchasing stock due to termination for unvested shares is excluded from triggering qualification, but when in doubt, double check!

• Investing your balance sheet in non-cash and cash equivalents

  Investing more than 10% of assets in mutual funds or corporate bonds that pay out 2+ years in the future could blow up QSBS as could investing in real estate and equivalents. Treasuries are OK, but you don’t want to get too fancy here and risk being classified as an investment company.

• Exceeding $50M in assets or no longer being a qualified trade or business

  Fairly self-explanatory

Given how high stakes QSBS can be for every single shareholder, I would memorize this list upfront and when in doubt, check with counsel.

Assuming you are good on all these requirements, it’s time to focus on building your company and you can largely afford to forget about QSBS for several years.

Let’s now fast forward in time to what could end up happening after you have built a successful business and end up selling your shares.

QSBS applies anytime you sell your shares — it does not matter if it’s an acquisition, selling your shares in a secondary transaction or going public.

QSBS Rollover

One of the neatest features of QSBS is you still have a path to take advantage of it even if your business ends up getting acquired before the five year mark.

The QSBS code calls for something called a “Section 1045 Rollover” which allows you to take all the money you make from selling your business before 5 years, pay zero taxes on it and within 60 days roll it over into another qualifying small business.

Your QSBS clock picks up from where you left off, and when that business is in turn acquired, you can take advantage of full QSBS eligibility.

Pretty dope, right?

The reality is this can be quite challenging to orchestrate since the 60-day mark does not leave you with a lot of time to line up another qualifying transaction.

However, one workaround that I have seen many serial founders do is use QSBS proceeds from either the sale of their business or angel investment to fund their OWN company.

This can be a phenomenal way of capitalizing your next startup with pre-tax proceeds.

Let’s dig a little bit into the fine print based on how you end up getting paid for the deal in less than 5 years:

If you get paid cash

This is the simpler scenario that we discussed above. You can immediately re-invest the proceeds into another qualifying C-corporation and your clock resumes ticking.

If you originally held shares for 3 years, you’d only need to hold shares for 2 more years to fully qualify.

However, this is only possible if you:

• Have held the original shares for at least 6 months

• Purchase the rollover QSBS shares within 60 days

• Report this on your taxes as a Section 1045 rollover

If you get paid stock in the acquiring company

This gets far trickier, and does require good tax and legal counsel to structure correctly.

However, the upshot is the transaction could still be structured in a way that QSBS is still maintained until the business that bought you is turn eventually sold.

However, the tax break would be capped at what the dollar value of your shares was at the time of the first acquisition.

QSBS Stacking

Now, the most fun part of this article and QSBS.

The most critical part to understand about how QSBS works is this $10 million limit applies per-shareholder, per-company.

Per-company means an angel investor who invests in 100+ companies gets a fresh $10M limit per company they invest in.

Per-shareholder is where the magic happens for the founders. You could theoretically transfers shares to multiply your QSBS limit to many tens of millions of dollars — and in one extreme case, more than $100M dollars.

There are two strategies that can be used here - you can use either one, or both:

Gifting Shares to Friends and Family

The easiest way to multiply your QSBS limit is gifting your shares to family and friends. Since the QSBS limit is per-shareholder, every person would get their own $10M limit.

Gifts to your spouse wouldn’t double your limit if you file jointly, but gifts to parents, siblings and children would all increase your limit. Since the QSBS limit is per-shareholder, each person gets their own $10M limit.

When you give a gift, the value of the gift is assessed at the time you make the transfer. And if it’s under $19,000 a year (as of 2025), it does not count against your lifetime gift tax exemption.

Critically, the 5-year holding period does NOT reset at the time of the gift. You could gift your shares 4 years in, and the recipient would only need to wait 1 year to claim the QSBS tax exemption.

This is a strategy I’m personally employing by gifting friends and family members <$19,000 of shares in current market value so they each would qualify for their own $10M exemption.

The founder of Roblox famously gave shares to each of his 4 children — which collectively, increased his family’s tax exemption by $40M.

A famous lawyer in San Francisco joked that raising children in the city is so expensive, that you need the QSBS exemption to offset it.

Trusts That Multiply QSBS

Trusts are a fancy word thrown around by finance professionals, while most normal people have no idea what they actually are.

The easiest way to think about a trust is it’s a legal document that has its own rights, similar to a person or a corporation.

This can be massively beneficial because you can set up certain types of trusts that could each end up getting their own $10M tax exemption as they serve as their own taxpayer.

In order for a trust to be able to multiply QSBS, they typically need to be set up for the benefit of someone other than yourself. This could be your children, your future children, your spouse or other family members.

(The exception to this is a CRUT could be set up to pay you an income stream for 20+ years, but they are a complicated dual-purpose structure I’ll skip for now)

These trusts would also have the separate benefit of bypassing estate taxes which becomes a very significant issue at large amounts of wealth.

Here are some common types of trusts that are used to multiply QSBS exemptions:

• Spousal Lifetime Access Non-Grantor Trust (SLANT)

• Dynasty Trusts

• Incomplete Non-Grantor Trusts (DING’s, NING’s etc.)

• Charitable Remainder Unitrusts (CRUT)

I’m trying to avoid this article becoming impossibly long to read, so I’m not going to dive deep into what each of these trusts do, but if y’all are interested, that can be a future topic we discuss over here.

You could also combine several of these strategies if needed. The way most people multiply QSBS many times is a combination of gifting shares, and setting up a handful of trusts.

QSBS Conversions

When people hear about QSBS for the first time, their mind is typically blown.

And it leaves a lot of business owners pondering whether they can convert their LLC or S-Corp to a C-Corp for the explicit reason of taking advantage of QSBS.

The good news is these types of conversions are possible and it does open up the possibility for qualifying for QSBS, but there are a few things to be aware of:

• Your 5-year clock starts from scratch

  Sadly, your 5 year waiting period only begins after your business is already a C-Corp. So any time up until that point running your business does not help you.

• Be wary of the asset test

  You don’t want your business to get too big before you make this switch. Otherwise, you may automatically be disqualified even if you are a C-Corp.

• S-Corps are trickier to convert

  While still doable, it is substantially more painful to make the switch when you have an S-Corp versus an LLC and will require expensive legal counsel.

Interestingly, C-Corp conversions open up a semi-insane, but totally legal way of potentially multiplying your QSBS limit to up to $500 million dollars.

QSBS Packing: The $500M Tax Break

Some very smart people have latched on to another loophole in the way the QSBS law was written to potentially get up to a $500M tax break.

As a reminder, the maximum QSBS exemption is either $10M or 10 times the basis of the stock.

You can theoretically use “10 times the basis of the stock” to multiply QSBS to almost $500M by following these steps:

• Start your business as an LLC

  The pass-through losses could be useful in the early years, and eventually you grow this company to theoretically ~$45M in value.

• At <$50M in assets, convert your business to a C-Corp

  Since your basis would be $45M, your total QSBS exemption is now 10 times your basis or $450M.

You could run this as close to $50M as you’d like while staying careful to not go above.

Does this mean you should actually do this?

I’m personally skeptical for a few different reasons:

• Building a startup is hard enough without making it harder for an even larger tax break. It’s super difficult to raise money as an LLC, granting employee stock is harder and generally not recommended unless you are a serial entrepreneur who knows exactly what you are doing.

• The QSBS exemption only kicks in after the basis is already paid off. To take advantage of the $450M exemption from the above example, you would have to sell your company for more than $45M to get any QSBS benefit.

• This delays your time to liquidity even further as the 5 year clock would only start on conversion.

But for the right founder and the right business, this loophole could be absurdly powerful.

How to Think About QSBS

As we draw to the close of this rather long article, I want to end by giving you my quick perspective on how every type of shareholder should think about QSBS.

If you are a founder reading this article, you should read the section for employees and investors as well, since it is your fiduciary duty to ensure that the people that believed in you also succeed if you succeed.

QSBS for Founders

This is likely to make the single biggest difference in your life versus every other shareholder.

However, there is not really that much to do for the majority of the time beyond actually building a successful business.

But here’s what you should be thinking about at different stages:

• At incorporation

  Doing the basics right is important upfront. Setting up a C-Corporation, buying your shares from the company directly and documenting it. Filing your 83b election and keeping the receipts if you are vesting your shares.

• While running your company

  Reading the section on QSBS requirements and particularly the bit on not accidentally blowing up QSBS status. If you are concerned about any kind of buyback, always check with counsel.

• Before a Series B

  Timing could vary here, but before a big priced Series B could be good time to look into whether it makes sense to multiply QSBS by setting up trusts or gifting shares. You could do it later on as well, but it’s likely to count against your lifetime gift tax exemption.

• At exit

  Double checking with your tax and legal counsel that you are good to claim for the QSBS exemption.

I would also proactively think about what you could do to make more shareholders at the company eligible for QSBS.

This could look like granting shares instead of options to early employees to start their clock ticking sooner. And potentially not leaving your investors hanging for a really long time without a priced round.

A note for international founders: if you have a Delaware C-Corp, QSBS could still be very significant for lots of your shareholders even if it doesn’t affect you. And if you are a foreign person who lives in the US and pays American taxes, QSBS can definitely benefit you directly as well.

QSBS for Investors

The biggest unlock for investors is owning shares directly instead of other derivative instruments like a SAFE.

Whether a SAFE is eligible for QSBS is entirely unclear and it depends on who you ask. Some investors have taken the rather aggressive stance that the 5-year clock starts when the SAFE is signed, regardless of when it actually converts to equity.

As far as I know, that has never been challenged so we don’t know where the chips may stack but the safer stance (pardon the pun) is to only start the count from when you own equity.

Some other considerations for investors:

• Be comfortable with rollovers

  On a large portfolio of bets, you will have some companies exit before the 5-year mark and if you are well prepared, you may be able to immediately deploy the funds in another qualifying company and defer taxes.

• QSBS likely passes through down to your investors

  If you run a fund, and your investment is QSBS eligible, this treatment likely passes down to your LP’s as well. This can make a huge difference in the net after-tax return of your fund. It’s unclear whether the carry you earn from a deal qualifies for QSBS, and very much depends on who you ask.

• Get familiar with Section 1244

  Most investors aren’t aware of Section 1244 - which is the opposite of QSBS in a lot of ways. Certain seed investments (priced rounds, less than <$1M raised) allow you to deduct the losses from your ordinary income up to $100K if married, $50K if single.

Beyond that, you want to always ask companies that you are investing in if they are eligible for QSBS to the best of their knowledge.

QSBS for Employees

For the longest time, no one thought about QSBS for employees because it was assumed employees would not own shares directly for 5+ years.

Thankfully, we’re starting to see this change and in the coming cycle, a lot more early startup employees should benefit from this.

Here is what I’d think about as an employee joining a startup:

• Can I own shares versus options?

  Your QSBS clock only starts from when you own shares in the business directly, and not stock options. Based on how low the exercise price is, it may be worth buying shares directly for at least a portion of your equity.

• Is the startup likely to qualify for QSBS?

  You can and should ask any future employer about this option. This also implies if you are joining a company that has raised $50M+, you will not be eligible for QSBS.

• QSBS rollovers could be a great way to fund your next venture

  If you are a startup employee that wants to someday start your own business, you could use a QSBS rollover. If the company you own equity in is acquired less than 5 years after you own the shares, you could use the proceeds to fund your next venture!

At my startup, we set up our employee equity plan very differently to make it possible for more of the team to participate in QSBS if we ever get to a significant exit.

But that is a story for another day…

I’d love to know what y’all think of this article and if you find these types of detailed breakdowns helpful.

As I plan future articles, I’d love to know what type of content you find most interesting: