Qualified Small Business Stock (QSBS) Exclusion: Your Path to a Tax-Free Business Sale

Imagine selling your $10 million business and keeping every penny instead of paying $2.6 million in capital gains taxes. If I heard that, my initial thought would be that it’s probably illegal. However, with proper planning, it's not only possible, it's clearly written in the tax code.

The tax saving strategy that we’re going to discuss today is one of my favorites and shows that yes, you can in fact exit tax-free.

What is the Qualified Small Business Stock Exclusion and How Does it Work?

The Qualified Small Business Stock Exclusion is a bit of a mouthful, so we’re going to call it QSBS for the remainder of this blog. The QSBS Exclusion was created by IRC §1202 and was recently expanded by the OBBBA. It has been amended several times over the years and depending on when your business was formed, you may have slightly different benefits.

The keyword in the QSBS Exclusion mouthful is Exclusion. A business owner who has structured their business to take advantage of QSBS can exclude 100% of their gains up to the greater of $15m or 10x their investment basis in the business, depending on the date that shares were issued. This means that when the time comes to sell, you could completely avoid capital gains taxes utilizing QSBS.

How Do You Qualify for QSBS Benefits?

The second most important word in Qualified Small Business Stock Exclusion is Qualified. There are specific characteristics that a business must meet to qualify for the QSBS Exclusion.

If you think your business meets all of these requirements, QSBS may be worth structuring around.

QSBS Timeline: How long do I need to own the business to qualify?

If your business qualifies, there are also requirements on your personal holding period to qualify. Both the date that the stock was issued and how long you have held the stock matter for qualification.

These recently changed during the passage of the OBBBA, so look at this table carefully to determine if you qualify.

Holding periods for QSBS stock were amended by the OBBBA. To elaborate slightly on the table above, the table below shows the new requirements for QSBS stock issued after 7/4/2025.

This means that you can begin to see QSBS benefits after owning stock for 3 years and you maximize your benefits after 5 years of ownership.

Can I still convert my LLC to a C-Corp to get the QSBS Exclusion?

If you’re reading this article and thinking to yourself – this seems too good to be true, why didn’t I form a C-Corp to start? All is not lost.

You can still convert your LLC, partnership, or S-Corporation to a C-Corporation to start your 5-year clock. Two things to note are that you may trigger taxes on certain assets at conversion and the value of the business at the time of transition is still taxable when sold, since that value was accrued when the business was not a C-Corporation.

Here’s what I mean:

• $5,000,000 LLC converts to C-Corp
• Value increases to $10,000,000 over the 5-year window and business is sold
• $5,000,000 would be taxable and the $5,000,000 growth would be excludable under QSBS

This could be well worth pursuing if you may be thinking of a sale in the next few years. Two possible negatives to note are that you may wind up paying more in ordinary income taxes as a C-Corp over those 5 years and the non QSBS portion of a C-Corp sale will be subject to the 3.8% NIIT while an LLC will not. These figures should be accounted for in your analysis.

QSBS Exclusion Case Study: How does it work?

We first met the Daniels in our Installment Sale Blog as owners of an engineering firm. As we know, engineering firms don’t qualify for QSBS, but luckily for us they just so happen to own an engineering software company that’s structured as a C-Corporation that they’re also selling for $10,000,000 and have $500,000 in basis. So, what would the value of QSBS be for the Daniels?

Assuming they met the QSBS requirements, the Daniels would save ~$2.7m in taxes and receive their $10m free and clear after the sale of their business.

While QSBS takes planning ahead due to the 3-5 year holding period, so do several other tax savings strategies. Where other strategies may have specific requirements, QSBS allows you to receive the full amount of your sales price once it’s sold with no looking back.

How to Maximize QSBS Through Planning

The QSBS Exclusion of 100% of your gains up to $15m or 10x your investment is already substantial, but there are additional ways to maximize QSBS planning. Two of these methods are called “packing” and “stacking.”

What is QSBS Stacking?

Let’s discuss “stacking” first. Stacking refers to giving your QSBS eligible shares to other eligible persons so that they can get the full $15m exemption. If you recall, to qualify shares must come directly from the company. Gifts and inheritance are excluded from that rule, so we can increase QSBS amounts through gifting. This most often includes:

• Children
• Parents
• Siblings
• Specific types of trusts
• Other individuals

But not:

• Spouses (as the exclusion may be shared but this is a gray area)
• Family Limited Partnerships

Each recipient inherits your holding period and basis, but they will have their own QSBS amount. By strategically gifting your shares to family members or others, you can increase the total amount of QSBS available.

One thing to note here is the assignment of income doctrine by the IRS. If you try to gift all of these shares the day before the sale, the IRS is going to look at you and laugh because they know exactly what you’re doing. If you’re going to consider this, there will need to be a healthy amount of time between the gift and the sale and there should be non-tax reasons for the transfer.

What is QSBS Packing?

The next strategy is called “packing.” Packing refers to buying additional shares of QSBS to increase your total amount eligible. If you’re facing a business sale that’s worth $25m, then your QSBS won’t be sufficient unless your basis is at least $2.5m. When you pack, you buy additional shares from your C-Corp to increase your basis and thus have the higher QSBS limit.

Remember, there does need to be a legitimate business reason in addition to the tax reasons to satisfy the IRS or they may disqualify the increased amount.

As you can see, you can definitely get creative when it comes to QSBS planning.

What are the drawbacks of the QSBS Exclusion?

Even though it may sound like it, QSBS isn’t perfect for everyone and there are drawbacks depending on your type of business. Here are a few:

• QSBS treatment isn’t recognized by all states. Several states do not recognize QSBS benefits. For my Georgia readers, Georgia does conform to the QSBS rules.
• AMT – QSBS gains may impact AMT taxes for those businesses incorporated before 9/28/2010.
• Timing – if you don’t have 3 years, it may not work for you.
• Taxes on Conversion – converting to a C-Corp may incur additional taxes if not done properly.
• High Income, Low Multiple Business – may not work as the additional taxes on C-Corp income may outweigh the benefit of the capital gains exclusion

Who is the QSBS Exclusion Best For?

For those that qualify, QSBS is one of the best tax laws out there. I believe that QSBS is best for:

• Business owners who know they are going to plan to sell their business early on, especially those who start up with that intent.
• Business owners who operate in a qualified business.
• Business owners with at least 3+ years from their sale if they haven’t planned from the start.
• Business owners who have a high expected sales price and low net profits.

If you think that any of these, are you, then QSBS may be right for you.

How do you structure your business as QSBS eligible?

• Review if your business is qualified
• Startup as a C-Corp or review tax implications of converting your business to a C-Corporation
• Hold for 5 years to receive maximum benefits
• Sell business in a stock sale

Working with Ironclad to Optimize Your QSBS Strategy

You can see that there’s more to QSBS planning than just knowing the basics. If you properly optimize your business sale utilizing QSBS, you can easily wind up with tens of millions of dollars in proceeds tax-free. However, it takes proactive planning.

Ironclad Wealth Management works with business owners throughout their business life and not just at the point of sale. If you need a 3-5 year plan to help optimize your QSBS or are looking at a sale in 6 months, we can help. From helping you identify the best strategy, to modeling out your sale with and without QSBS, to integrating with your CPA and attorneys to make sure it goes off without a hitch, Ironclad Wealth Management is here to help.

Book your business transition strategy session with Ironclad Wealth Management today to build a tax-efficient exit and close your Wealth Gap.

Want to Keep Reading more about saving capital gains on your business sale? Check out our blogs on Asset vs. Stock Deals, Installment Sales, Structured Installment Sales, Qualified Opportunity Zone Funds, Tax Loss Harvesting, Charitable Remainder Trusts, and Employee Stock Ownership Plans (ESOPs).

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