For founders, one early decision can be worth millions: choosing the right entity structure.
Under Section 1202 of the Internal Revenue Code, holders of Qualified Small Business Stock (QSBS) can exclude up to $15 million (or 10× their investment basis, whichever is greater) of gain from federal income tax when they sell their shares — but only if the stock was issued by a C-corporation.
Why It Matters
When you sell your company, the QSBS exclusion can mean the difference between keeping your full $15 million gain or paying several million in federal tax. But the rule is strict:
- Only U.S. C-corporations can issue QSBS.
- LLCs taxed as partnerships, partnerships, and S-corps do not qualify.
- To receive the full 100% exclusion, you must hold the stock for more than five years.
- 3 to <4 years: 50% exclusion
- 4 to <5 years: 75% exclusion
- The company’s gross assets must not exceed $50 million before mid-2025, or $75 million for stock issued after July 4, 2025, per the One Big Beautiful Bill Act (OBBBA) update.
Why Startups Care
Most venture-backed companies are Delaware C-corps for a reason. Venture funds and experienced angels know QSBS can dramatically improve their after-tax returns. Incorporating as a C-corp also starts the five-year QSBS clock immediately — a quiet but crucial tax-planning move.
The $15 Million Mistake
If you form as an LLC taxed as a partnership, an S-corp, or a partnership, you cannot issue QSBS. Converting later doesn’t fix it retroactively. The five-year clock does not start until you are a C corporation, and if you start as an S-corp your founder shares will never qualifiy. That’s a self-inflicted, multi-million-dollar penalty for founders planning to raise capital or sell.
The Takeaway
Only C-corps can issue QSBS. That single fact can mean a $15 million swing in your pocket at exit.
If your goal is to raise money and eventually sell your company, start as — or convert early to — a C-corporation. The QSBS advantage is simply too valuable to miss.
