Understanding Qualified Small Business Stock (QSBS)

Investing in small businesses can be a rewarding venture, both financially and personally. One of the most attractive incentives for investors with this interest is the Qualified Small Business Stock (QSBS) exclusion. Section 1202 of the Internal Revenue Code (IRC) offers significant tax benefits for non-corporate taxpayers investing in QSBS, making it an appealing option if you’re looking to support innovative startups and small enterprises.

Conversely, if you are the holder of the issuing company, QSBS can attract investors looking for tax-efficient investments and potentially enhance the perceived value of your company’s stock and its credibility. With more of these investments, your small business may be able to scale more rapidly and compete effectively in its market.

What is QSBS?

QSBS refers to shares issued by a qualified small business. As defined by the tax code, the business must be a domestic C corporation with gross assets not exceeding $50 million at the time of, and immediately after, the stock issuance.¹ The issuance could occur with an initial public offering (IPO) or as compensation of stock options. The valuation is based on the original cost of the assets.

Key benefits of QSBS for investors

The primary allure of QSBS lies in its tax advantages. Here are some key benefits:

• Capital gains exclusion: In 2025, investors can exclude up to 100% of the capital gains from federal taxes if they hold the QSBS for more than five years, and if the shares were acquired after Sept. 27, 2010.¹ This exclusion applies to the greater of $10 million or 10 times the adjusted basis of the investment. However, some states, like California, may not allow the exclusion.²
• Deferral of gains: If an investor sells QSBS before the five-year holding period, they can defer the capital gains by reinvesting the proceeds in another QSBS within 60 days.
• No alternative minimum tax (AMT): For QSBS acquired after Sept. 27, 2010, the gains are not subject to the AMT of 3.8% in 2025.² The AMT exemption is $88,100 for single filers and $137,000 for married couples filing jointly in 2025. These amounts start to phase out if income is more than $626,350 for singles or $1,252,700 for joint filers.

Eligibility criteria

To benefit from QSBS, both the investor and the issuing company must meet specific criteria. The non-corporate taxpayer who wants to invest in QSBS must acquire the stock at its original issue, not on the secondary market. In addition to being a C Corp in the U.S. with gross assets not exceeding $50 million, the issuing company must be actively engaged in a qualified trade or business, excluding sectors like hospitality, personal services, financials, farming, and mining.³

How to leverage QSBS

As an investor, QSBS can be a strategic tool to help maximize returns while minimizing tax liabilities. For example, if QSBS was purchased for $1 million and sold for $15 million, you could exclude the limit of $10 million and pay capital gains tax on $5 million. Alternatively, you could gift some QSBS to family members or create certain types of irrevocable trusts to “stack” multiple exclusions (combining different exclusions or spreading the benefits across multiple entities). Each separate taxpayer qualifies for their own $10 million exclusion. To leverage QSBS, plan to hold the stock for at least five years to take full advantage of the capital gains exclusion. Also, consider investing in multiple qualified small businesses to spread risk and increase the potential for high returns. Lastly, stay informed on changes in tax laws and regulations that may impact QSBS benefits.

Potential risks for investors

Investing in QSBS can offer substantial tax benefits, but it’s not without risks, including:

• Business and liquidity risk: Small businesses, especially startups, are inherently risky. There’s no guarantee that the business will succeed or that its stock value will appreciate. Additionally, QSBS investments are typically in private companies, meaning the stock is not publicly traded. This can make it difficult to sell the stock quickly or at a favorable price. Investors may need to hold onto the stock for at least a five-year period.
• Returns risk: Small businesses can experience significant fluctuations in their financial performance and stock value as well as market valuation. This volatility could lead to substantial losses for investors. Diversifying investments across different sectors and asset classes can help mitigate the risk of concentration in a portfolio. Economic downturns and changes in market conditions can also adversely affect small businesses more than larger, established companies.
• Regulatory and compliance risk: The tax benefits associated with QSBS are subject to specific IRS regulations. If the issuing company or the investor fails to meet these requirements, the tax benefits may not be available. Changes in tax laws and regulations can also impact the advantages of QSBS.

Make informed decisions

QSBS offers a unique opportunity for investors to support small businesses while enjoying substantial tax benefits. As an investor or QSBS issuing company, it’s important to understand the eligibility criteria and strategic advantages to make informed decisions that align with your financial goals. Keep in mind that carefully evaluating the investing risks is also crucial.

Whether you’re looking at investing in QSBS or are considering issuing QSBS shares for your business, you’ll want to be sure it fits into your financial plan as well as your tax strategies. Talk to your Mercer Advisors wealth advisor who can consult with our investment management and tax planning and preparation teams to provide guidance.

If you’re not a Mercer Advisors client and want to learn more about QSBS and other financial strategies that could align with your goals, we can help. Our integrated wealth management solution includes tax planning, estate planning, insurance, financial planning, investment management, and more. Your hand-picked wealth advisor coordinates with specialists in these areas. Let’s talk.

^1. “What Is the 1202 Exclusion and How Does It Work for Small Business Stock?” Accounting Insights, Jan. 29, 2025.
^2. “Alternative Minimum Tax (AMT) Rules and Exclusions for 2025.” Yahoo Finance, March 23, 2025.
^3. “Understanding Qualified Small Business Stock (QSBS): Frequently Asked Questions.” Compass CPA, Dec. 18, 2023.

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