The Founder’s Super-Exemption: QSBS (Section 1202)
The Founder’s Super-Exemption: QSBS (Section 1202)
The greatest tax loophole left in America. How to sell your startup for $10M (or up to $50M with “Stacking”) and pay exactly $0 in Federal Capital Gains Tax.
Executive Summary
- The C-Corp Advantage: Most small businesses start as LLCs to avoid double taxation. But if you plan to exit big, the LLC is a mistake. Under **IRC Section 1202**, if you hold “Qualified Small Business Stock” (QSBS) in a C-Corp for 5+ years, you can exclude **100% of the gain** from federal taxes.
- The Limits: The exclusion is capped at the greater of **$10 Million** or **10x your cost basis**.
👉 Example: You invest $100k. You sell for $10M after 5 years. Tax = $0. You keep the full $10M. - The “Stacking” Multiplier: The $10M limit is *per taxpayer*. Smart founders gift shares to separate Irrevocable Trusts (e.g., for 3 children) *before* the sale. Each trust gets its *own* $10M exemption.
👉 Math: Founder ($10M) + 3 Trusts ($30M) = **$40M Tax-Free Exit**.
The “Original Issuance” Rule
Critical Condition: To qualify, you must acquire the stock at **”Original Issuance”** directly from the company (not bought from another shareholder on the secondary market).
👉 Size Cap: The company’s gross assets must be under **$50 Million** at the time the stock is issued. Once you cross $50M, new stock issued is no longer QSBS qualified (but old stock keeps its status).
Mechanic: The Tax-Free Waterfall
Simulation: Selling a Tech Startup ($10M Exit Price)
| Feature | LLC / S-Corp | C-Corp (QSBS Qualified) |
|---|---|---|
| Tax on Exit | 23.8% (Federal min) | 0% (Up to $10M/$50M) |
| Investor Preference | Low (VCs hate K-1s) | High (VCs want QSBS) |
| Loss Deduction | Pass-through to owner | Trapped in corporation |
“Founders obsess over dilution, but tax is the biggest dilution of all. Choosing a C-Corp structure early isn’t just paperwork; it’s a decision to preserve 24% of your future exit value. It is the single most valuable box you will ever check.”