How happy would you feel if someone offered you a huge sum of money to buy the company you’ve built your whole life? But most of the time, worry comes first. It’s the taxes. Mr. Kim invested $100,000 of his own money in 2011 to establish a small manufacturing company in the United States. The business, which started with just a few employees, grew steadily, and in 2026 an investor offered to buy the company for $5 million. Excluding the $100,000 investment, the profit is a whopping $4.9 million. Applying the standard long-term capital gains tax rate of 20%, federal taxes alone would amount to nearly $1 million.
However, amazingly, Mr. Kim may not have to pay a single penny in federal capital gains taxes. The U.S. tax code has a provision called ‘QSBS’ (Qualified Small Business Stock). The federal government exempts all or part of the tax on the profit when stock in a qualified small business is held for a long period and then sold. It is a kind of investment incentive designed by the government to encourage entrepreneurship, investment, and job creation.
What kind of companies qualify? It must be a C Corporation established in the United States. If you are selling shares of a sole proprietorship, general LLC, or S Corporation, it does not apply. Also, in principle, you must acquire stock initially issued by the company. There are also limits on company size. Stock issued through July 4, 2025, must have had total assets of $50 million or less at the time of issuance. For stock issued after that, the threshold increased to $75 million. There is also a condition that the majority of the company’s assets must be used in the active conduct of a trade or business. Industry is also important. Manufacturing or R&D businesses can qualify, but professional services like medical, legal, and accounting, as well as finance, hotels, and restaurants, are generally excluded.
So what should business owners currently operating an S Corporation do? You do not necessarily have to create a new company from scratch. You can change the tax filing status of your existing S Corporation to convert it into a C Corporation. However, simply switching to a C Corporation does not automatically make your existing stock tax-exempt. Stock newly issued after the conversion can qualify if certain conditions are met. In some cases, setting up a new C Corporation and transferring the existing business is also an option. However, the appreciation in business value that occurred before the conversion is not exempt from tax.
The holding period of the stock is also important. Qualified stock acquired between September 28, 2010, and July 4, 2025, can receive a 100% exclusion of capital gains if held for more than five years. The tax exemption limit is also enormous. Previously, the general limit per shareholder per company was the greater of $10 million or 10 times the stock’s basis, but under new regulations, the basic limit has increased to $15 million.
There are important points to watch out for here. There are two main ways to sell a company: ‘Asset sale,’ where the company sells its machinery, inventory, goodwill, etc., and ‘Stock sale,’ where shareholders sell their own stock. QSBS benefits apply in principle only to ‘stock sales.’ Furthermore, even if federal taxes are exempt, state taxes are not necessarily waived. Notably, Illinois recently changed its laws so that starting in 2026, the federal QSBS tax exemption will not be recognized in calculating state income taxes. If you plan to sell your company someday, the corporate structure you choose from the very beginning can sometimes make a difference of millions of dollars in taxes. In business, knowing how to protect the money you’ve made is just as important as working hard to earn it.
