QSBS for Private Equity: A Practical Playbook for Fund Managers

Qualified Small Business Stock (“QSBS”)1 can be highly advantageous in private equity structures when the portfolio company’s stock is acquired at original issuance, the issuer is within the aggregate gross asset cap, and the active‑business test is satisfied. Below is a concise playbook teams can operationalize from day one.

TL;DR

  • Acquire portfolio company equity by original issuance directly from the issuer (not via a secondary).
  • Confirm C‑corp status and the aggregate gross asset cap at issuance.
  • Document that at least 80% of assets by value are used in the active conduct of a qualified trade or business; include attribution of majority‑owned subs.
  • Hold more than five years and track by block.
  • For funds, rely on §1202(g) pass‑through: partners may claim their distributive share if they held their interest continuously from the partnership’s original issuance date through exit.

QSBS Requirements (Statutory)

  1. Original issuance. Stock must be acquired directly from the issuing C‑corp in exchange for money, property (not stock), or services.2
  2. Qualified Small Business. Immediately before and after the issuance, the corporation’s aggregate gross assets must not exceed the statutory cap (generally $50M; $75M for stock issued after July 4, 2025).3
  3. Active business requirement. During substantially all of the holding period, at least 80% (by value) of the company’s assets must be used in the active conduct of a qualified trade or business.4
  4. Subsidiary attribution rule. If the issuer controls a subsidiary (more than 50% by vote or value), the subsidiary’s assets and activities are treated as those of the parent for the 80% test.5

Holding Period & Pass‑Through Mechanics

To qualify for the exclusion, the stock must be held for more than five years. For partnerships (including funds taxed as partnerships), §1202(g) permits partners to claim the exclusion for their distributive share of gain if the partnership acquired QSBS at original issuance and the partner held its interest continuously from that date through the disposition of the stock.

“Catch‑Up Issuance” in Multi‑Close Funds

In a multi‑close fund, teams often start the QSBS clock with a nominal issuance and then complete a “catch‑up” issuance at (or near) final close to align portfolio‑company shares with outstanding fund units. Each issuance is a separate original issuance with its own acquisition date and five‑year clock. Late‑admitted LPs typically participate only with respect to units outstanding on the catch‑up date and must hold continuously thereafter to benefit under §1202(g).

Implementation Checklist

  1. Board actions. Approve each stock issuance (including any catch‑up) for qualifying consideration; record acquisition date(s).
  2. Asset‑cap memo. Document aggregate gross assets immediately before and after each issuance; retain schedules supporting §1202(d).
  3. Active‑business tracking. Maintain records showing satisfaction of the 80% test during substantially all of the holding period; include majority‑owned subs under the attribution rule.
  4. Cap table & LP ledger. Track QSBS by block, link partner pro‑rata fractions to acquisition dates, and flag transfers that would break continuous ownership.

 

Footnotes

  1. 26 U.S.C. § 1202(c). ↩︎
  2. 26 U.S.C. § 1202(c)(1). ↩︎
  3. 26 U.S.C. § 1202(d). For stock issued after July 4, 2025, the aggregate gross asset cap was raised to no more than $75 million. ↩︎
  4. 26 U.S.C. § 1202(c)(2)(A); 26 U.S.C. § 1202(e)(1–3). ↩︎
  5. 26 U.S.C. § 1202(e)(5). ↩︎

Legal Disclaimer

The information provided in this article is for general informational purposes only and should not be construed as legal or tax advice. The content presented is not intended to be a substitute for professional legal, tax, or financial advice, nor should it be relied upon as such. Readers are encouraged to consult with their own attorney, CPA, and tax advisors to obtain specific guidance and advice tailored to their individual circumstances. No responsibility is assumed for any inaccuracies or errors in the information contained herein, and John Montague and Montague Law expressly disclaim any liability for any actions taken or not taken based on the information provided in this article.

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