QSBS Redemption Rules: Company Buybacks Around a Funding Round

Can a company stock buyback cost other shareholders QSBS?

Yes. Under section 1202(c)(3), when a corporation buys back its own stock, two tests can take away qualified small business stock (QSBS) status from shares it issued around that time, even from holders who sold nothing.

Both tests come from the statute, and the regulation, 26 CFR 1.1202-2, adds the de minimis floors and the exceptions. The 2025 changes to QSBS left these buyback rules unchanged (Public Law 119-21, section 70431).

What makes a case not simple: a buyback within a year of a round closing, several small buybacks that add up, a seller who was a contractor rather than an employee or director, or a purchase by the company's subsidiary or by an investor the company is behind. Shares that fail never qualify, and holders often find out only when they sell, years later.

Gather: the stock ledger, every repurchase with its date, price, number and class of shares and reason, the value of all outstanding stock at each date, and the issuance date of every share, option exercise and conversion.

What is a significant redemption under QSBS, and which shares does it taint?

A significant redemption happens when, in the two years beginning one year before a stock issuance, the company buys back stock with a total value above 5% of the value of all its stock at the start of those two years (26 CFR 1.1202-2(b)). Every share issued in that issuance then fails QSBS, whoever holds it.

• Value, not price paid. Each purchase is measured by the value of the stock bought at the time of purchase, then added together across the window.
• The base is fixed. It is the value of all the company's stock at the start of the window, one year before the issuance, not the higher value at the round.
• Every issuance has its own window. Preferred sold in the round, founder grants, option exercises and note or SAFE conversions are each issuances with their own dates.

What are the two QSBS buyback windows?

The two windows are one year either side of an issuance for everyone, and two years either side for the seller and people related to the seller. Both run from each issuance date, so a buyback can taint stock issued months before it.

Related persons are those named in section 267(b) or section 707(b): family (spouse, brothers and sisters, ancestors and lineal descendants) and certain companies, partnerships and trusts tied to the seller. So buying out a co-founder can cost QSBS on recent shares issued to the co-founder's spouse or holding company, not just the co-founder's own.

Which buybacks are ignored under the QSBS redemption rules?

A buyback is ignored if it stays under the de minimis floor or fits one of four exceptions in 26 CFR 1.1202-2(c) and (d). Purchases that fit an exception count toward neither test; the de minimis floor is checked for each test separately.

De minimis floor. A purchase counts only if the total paid is more than $10,000 and the stock bought is more than 2% of the stock measured. Both limits must be exceeded. For the holder test the 2% is of stock held by the seller and related persons; for the significant redemption test it is of all outstanding stock. Each purchase's share is measured by value just before it, and purchases in the window are added together.

A shareholder who transfers shares to an employee or contractor is not treated as a company purchase, even if the tax rules treat the shares as passing through the company first (26 CFR 1.1202-2(c)).

The regulation does not define "incident to" or "bona fide termination." A buyback agreed long after someone left, or from a co-founder who keeps a board seat, needs a closer look.

Does buying back a departing co-founder's unvested shares count?

It can. The regulation has no separate rule for unvested shares and does not say whether it matters if the founder filed an 83(b) election, so the cautious reading tests a repurchase under a vesting agreement like any other purchase. It is ignored if the amount paid is at or under $10,000 or the shares are at or under 2% of the stock measured for that test, or if the termination-of-services exception applies.

Repurchases at original cost are often small enough to fall under the floor, but they add up with every other purchase in the same window. A co-founder who served only as a contractor gets no termination-of-services exception, so only the floor helps. Investor-imposed re-vesting is covered in founder re-vesting at a priced round.

Does a secondary sale to an investor count as a redemption?

Usually not. When an investor buys shares directly from a holder, the company buys nothing, so neither test is triggered by that sale alone. The buyer does not get QSBS on those shares, because QSBS must be acquired at original issue (IRS Publication 550).

Two points can bring a secondary back in:

• The company behind it. The holder test covers purchases made "directly or indirectly" by the company (26 CFR 1.1202-2(a)). A sale the company funds, or shares it later takes from the buyer, may count. The rules give no bright line, so counsel should structure such a deal.
• A subsidiary buying. Under section 1202(c)(3)(C), a purchase that section 304(a) treats as a redemption of the company's stock, such as its own subsidiary buying its shares from a holder, counts as the company buying its own stock. When a sister company under the same control buys, section 304 treats the buyer as redeeming its own stock instead.

The seller's own tax on a buyback, sale or dividend under section 302, is in selling startup shares in a tender offer.

How do we time a buyback around a priced round?

Keep any buyback that could exceed 5% more than one year from every issuance, before or after, or fit it into an exception. Because the window runs one year after each issuance too, a buyback soon after the round can take QSBS from the round's preferred retroactively.

1. List every issuance in the past year and planned in the next: round closings (each closing is its own date), conversions, grants and option exercises.
2. Value the proposed buyback and every purchase already made in each window, and compare with the value of all stock at each window's start.
3. Check the seller's and related persons' issuances in the two years either side.
4. Confirm whether the de minimis floor or an exception applies, and document the facts that support it.
5. If the test fails, move the buyback outside the window, reduce it, or have the round close later. Unwinding a buyback afterwards is not addressed in the rules.

A buyback that a recapitalization or pay-to-play forces is covered in down round and recapitalization tax.

What buyback records should the company keep for a QSBS attestation?

Keep a buyback log that lets anyone rebuild both tests for every issuance date. Investors and their counsel ask about buybacks when the company signs a QSBS statement; what that statement covers is in QSBS attestation letters.

• Stock ledger with every issuance date by class, including option exercises and conversions.
• Each repurchase: date, seller, number and class of shares, price paid and value at the time.
• Value of all outstanding stock before each repurchase and at the start of each window, with the valuation used.
• The seller's related persons who also hold stock.
• The reason for each repurchase and the exception relied on, with the employment, board, death, disability or divorce records behind it.
• Board approvals and repurchase agreements, and any company role in secondary sales.

Holders report the exclusion on Form 8949 with code Q (IRS instructions). Whether a holder's own shares qualify, and for how long they must be held, is in QSBS for founders and early employees.

Example

These examples are illustrative; figures are in US dollars.

Co-founder leaves, company buys her vested shares

A co-founder worked as an independent contractor, never as an employee or director. The company pays her $400,000 for her vested shares, three months before its Series A closes. The shares bought are worth about 6% of the value of all stock both a year before the closing and just before the purchase. The termination-of-services exception does not cover contractors, and the purchase is far above the de minimis floor. The Series A preferred is not QSBS. Other stock issued within a year either side of the buyback needs the same test.

Same buyback, 14 months before the round

The company makes the same $400,000 purchase 14 months before the Series A closes. The buyback falls outside the one-year window for the Series A, so the new preferred is not tainted by it. Stock issued within a year of the buyback, such as option exercises two months later, can still be tainted, and so can any stock issued to her or a related person within two years either side.

Unvested shares repurchased at cost

A departing founder's unvested shares are bought back for $5,000, the price she paid, under her vesting agreement. Assuming no other purchase in the window, the total paid is under the $10,000 floor, so the purchase is disregarded for both tests. If she got the shares for services as an employee or director, the termination-of-services exception may also apply.

Different for you?

• You are the one selling shares back and want to know your tax: see selling startup shares in a tender offer.
• Investors want the company to sign a QSBS statement: see QSBS attestation letters and get startup tax help.
• A buyback already happened within a year of a round: the round's stock may have lost QSBS; get startup tax help before the next statement to investors.
• You want to know whether your own shares qualify: see QSBS for founders and early employees.
• The round is a down round with a recap or pay-to-play: see down round and recapitalization tax.
• Investors want founders to re-vest: see founder re-vesting at a priced round.