Strategy Snapshot
Section 1202 lets eligible shareholders exclude a large amount of gain, often the greater of $10 million or 10 times basis, on the sale of qualified C-corporation stock. The 2025 law raised the caps and added partial exclusions at shorter holding periods. The catch is that eligibility is set years earlier, at the moment the stock is issued.
For qualifying stock, you can exclude the greater of a multi-million-dollar cap or 10x your basis from federal capital gains tax. On a successful startup exit, that can mean paying zero federal tax on the gain.
Original-issue stock in a domestic C-corporation with assets under the limit when issued, an active qualified business, and a long enough holding period. Each piece must hold true.
Eligibility is determined at issuance and over the holding period, not at sale. Converting to a C-corp too late, exceeding the asset limit, or running a disqualified business can quietly destroy the benefit.
Qualified Small Business Stock is the most powerful tax benefit in the startup world, and the one founders most often disqualify themselves from by accident. Done right, Section 1202 can let you sell your company and pay zero federal tax on millions of dollars of gain. Done without planning, you discover at the exit that a decision made years earlier, often the choice to operate as an LLC, took the benefit off the table.
QSBS can turn a multi-million-dollar capital gain into a multi-million-dollar tax-free event. There is almost nothing else in the code that does this for ordinary founders and early employees.Why it matters so much
What the Exclusion Is Worth
If your stock qualifies, you can exclude gain on its sale up to the greater of a large dollar cap or 10 times your basis. The 2025 tax law meaningfully expanded the benefit for newly issued stock.
| Stock acquired before July 5, 2025 | Stock acquired after July 4, 2025 | |
|---|---|---|
| Per-issuer cap | Greater of $10M or 10x basis | Greater of $15M or 10x basis |
| Gross asset limit | $50M | $75M |
| 100% exclusion at | 5 years | 5 years |
| Partial exclusion | None before 5 years | 50% at 3 years, 75% at 4 years |
The “10x basis” alternative is the underappreciated part. An investor who puts in $3 million can shelter up to $30 million of gain, well above the dollar cap. And because the cap is per issuer, founders and investors can multiply the benefit across separate qualifying companies.
The Requirements That Must All Be True
This is where QSBS is won or lost, usually long before anyone is thinking about selling. To qualify, all of the following must hold:
- C-corporation. The stock must be in a domestic C-corporation, at issuance and essentially throughout your holding period.
- Original issuance. You must acquire the stock directly from the company (for cash, property, or services), not buy it from another shareholder.
- Gross asset test. The company’s aggregate gross assets must be at or below the limit ($75M for post-July 2025 stock, $50M before) at all times up to and immediately after your stock is issued.
- Active business. At least 80% of assets must be used in a qualified active business.
- Qualified business. It must not be an excluded business (see below).
- Holding period. You must hold long enough to reach the exclusion tier you want.
Which Businesses Are Excluded
QSBS is aimed at operating and product companies, not service firms. Excluded businesses include:
- Health, law, accounting, consulting, and other businesses built on the skill or reputation of employees
- Financial services, banking, insurance, and investing
- Farming, hospitality (hotels, restaurants), and mineral extraction
Most software, technology, biotech, consumer product, and manufacturing companies qualify. The same service-business concept that limits the QBI deduction shows up here, so founders in those fields need a clear-eyed read of whether they fit.
The 5-Year Clock, and How to Protect It
The 100% exclusion requires a 5-year holding period. Two tools help when a sale comes early or eligibility is at risk:
- Section 1045 rollover: if you have held QSBS for more than 6 months and sell before 5 years, you can defer the gain by rolling the proceeds into new QSBS within 60 days, preserving and continuing the holding period.
- Partial exclusions: for post-July 2025 stock, a sale at 3 or 4 years still captures 50% or 75% of the benefit, which softens the all-or-nothing pressure that existed under the old rules.
When to Seek Help
QSBS is not a filing you optimize at tax time, it is a structural advantage you either set up correctly or forfeit. Get advice at formation or financing, when the entity choice and stock issuance actually determine eligibility, and again well before a sale, to confirm the tests are met and to plan the holding period, any rollover, and stacking across shareholders. For founders and early investors, this is one of the highest-return conversations you can have with a tax advisor, because the upside is measured in the tax you will never have to pay.
Last updated: 2026