Key Takeaways
- Qualified small business stock (QSBS) under IRC Section 1202 lets eligible shareholders exclude some or all of their federal capital gain when they sell C corporation stock.
- For stock issued after July 4, 2025, the exclusion is 50% after 3 years, 75% after 4 years, and 100% after 5 years.
- The gain eligible for exclusion is capped per company at the greater of $10 million ($15 million for stock issued after July 4, 2025) or 10 times the shareholder's basis.
- The company must be a domestic C corporation with gross assets under $50 million at issuance ($75 million for stock issued after July 4, 2025) and must run a qualified active business.
- Many service businesses, including health, law, accounting, consulting, and financial services, cannot issue QSBS.
QSBS is stock in a qualifying small C corporation that, under IRC Section 1202, can let shareholders exclude up to 100% of their federal capital gain on a sale. Founders must acquire the stock at original issue, the company must meet asset and business-type tests, and the stock must be held for 3 to 5 years.
For founders, QSBS can be the difference between paying federal tax on an exit and paying little or none. Certified Maverick, the certification and directory network for tax strategists founded by David A. Perez, trains advisors to spot QSBS eligibility early, when it can still be protected. This guide explains the rules and the 2025 changes.
What Is Qualified Small Business Stock?
Qualified small business stock is stock issued by a domestic C corporation that meets the requirements of IRC Section 1202. Shareholders who hold it long enough can exclude part or all of their gain from federal income tax when they sell. The excluded gain is also not subject to the 3.8% net investment income tax.
What Are the QSBS Requirements?
Both the stock and the company must qualify:
- C corporation. The issuer must be a domestic C corporation when the stock is issued and during most of the holding period. LLCs and S corporations do not qualify.
- Original issuance. You must acquire the stock directly from the company in exchange for money, property (other than stock), or services. Stock bought from another shareholder does not qualify.
- Gross asset test. The company's aggregate gross assets must not exceed $50 million before and immediately after the stock is issued, or $75 million for stock issued after July 4, 2025.
- Active business test. At least 80% of the company's assets must be used in a qualified trade or business during substantially all of the holding period.
- Holding period. You must hold the stock for at least 5 years for a full exclusion, or at least 3 years for a partial exclusion on stock issued after July 4, 2025.
Which Businesses Do Not Qualify?
Section 1202 excludes businesses in certain fields, including:
- Health, law, engineering, architecture, accounting, actuarial science, and performing arts
- Consulting, athletics, financial services, and brokerage services
- Any business whose main asset is the reputation or skill of its employees
- Banking, insurance, financing, leasing, and investing
- Farming, and certain oil, gas, and mining businesses
- Hotels, motels, and restaurants
Most technology, software, manufacturing, and many product companies can qualify.
How Much Gain Can Founders Exclude?
The exclusion depends on when the stock was issued and how long it was held.
| Stock issued before July 5, 2025 | Stock issued after July 4, 2025 | |
|---|---|---|
| Exclusion after 3 years | None | 50% |
| Exclusion after 4 years | None | 75% |
| Exclusion after 5 years | 100% (for stock acquired after September 27, 2010) | 100% |
| Per-company cap on excluded gain | Greater of $10 million or 10x basis | Greater of $15 million (indexed after 2026) or 10x basis |
| Gross asset limit at issuance | $50 million | $75 million (indexed after 2026) |
With a partial exclusion, the gain that is not excluded is generally taxed at a maximum 28% federal rate rather than the usual 20% long-term capital gains rate.
What Changed in 2025?
The One Big Beautiful Bill Act, signed July 4, 2025, made three main changes for stock issued after that date: a tiered exclusion starting at 3 years, a higher per-company cap of $15 million, and a higher gross asset limit of $75 million. Stock issued on or before July 4, 2025 keeps the earlier rules.
Can You Defer Gain if You Sell Before 5 Years?
Yes, in some cases. Under IRC Section 1045, a shareholder who has held QSBS for more than 6 months can defer gain by reinvesting the proceeds in other QSBS within 60 days. The holding period of the original stock carries over to the new stock.
How Can Founders Protect QSBS Eligibility?
- Choose the C corporation structure early. QSBS clocks start at issuance, so converting late shortens the time available.
- Document the gross asset test at each issuance, including option exercises.
- Watch redemptions. Certain stock buybacks by the company around the time of issuance can disqualify stock.
- Keep the business active. Holding too much cash or investment assets for too long can fail the 80% active business test.
- Consider gifting before a sale. Gifts of QSBS can carry over the holding period and may let family members use their own caps. This requires careful legal and tax advice.
What Are the Risks and Limitations?
QSBS rules are strict and fact-specific. Failing a single requirement, such as the asset test at issuance or the business-type test, can disqualify the entire exclusion. Not every state follows the federal rule; California, for example, does not allow the Section 1202 exclusion. Companies rarely certify QSBS status for shareholders, so founders should keep their own records and get a formal review before relying on the exclusion.
What's the Bottom Line?
QSBS under IRC Section 1202 can let founders and early investors exclude up to 100% of their federal gain on qualifying C corporation stock, subject to per-company caps of $10 million or $15 million or 10 times basis. Stock issued after July 4, 2025 qualifies for a partial exclusion after 3 years and a higher cap. Eligibility depends on the entity type, asset levels, business type, and holding period, so it should be planned and documented from the start.
Frequently Asked Questions
QSBS stands for qualified small business stock. It is stock issued by a qualifying domestic C corporation that lets shareholders exclude part or all of their federal capital gain under IRC Section 1202. The company must meet a gross asset test and an active business test, and the shareholder must acquire the stock at original issue and hold it for at least 3 to 5 years.
The excluded gain is capped per company at the greater of $10 million or 10 times your basis for stock issued before July 5, 2025. For stock issued after July 4, 2025, the dollar cap rises to $15 million. The full exclusion requires a 5-year holding period.
No. Only stock in a domestic C corporation can qualify. An LLC taxed as a partnership or S corporation does not qualify, although an LLC that converts to a C corporation can issue QSBS from that point forward. The holding period starts at the conversion, not when the LLC was formed.
For stock issued after July 4, 2025, yes: you can exclude 50% of the gain after 3 years and 75% after 4 years. For older stock, there is no partial exclusion, but IRC Section 1045 may let you defer gain by reinvesting in other QSBS within 60 days.
It depends on the state. Many states follow the federal exclusion, but some do not. California, for example, does not allow the Section 1202 exclusion, so California residents may owe state tax on gain excluded federally. Check your state's rules before relying on the exclusion.