What Is QSBS? How the Section 1202 Stock Exclusion Works
Section 1202 can make startup stock gains federally tax-free. The 2025 tax law added a 3-year tier, a $15 million cap and a $75 million asset test for new stock.
Qualified small business stock (QSBS) is stock in a US C corporation that meets the tests in Internal Revenue Code section 1202, and a non-corporate holder who sells it can exclude part or all of the gain from federal income tax. For stock issued after July 4, 2025, the exclusion is 50% after 3 years, 75% after 4 and 100% after 5, capped per company at $15 million or 10 times basis. Older stock follows older rules.
The changes came from Public Law 119-21, signed July 4, 2025. The current text of 26 U.S.C. 1202 shows both the old and new rules side by side. This article explains how they work as of November 2026; it is not tax advice.
What makes stock qualified small business stock?
Stock qualifies only if all of these tests are met:
- C corporation: the issuer is a domestic C corporation. LLC units and S corporation shares do not qualify while the entity is not a C corporation.
- Gross assets: the company’s aggregate gross assets did not exceed $75 million at any time before, or immediately after, the stock was issued. The limit was $50 million for stock issued on or before July 4, 2025, and the $75 million figure is indexed for inflation after 2026.
- Original issue: you got the stock from the company itself (directly or through an underwriter) for money, property or services. Shares bought from another shareholder do not qualify.
- Active business: at least 80% of the company’s assets, by value, are used in a qualified trade or business during substantially all of your holding period.
- Non-corporate holder: individuals, trusts and owners through partnerships or S corporations can claim it; C corporations cannot.
Some fields are excluded altogether: services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage; any business whose main asset is the reputation or skill of its employees; banking, insurance, financing, leasing and investing; farming; oil, gas and mining that qualify for depletion; and hotels, motels and restaurants. Large redemptions by the company around the issue date can also disqualify stock.
How much of the gain can be excluded?
The percentage depends on when you acquired the stock and how long you held it.
| Stock acquired | Holding period | Gain excluded | AMT preference |
|---|---|---|---|
| Aug. 11, 1993 to Feb. 17, 2009 | More than 5 years | 50% | 7% of excluded gain |
| Feb. 18, 2009 to Sept. 27, 2010 | More than 5 years | 75% | 7% of excluded gain |
| Sept. 28, 2010 to July 4, 2025 | More than 5 years | 100% | None |
| After July 4, 2025 | 3 years | 50% | None |
| After July 4, 2025 | 4 years | 75% | None |
| After July 4, 2025 | 5 years or more | 100% | None |
The alternative minimum tax column reflects section 57(a)(7) as amended in 2025, which now applies the 7% preference only to stock acquired on or before September 27, 2010. Any part of the gain that is not excluded is generally taxed at a maximum 28% rate rather than the usual long-term rate, which matters most for the 50% and 75% tiers.
What is the $10 million or $15 million cap?
The exclusion is capped per taxpayer, per issuing company. The cap for a given year is the greater of:
- a dollar limit: $10 million for stock acquired on or before July 4, 2025, or $15 million for later stock (indexed for inflation after 2026), minus gain already excluded from that company’s stock in earlier years; or
- 10 times basis: 10 times the adjusted basis of the qualifying stock of that company you sold during the year.
A founder who paid a fraction of a cent per share has almost no basis, so the dollar limit is the one that matters. An angel who paid $2 million in cash could look to the basis test: 10 times $2 million is $20 million of potential excluded gain. Because the cap applies per taxpayer, gifts of stock to separate taxpayers, such as non-grantor trusts, can multiply it; that planning needs a tax attorney.
How does QSBS apply to founders and early employees?
For founders, stock bought at formation is usually original-issue stock, so the main questions are whether the company stays a qualifying C corporation and when the clock started.
- Restricted founder stock: with a timely 83(b) election, the holding period generally starts when the stock is issued; without one, it starts as the shares vest. Our guide to the 83(b) election explains the 30-day deadline.
- Stock options: the option itself is not stock. The QSBS holding period starts when you exercise and receive shares, and the asset test is measured at that time, so a company that has grown past $75 million in gross assets may no longer issue qualifying stock. See ISO vs NSO stock options for the separate tax rules on exercise.
- RSUs: shares delivered when RSUs settle are acquired at settlement, which starts the holding period then.
- Gifts and inheritance: stock received by gift or at death keeps its QSBS status and the transferor’s holding period.
What happens if the company is sold?
In a cash acquisition, you report the gain on your shares and apply the exclusion if the holding period is met. If the deal closes before your stock reaches 3 years (new stock) or 5 years (older stock), there is no exclusion on that sale.
Two rules can help. Under section 1045, a holder of QSBS held more than 6 months can roll the gain into new QSBS bought within 60 days and defer it. In some tax-free stock-for-stock reorganizations, the acquirer’s shares can carry QSBS treatment for the gain built up before the exchange. Our explainer on how cash and stock mergers are taxed covers the general rules for each deal type.
How do I claim the exclusion on my tax return?
- Collect proof that the stock qualified: the company’s QSBS statement or representation, your stock certificate or ledger entry, and the issue date.
- Report the sale on Form 8949 as you normally would.
- Enter code Q in column (f) and the excluded amount as a negative number in column (g), as the Form 8949 instructions describe.
- Carry the totals to Schedule D. Use code R instead if you are electing a section 1045 rollover.
State tax is separate. Some states, including California, do not follow the federal exclusion, so a federally tax-free gain can still be taxable there.
Bottom line
For startup employees, the date that usually matters is the exercise date, not the grant date, and the company’s gross assets on that day. Ask the company’s finance team whether it tracks QSBS status and will provide a written statement, and keep records of every purchase, because the burden of showing that stock qualified is on you. A tax professional can confirm how the rules apply to your shares.
FAQ
Does QSBS apply to shares of public companies?
It can. If you acquired the stock at original issue while the company met the asset test, the stock can stay qualified after an IPO, as long as the other tests are met for substantially all of your holding period.
Can an LLC convert to a C corporation and issue QSBS?
Yes, stock issued after the conversion can qualify. The gross asset test then counts property contributed at its fair market value, and the exclusion generally does not cover gain built up before the conversion.
Is the $15 million cap per person or per company?
Both: it is per taxpayer and per issuing company. A person who holds qualifying stock in two different companies has a separate cap for each.
Do I need to file anything when I receive QSBS?
No federal form is filed when you receive the stock. The exclusion is claimed in the year of sale on Form 8949 and Schedule D, so the records you keep from the start matter.
