Section 1202 is the most generous capital gains tax break in the entire Code, and most founders, early employees, and investors don't know it exists - or assume their company doesn't qualify. If you got stock in a US C-corporation when it was small, held it for at least three years (post-OBBBA) or five years (pre-OBBBA), and the company stayed within size and business limits, you may be able to exclude $15 million or more of the eventual gain from federal tax entirely. The One Big Beautiful Bill Act (P.L. 119-21, signed July 4, 2025) significantly expanded the rules. This article walks through how it works.
QSBS lets you exclude up to $15 million (or 10 times your basis, whichever is greater) of capital gain on the sale of qualifying small business stock - if the stock was originally issued by a domestic C corporation that had under $75 million in aggregate gross assets at issuance, in a non-excluded industry, and you held it long enough.
The first thing to understand: there are now two sets of QSBS rules running in parallel. Stock issued on or before July 4, 2025 follows the pre-OBBBA rules. Stock issued after July 4, 2025 follows the new (more generous) rules. Pre-OBBBA stock cannot be "converted" to post-OBBBA treatment - the acquisition-date carryover rules prevent simple resets via reorganizations.
For stock issued after July 4, 2025, OBBBA replaced the old all-or-nothing five-year requirement with a graduated schedule:
The exclusion is capped per taxpayer per issuing company at the greater of:
The 10x basis alternative is what makes QSBS extraordinary for higher-basis investors. A late-stage VC who invests $5 million in QSBS could potentially exclude up to $50 million of gain, regardless of the $15M cap. Most founders with founder stock at $0 or near-zero basis will be limited to the $15M cap. Late-stage cash investors, recapitalizing investors, and angels who participated meaningfully often have enough basis that 10x basis is the binding constraint.
For stock to be QSBS, every one of the following has to be true. Missing any one disqualifies the stock entirely.
The issuer must be a domestic (US) C corporation - on the date of issuance and during substantially all of the holding period. LLCs taxed as partnerships, S corporations, foreign corporations, REITs, and RICs cannot issue QSBS.
This is the first reason many companies don't qualify: the founder structure. Most startups now begin as Delaware C corps from inception, often QSBS-driven. Companies that started as LLCs and converted to C-corp status only start the QSBS clock at the conversion date, and only equity issued after the conversion qualifies.
The stock must be issued directly by the corporation to the taxpayer, in exchange for cash, property (other than stock), or services. Buying QSBS from another shareholder on the secondary market does not qualify - the buyer's stock is not QSBS in their hands. Exceptions: stock received by gift or inheritance generally retains QSBS status (with the holding period tacked on); stock received in tax-free reorganizations under §351 or §368 also generally retains QSBS status.
Immediately before and immediately after the stock is issued, the corporation's aggregate gross assets cannot exceed:
"Aggregate gross assets" means cash plus the aggregate adjusted tax basis of other property held by the corporation. Property contributed to the corporation in §351 contributions is treated as if its basis equals fair market value at the time of contribution.
The test applies only at the time of issuance. A company that grows past $75M in assets after issuing QSBS doesn't disqualify the stock that's already out - but no new QSBS can be issued from that point forward.
For substantially all of the taxpayer's holding period, at least 80% of the corporation's assets (by value) must be used in the active conduct of one or more "qualified trades or businesses." This is checked continuously throughout the holding period, not just at issuance. Holding too much cash, marketable securities, or non-business real estate can fail this test.
The active business cannot be in certain excluded categories. The list is long and matters:
What does qualify: tech (software, hardware, biotech, clean tech), manufacturing, retail (other than restaurants), most consumer products and services. The IRS has been increasingly liberal in interpreting where "tech" or "service" companies fall - a SaaS analytics platform that serves law firms is generally not a "law" business.
One detail that surprises a lot of investors: the portion of QSBS gain that's not excluded isn't taxed at regular long-term capital gains rates. It's taxed at a special 28% rate (the "Section 1202 gain rate"), plus the 3.8% Net Investment Income Tax if applicable.
This matters for:
So if you have $20M of gain from post-OBBBA QSBS held 4 years, the $5M not excluded is taxed at 28% (federal), not 20%. Plus 3.8% NIIT. Add state tax if your state doesn't conform.
Federal QSBS exclusion does not automatically apply at the state level. Several states tax the full gain even when the federal exclusion applies:
For a California founder, this is a roughly 13% state tax bill on what would otherwise be tax-free federal income. On a $15M federal exclusion, that's $1.95M of state tax. The planning response: many California QSBS holders move to no-tax states (Texas, Florida, Tennessee, Nevada) before sale - or use non-grantor irrevocable trusts established in QSBS-friendly jurisdictions.
The $15M cap is per taxpayer per issuing company. With careful planning, you can multiply it across multiple taxpayers.
QSBS gifted to family members (or trusts for their benefit) carries with it the donor's holding period and basis. Each donee gets their own $15M cap. A founder who gifts $5M of QSBS to each of three children before sale has potentially created three additional $15M exclusions on top of their own.
Constraints: the gift must be a real, complete transfer. Reciprocal gifts and step transactions are scrutinized. Annual gift tax exclusion ($19,000 in 2026) and lifetime exemption ($15M in 2026, OBBBA) need to be considered.
A non-grantor trust is a separate taxpayer for income tax purposes. Each non-grantor trust gets its own $15M cap. By gifting QSBS to multiple non-grantor trusts (often situated in no-state-tax jurisdictions like South Dakota, Nevada, Wyoming, or Alaska), the same founder can multiply both federal and state QSBS exclusion many times over.
Considerations: the gift uses lifetime exemption (for amounts over $19K per donee per year); the trust must have a real purpose beyond tax savings; the trust's administration must be genuinely separate. Self-settled trust structures and gift-and-leaseback arrangements can fail under economic substance doctrine.
If you sell QSBS before meeting the holding period (under three years post-OBBBA, under five years pre-OBBBA), Section 1045 lets you roll the proceeds into new QSBS within 60 days, deferring the gain. The original stock must have been held more than six months for §1045 to apply. The new stock's holding period continues from the original.
Useful when an early acquisition disrupts a planned hold. The seller takes the cash, finds new qualifying QSBS investments within 60 days, and preserves the eventual exclusion when the new stock matures.
Establish QSBS status from day one. If you're forming a new company, a Delaware C corporation almost always beats an LLC for QSBS-eligible founders and early employees. The QSBS clock starts at C-corp issuance.
Document the aggregate gross assets test. Each round of issuance needs a contemporaneous calculation showing the $50M / $75M test was met. After-the-fact reconstruction is much harder.
Run the active business test continuously. If the company holds large cash balances post-fundraising or invests in non-business real estate, the 80% test can fail in years where you weren't tracking.
Plan stacking 1 to 3 years before sale. Trust formation, gifting, and state-residency moves done in the year of sale draw scrutiny. Done years in advance, with separate economic purposes, they hold up.
Don't bet the farm on QSBS for excluded industries. If your company is in health, financial services, consulting, or another excluded category, build your exit financial model assuming no QSBS. Treat any actual exclusion as upside.
For pre-OBBBA stockholders: the new rules don't apply retroactively. Your pre-OBBBA QSBS keeps the original $10M cap and 5-year all-or-nothing hold, even if you continue holding past July 4, 2025. The new regime is a separate generation; old shares don't get a free upgrade.