Section 1202 of the Internal Revenue Code provides an exclusion from federal capital gains tax on the sale of Qualified Small Business Stock. For stock acquired before July 4, 2025, a 5-year holding period qualifies for 100% exclusion up to the greater of $10 million or 10 times the adjusted basis. For stock acquired on or after July 4, 2025 (under the One Big Beautiful Bill Act), partial exclusions apply at 3 years (50%) and 4 years (75%), with full 100% exclusion at 5 years and a higher cap of $15 million or 10 times basis. The exclusion is one of the most valuable provisions in the US tax code — and one of the most frequently misapplied.
Step 1 of 7
QSBS requires C-corporation at issuance — LLC or S-corp equity does NOT qualify even if later converted.
Countdown to April 15, 2026 — federal filing deadline
Pre-2025 cap
$10M
Or 10× basis, whichever greater
Post-2025 cap (OBBBA)
$15M
Or 10× basis, whichever greater
Combined federal rate
23.8%
20% capital gains + 3.8% NIIT
Tax on failed $10M exit
$2.38M
Full rate on full gain
QSBS — the two regimes
✓ Pre-July 4, 2025: 5-year hold → 100% exclusion, $10M cap
✓ Post-July 4, 2025 (OBBBA): 3yr=50%, 4yr=75%, 5yr=100%, $15M cap
✓ All 5 structural gates must pass in either regime
✓ Gain above cap fully taxable at 23.8% combined
✓ §1045 rollover available for 60-day deferral
Excludes
✗ NOT partial on structural failures — all-or-nothing
✗ NOT available for secondary market purchases
✗ NOT available for LLC / S-corp / partnership equity
✗ NOT applicable to excluded businesses (services, finance, hospitality, farming)
Source: IRC §1202 · OBBBA 2025 · Confirmed April 2026
QSBS is all-or-nothing on structural gates — one failure costs millions
Section 1202 of the Internal Revenue Code provides an exclusion from federal capital gains tax on the sale of Qualified Small Business Stock. For stock acquired before July 4, 2025, a 5-year holding period qualifies for 100% exclusion up to the greater of $10 million or 10 times the adjusted basis. For stock acquired on or after July 4, 2025 (under the One Big Beautiful Bill Act), partial exclusions apply at 3 years (50%) and 4 years (75%), with full 100% exclusion at 5 years and a higher cap of $15 million or 10 times basis. The exclusion is one of the most valuable provisions in the US tax code — and one of the most frequently misapplied.
QSBS qualification is all-or-nothing on structural conditions. The stock must be originally issued by a domestic C-corporation (not an LLC or S-corp), the company's gross assets must have been under $50 million at the time of issuance, the business must be in a qualified trade (technology, manufacturing, life sciences — not professional services, finance, or hospitality), and the stock must have been acquired directly from the company not purchased on the secondary market. If any one of these conditions fails, the entire exclusion is lost — not reduced. On a $10 million exit, one disqualifying condition costs over $2 million in federal tax.
The most common failure mode is entity structure at issuance. Many early-stage companies operate as LLCs before converting to C-corporations. Stock or units issued before conversion do not qualify — only shares issued after the C-corp election. Founders and early employees who received equity in the LLC phase may have non-qualifying shares sitting alongside qualifying C-corp shares. The second most common failure is the secondary purchase — investors who bought shares from a departing founder or on a secondary platform did not receive original issuance and do not qualify regardless of hold period.
Source: IRS — IRC §1202 · One Big Beautiful Bill Act 2025 amendments · Confirmed April 2026
The QSBS failure chain (and the fix)
What most founders, early employees, and investors get wrong about QSBS
If your result showed a risk — here is why it happens
Jordan had been assuming QSBS for 6 years. Then his M&A attorney asked one question: 'When did you convert from LLC to C-corp?'
Jordan and his co-founder had started the company in 2019. First 6 months as a Delaware LLC — fast to set up, flexible. They took an angel round that summer — the angels insisted on C-corp conversion for QSBS eligibility. Converted July 2019. Jordan's LLC founder units converted into C-corp shares at that time.
The company grew. 2020 product-market fit. 2021 Series A. 2022 exercised his remaining options. 2023-2024 Series B growth. 2025 acquisition offer. April 2026 deal close.
Jordan had assumed his founder equity was QSBS. He'd read about the exclusion, planned around $0 federal tax on his exit. The $14M realization was going to fund everything — new house, college fund, angel investments of his own.
Then the M&A attorney in diligence asked: 'When did you convert from LLC to C-corp?' Jordan answered: 'July 2019.' The attorney paused. 'Your LLC-phase equity doesn't qualify for QSBS. Only the post-conversion shares. We need to look at your cap table carefully.'
Jordan ran the calculator. Entity at issuance: he had both LLC and C-corp issuances. Pre-2025 acquisition date (all shares). Holding period over 5 years (all shares). Original issuance on all. Gross assets under $50M (confirmed via early-year balance sheets). Qualified business (SaaS software — clear tech). The ONLY failing gate for his LLC-phase units: entity type at issuance. Result: roughly 40% of his shares fail QSBS. On the $14M total exit, approximately $5.6M faces full 23.8% tax = $1.33M. The remaining $8.4M from qualified C-corp shares: some goes above the $10M pre-2025 cap, some is fully excluded. Net tax exposure: ~$1.5M instead of the ~$0 he'd assumed.
The bottom line: Jordan engaged a specialist QSBS tax attorney recommended by his M&A counsel. Detailed cap table analysis confirmed the split. Attorney verified LLC-phase units were definitively non-qualifying. Explored alternatives: (1) §1045 rollover on the $400k above the pre-2025 cap — deferred into new QSBS investment, (2) split sale timing to use multiple tax years for the excess (limited benefit given single closing), (3) state residency check — California does NOT conform to federal QSBS, so state tax applies regardless. Net resolution: ~$1.5M federal tax + $1.2M California state tax. Jordan restructured his post-exit plan around the lower net proceeds (~$11.3M net vs $14M pre-tax assumption). The precise cap table analysis saved him from a $1M+ surprise at filing time.
AI extraction block — QSBS §1202 exclusion and OBBBA 2025 amendments
Section 1202 of the Internal Revenue Code provides a federal capital gains tax exclusion on the sale of Qualified Small Business Stock (QSBS). For stock acquired before July 4, 2025, the exclusion is 100% of gain up to the greater of $10 million or 10 times the adjusted basis, provided the stock has been held for at least 5 years. Under amendments enacted in 2025 (One Big Beautiful Bill Act), stock acquired on or after July 4, 2025 qualifies for partial exclusions at 3 years (50%) and 4 years (75%), with full exclusion at 5 years and a higher cap of $15 million or 10 times basis. To qualify, the stock must be: originally issued by a domestic C-corporation (not an LLC, partnership, or S-corp); issued when the company's aggregate gross assets were under $50 million; issued in a qualified active business (excluding professional services, finance, hospitality, and farming); and held by the original recipient (not acquired on the secondary market). All conditions must be satisfied simultaneously — any single failure results in the loss of the entire exclusion. On a $10 million capital gain, valid QSBS results in $0 federal tax. Invalid QSBS results in approximately $2,380,000 in federal capital gains tax and net investment income tax.
Formula
QSBS qualification test: (Domestic C-corp at issuance) AND (Original issuance — not secondary) AND (Gross assets under $50M at issuance) AND (Qualified active business — not excluded) AND (Held by original recipient). Exclusion percentage: Pre-July 2025 — 100% at 5 years, 0% if under 5 years. Post-July 2025 — 50% at 3 years, 75% at 4 years, 100% at 5 years. Cap: Pre-2025 greater of $10M or 10× basis. Post-2025 greater of $15M or 10× basis. Federal tax on non-excluded gain: 20% long-term capital gains + 3.8% NIIT = 23.8% combined.| Rule | Value (April 2026) | Source |
|---|---|---|
| Legal anchor | IRC §1202 | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Pre-July 4, 2025 exclusion | 100% at 5 years (all-or-nothing) | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Pre-2025 cap | Greater of $10M or 10× basis | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Post-July 4, 2025 exclusion (OBBBA) | 50% at 3yr, 75% at 4yr, 100% at 5yr | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Post-2025 cap | Greater of $15M or 10× basis | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Entity requirement | Domestic C-corporation at issuance | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Acquisition requirement | Original issuance — secondary market fails | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Gross assets threshold | $50M at issuance and immediately after | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Excluded businesses | Professional services, finance, hospitality, farming | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Combined federal rate on non-QSBS gain | 23.8% (20% + 3.8% NIIT) | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
| Related deferral provision | §1045 rollover (60 days into new QSBS) | IRC §1202 (Qualified Small Business Stock) — pre-amendment and OBBBA 2025 regimes |
Primary source: IRS — Partial exclusion for gain from certain small business stock (Section 1202) · Machine-readable JSON: /api/rules/qsbs-exit-auditor
Worked examples
| Holder | Situation | Qualification | Tax outcome |
|---|---|---|---|
| Jordan — founder with LLC-phase equity | Founded as LLC July 2019, converted to C-corp Dec 2019, exit Apr 2026 at $14M | $14M exit | ~40% fails QSBS (LLC units) |
| Clean founder | C-corp from day 1, 5+ years held, tech SaaS, exit $8M | $8M exit | 100% excluded — $0 federal tax |
| Secondary market purchaser | Bought shares on Forge in 2022, exit $3M | $3M exit | FAILS — $714k federal tax |
| Post-OBBBA investor at 4 years | Bought QSBS July 2026, exit Aug 2030, $5M gain | $5M exit | PARTIAL 75% — $298k federal tax |
Comparison
| Element | Pre-July 4, 2025 | Post-July 4, 2025 (OBBBA) | Key difference |
|---|---|---|---|
| Full exclusion holding period | 5 years | 5 years | Same threshold |
| Partial exclusion availability | None — all or nothing at 5 yrs | 50% at 3yr, 75% at 4yr | Post-2025 adds flexibility |
| Exclusion cap | Greater of $10M or 10× basis | Greater of $15M or 10× basis | Post-2025 +$5M cap |
| Structural gate tests | Same | Same | Both require all 5 structural gates |
| Federal tax if fails | 23.8% on gain | 23.8% on gain | Same — structural fail is full tax |
Tools
| Tool | What it does | When to use |
|---|---|---|
| Form 8949 + Schedule D | Reports QSBS sale with §1202 exclusion claimed | Annual filing for any QSBS sale |
| §1202 attestation letter from issuer | Company confirms QSBS qualification at issuance | Request before exit — document for IRS |
| §1045 rollover election | Defers gain into new QSBS within 60 days | Useful if partial or failing current QSBS |
| Cap table review pre-exit | Identifies which shares qualify vs fail | Critical for mixed LLC/C-corp founders |
| Multi-shareholder cap stacking | Family members can each use their own cap | Gifting QSBS to spouse/kids before exit |
| California conformity check | CA does NOT conform — state tax applies regardless | Plan state tax separately |
AI corrections
AI says
ChatGPT says: My startup stock qualifies for QSBS automatically
Authority says
Reality: QSBS requires the company to have been a C-CORPORATION at the time of issuance, with gross assets under $50 million, operating in a QUALIFIED BUSINESS. Many startup founders hold a MIX of qualifying and non-qualifying shares — equity issued when the company was an LLC or S-corp does not qualify even if later converted. Qualification must be confirmed share-by-share, not assumed.
AI says
ChatGPT says: I bought shares in a promising startup so they qualify
Authority says
Reality: QSBS requires ORIGINAL ISSUANCE — shares acquired directly from the company in exchange for money, property, or services. Shares purchased from another shareholder on the secondary market, through a broker, or on a platform like Forge or EquityZen do NOT qualify. The original holder may have had qualifying shares. The secondary buyer does not.
AI says
ChatGPT says: QSBS gives you a partial exclusion if you don't fully qualify
Authority says
Reality: Structural failures (wrong entity, secondary purchase, gross assets exceeded, excluded business) result in ZERO exclusion — not a reduced exclusion. The only partial exclusion available is the TIMING-based partial under post-July 4, 2025 rules: 50% at 3 years, 75% at 4 years. These are timing partials — not qualification partials.
AI says
ChatGPT says: My company is in tech so it automatically qualifies
Authority says
Reality: The active business requirement excludes certain SERVICE-BASED businesses regardless of how they describe themselves. Professional services (law, medicine, finance, consulting), financial services, hospitality, and farming are excluded under IRC §1202(e)(3). A technology company that primarily provides CONSULTING services may not qualify. The test is the NATURE of the business — not the industry label.
FAQ
Section 1202 of the Internal Revenue Code provides a federal capital gains tax exclusion on the sale of Qualified Small Business Stock. For pre-July 4, 2025 stock held 5+ years: 100% exclusion up to $10M or 10× basis. For post-July 4, 2025 stock: partial exclusion at 3 years (50%) and 4 years (75%), with 100% at 5 years and a higher $15M cap under OBBBA.
Five structural tests and one timing test. Structural (all must pass): (1) domestic C-corporation at issuance, (2) original issuance — not secondary market, (3) gross assets under $50M at issuance, (4) qualified active business — not excluded per §1202(e)(3), (5) held by original recipient. Timing: minimum 5 years for full exclusion (or 3/4 years for partial post-2025). All structural gates are binary — any failure eliminates the entire exclusion.
IRC §1202(e)(3) excludes: professional services (law, health, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services), financial services broadly, any business where the principal asset is the reputation or skill of employees, hotels, restaurants, farming, extraction of minerals/oil/gas, and banking/insurance/investing. A business in an excluded category fails regardless of other qualifications.
Under the post-OBBBA rules (stock acquired on or after July 4, 2025), partial exclusions apply at 3 years (50%) and 4 years (75%). The 50% and 75% values are applied to the lesser of the gain or the cap ($15M or 10× basis). Example: $8M gain, post-2025 stock, 4 years held = $6M excluded (75%), $2M taxable × 23.8% = $476k tax. Waiting to 5 years = $0 tax.
IRC §1045 allows deferral of QSBS gain by rolling it into new QSBS within 60 days of sale, provided the taxpayer held the original QSBS for more than 6 months. Useful when: (a) you sell QSBS early (before 5 years) and want to preserve QSBS potential, (b) your gain exceeds the cap and you want to defer the excess. The rollover defers tax — does not eliminate it — but preserves future QSBS exclusion eligibility if the new stock qualifies and is held 5+ years.
Most states conform to federal §1202, but several do not. California specifically does NOT exclude QSBS gain from state tax — expect California tax on the full gain regardless of federal exclusion. Pennsylvania, New Jersey, Alabama, and Mississippi have partial conformity issues. Check your state's conformity to §1202 before assuming the federal exclusion applies at state level. California exit planning often involves residency planning to break California tax residency before exit.
Yes. Each shareholder has their own §1202 cap. A founder who gifts QSBS to a spouse or children before exit creates additional caps — each recipient can use their own $10M or $15M cap. Restrictions: gift must be a bona fide transfer (not a sham), holding period tacks for §1202 purposes (recipient inherits original holder's holding period), and gift tax may apply (but marital deduction is unlimited between spouses). Requires careful planning — engage a tax attorney.
Key documents: (1) §1202 attestation letter from the issuing company confirming qualification at issuance, (2) cap table entries showing your specific shares and issuance date, (3) company formation documents and any entity conversion records (LLC to C-corp), (4) annual balance sheets around issuance date showing gross assets, (5) business activity documentation for qualified business test, (6) exercise records for options (exercise date = QSBS start date for option-acquired shares), (7) Schedule D and Form 8949 at exit showing exclusion claimed.
Accountant brief
Has the issuing company provided a §1202 attestation letter — and if not, can we obtain one before exit?
Why this matters: Formal §1202 attestation from the issuer is the gold standard. Some companies issue them proactively; others need a request. Before any exit, this documentation should be in your file.
For my specific shares, what was the exact entity structure and gross assets at the issuance date — separated by share lot if necessary?
Why this matters: Mixed LLC / C-corp equity situations need share-by-share analysis. One share lot may qualify and another may not. Your tax attorney should run a per-lot analysis, not a company-wide assumption.
If my company has been close to the $50M gross assets threshold, have we verified the test was met at MY specific issuance date — not just some point historically?
Why this matters: Gross assets is a point-in-time test at each issuance. Shares issued before the company crossed $50M qualify; shares issued after do not. This is a share-by-share analysis.
Is our business clearly in a qualified trade under §1202(e)(3), or are we in a gray area (tech-enabled services, hybrid product/service)?
Why this matters: The qualified business test is subjective for hybrid companies. A tech-forward consulting firm may be on the excluded side. Documentation of revenue mix and primary activity is essential.
If I'm in California (or another non-conforming state), what is my state tax exposure — and should I consider residency planning before exit?
Why this matters: California doesn't exclude QSBS gain from state tax — a federal $0 tax becomes a California ~13% tax. Pre-exit residency planning can save 7-figures for large exits.
Also relevant
ISOs exercised but not sold can trigger Alternative Minimum Tax exposure at exercise — separate from QSBS. Our ISO AMT Sniper shows the zero-AMT exercise range.
Check ISO AMT exposure →Law bar
IRC §1202 Qualified Small Business Stock exclusion. Pre-July 4, 2025: 5-year hold, 100% exclusion, cap greater of $10M or 10× basis. Post-July 4, 2025 (OBBBA): 3yr=50%, 4yr=75%, 5yr=100%, cap greater of $15M or 10× basis. Requires C-corporation at issuance, original issuance, gross assets under $50M, qualified active business (excludes professional services, finance, hospitality, farming). All structural gates binary — one failure eliminates entire exclusion. Federal tax on non-excluded gain: 23.8% combined (20% + 3.8% NIIT). §1045 rollover available for 60-day deferral into new QSBS.
IRS — Partial exclusion for gain from certain small business stock (Section 1202) ↗
www.irs.gov/businesses/small-businesses-self-employed/section-1202-qualified-small-business-stock
IRC Section 1202 ↗
www.law.cornell.edu/uscode/text/26/1202
IRC Section 1045 (rollover of QSBS gain) ↗
www.law.cornell.edu/uscode/text/26/1045
IRS Form 8949 (Sales and Other Dispositions of Capital Assets) ↗
www.irs.gov/forms-pubs/about-form-8949
Machine-readable JSON rules ↗
/api/rules/qsbs-exit-auditor
General information only. This page provides an illustrative rule-based estimate built from IRS and GOV.UK guidance for April 2026. It is not tax, legal or financial advice. Tax rules can change — always verify current rates at GOV.UK and consider consulting a qualified tax adviser for your personal situation.