Overview · 3 min read
QSBS: the Section 1202 exclusion
Qualified small business stock can let you exclude millions of dollars of gain from federal tax when you sell. For many founders and early employees, it is the single largest tax benefit they will ever have.
The rules were expanded for stock issued after July 4, 2025. Whether your shares qualify depends on facts about the company and how you got the stock. Those facts are easy to check now and hard to prove years later.
- Who it fits
- Founders, early employees and angel investors in US C corporations.
- Usually not a fit
- Owners of LLCs and S corps, and buyers of shares on the secondary market.
- Figures
- 2026 tax year
The key rule
For stock issued after July 4, 2025, 50% of the gain is excluded after three years, 75% after four and 100% after five, up to the greater of $15 million or ten times your basis per company. Stock issued earlier generally needs five years and is capped at $10 million.
How it works
To qualify, all of these need to be true:
- C corporation. The company is a domestic C corporation when the stock is issued and for substantially all of the time you hold it.
- Original issue. You received the stock directly from the company, for money, property or services. Shares bought from another shareholder do not count.
- Size. The company's gross assets were $75 million or less when your stock was issued ($50 million for stock issued before July 5, 2025).
- Active business. At least 80% of the company's assets are used in an active, qualified business. Fields such as health, law, consulting, finance and many professional services are excluded. Most software and hardware companies qualify.
- Holding period. You held the stock long enough: three, four or five years for newer stock, five years for older stock.
The exclusion is per company and per taxpayer. Gifts to family members or certain trusts can sometimes multiply the cap, but this needs careful planning before a sale.
5 steps
Confirm the company’s status
Ask the company whether it is a C corporation and whether it met the gross asset test when your shares were issued. Many companies will provide a QSBS representation letter.
Check how you got the stock
Founder stock, early-exercised options and exercised options all count from the date you own the shares. Unexercised options and RSUs do not start the clock.
Start the clock early
Early exercise with an 83(b) election starts the holding period years sooner than waiting to exercise.
Keep the evidence
Store your purchase or exercise agreements, the company's QSBS letter, cap table records and any 83(b) election in one place.
Plan before any sale or deal
Before a sale, merger or tender offer, we check the holding period, the cap, your state and any rollover options. If you sell before the holding period, a Section 1045 rollover into new QSBS within 60 days may preserve the benefit.
Example
A founder exit
You received founder shares in 2026 for $1,000. In 2032 the company is acquired and your shares are worth $12 million. With the five-year holding period met and the gain under $15 million, the full gain may be excluded from federal tax.
Common mistakes
- Some states, including California, do not follow the federal exclusion.
- A conversion to an LLC or S corp, or certain redemptions, can end QSBS status.
- A secondary sale counts as a sale. Check the holding period before tendering shares.
Key dates
- Issue date
- Holding period starts.
- Three, four, five years
- Partial and full exclusion for stock issued after July 4, 2025.
Questions we hear
Do RSUs qualify?
Shares delivered from RSUs can qualify, starting from the delivery date, if the company still meets the tests then.
What to send us
- Stock purchase or exercise agreements
- Company QSBS letter
- 83(b) election
- Details of any expected sale
Upload them to your client portal.
General education for TaxSquad clients, not advice for your situation. Rules and figures change. Talk to us before acting on this guide.