Qualified small business stock (QSBS) can let founders, employees and investors sell C corporation shares partly or fully free of federal income tax. The benefit comes from Section 1202 of the tax code. However, the rules are strict, and the 2025 tax law changed them for stock issued after July 4, 2025. This guide explains how QSBS works today.
What is QSBS?
QSBS is stock that a non-corporate taxpayer, such as an individual or trust, gets directly from a qualifying U.S. C corporation. If the stock meets every requirement and you hold it long enough, you can exclude some or all of your gain when you sell.
How much QSBS gain can you exclude?
The exclusion is limited for each company that issued the stock. You can exclude the greater of two amounts: a dollar cap or 10 times your basis in the stock.
| Stock issued before July 5, 2025 | Stock issued after July 4, 2025 | |
|---|---|---|
| Dollar cap per company | $10 million | $15 million (indexed for inflation after 2026) |
| Holding period for full exclusion | More than 5 years | 5 years |
| Partial exclusion | None before 5 years | 50% after 3 years, 75% after 4 years |
| Company gross asset limit | $50 million | $75 million (indexed after 2026) |
Older stock has different percentages. For example, stock acquired before September 28, 2010, may qualify for only a 50% or 75% exclusion. Also, any gain that isn’t excluded under a percentage limit is generally taxed at up to 28%.
Example: Maria buys QSBS for $2 million in 2019 and sells it in 2026 for $20 million. Her gain is $18 million. Ten times her basis is $20 million, which is more than the $10 million cap. So she can exclude her whole $18 million gain, assuming she meets all the rules.
Key QSBS requirements
1. C corporation stock at original issuance
You must get the stock directly from a domestic C corporation, in exchange for money, property or services. Shares bought from another shareholder don’t qualify. However, stock received as a gift or inheritance keeps its QSBS status. In addition, certain company redemptions around the time of issuance can disqualify stock.
2. The company must be “small”
The company’s aggregate gross assets can’t exceed the limit at any time before, and immediately after, the stock is issued. For this test, you generally use the tax basis of the assets, not their market value. The company’s value when you sell doesn’t matter.
3. An active qualified business
At least 80% of the company’s assets must be used in an active qualified business. Many service fields don’t qualify. For example, these include health, law, accounting, consulting, financial services, hospitality, farming and businesses whose main asset is an employee’s skill or reputation. Also, too much investment real estate or portfolio stock can disqualify the company.
4. The holding period
You must hold the stock long enough, as shown in the table above. If you convert preferred stock to common in a tax-free exchange, the holding periods combine. Likewise, gifted or inherited stock includes the prior owner’s holding period.
5. Reporting the exclusion
You claim the exclusion on Form 8949 and Schedule D of your return. In addition, keep records from the company showing the stock qualifies, such as its asset levels and business activity.
What if you haven’t held QSBS long enough?
Section 1045 may help. If you have held QSBS for more than six months, you can defer the gain by reinvesting the proceeds in new QSBS within 60 days. Your basis and holding period then carry over to the new stock. However, you only defer the gain on the amount you reinvest.
Other QSBS planning points
- Trusts and gifts. Each separate taxpayer gets its own cap. So gifts to family members or non-grantor trusts may multiply the exclusion. However, grantor trusts are treated as you for income tax purposes.
- State taxes. Most states follow the federal exclusion. However, some do not, including California. So California residents generally pay state tax on the full gain.
- Converting an LLC or S corporation. An LLC taxed as a partnership can convert to a C corporation, and stock issued at that point may qualify. By contrast, stock of an S corporation that simply revokes its election generally doesn’t qualify.
For the full rules, see the text of Section 1202.
Get help with QSBS planning
QSBS is generally all or nothing. If one requirement fails, you lose the exclusion. So plan early, ideally before you form the company or accept stock. To review your situation, call (415) 842-2940 or book a free 15-minute call.