Qualified Small Business Stock (IRC §1202): The Gain Exclusion and the 2025 Changes
In Short
Qualified Small Business Stock is original-issue stock in a qualifying C corporation whose gain can be partly or fully excluded from federal income tax under IRC §1202 if held long enough. It is commonly used by startup founders, early employees and angel and venture investors.
TL;DR
- Stock must be acquired at original issue from a domestic C corporation that meets a gross-asset test and an active business test [1].
- For stock acquired after July 4, 2025, the exclusion is 50% after 3 years, 75% after 4 years and 100% after 5 years [1].
- For that newer stock, the gross-asset limit is $75,000,000 and the per-issuer gain cap is $15,000,000 or 10 times basis, if greater [1].
- Many service fields — health, law, accounting, consulting, financial services and others — are excluded [1].
- Gain on QSBS held more than 6 months can be rolled into new QSBS within 60 days under IRC §1045 [2].
Quick Facts
| Legal Reference | IRC §1202 |
|---|---|
| Complexity | High |
| Audit Risk | Medium |
| Setup Cost | Moderate — legal structuring and records at issuance |
| Time to Implement | Set at issuance; benefit after a 3- to 5-year hold |
| Illustrative Example | Illustrative example, not a projection. A founder buys newly issued shares of a software C corporation for $10,000 in September 2025, when the company's gross assets are under $75,000,000. Five years later, the founder sells the shares for $8,010,000. If every requirement is met, the full $8,000,000 gain is within the $15,000,000 per-issuer cap and is excluded. If the founder sold after 3 years, only 50% of the gain would be excluded. Actual results depend on the facts and the company's records. |
Key Numbers & Limits
| Item | Limit or Rule | Notes |
|---|---|---|
| Exclusion — Stock Acquired After July 4, 2025 | 50% after 3 years; 75% after 4 years; 100% after 5 years | [1] |
| Exclusion — Stock Acquired After September 27, 2010 and On or Before July 4, 2025 | 100% if held more than 5 years | [1] |
| Aggregate Gross Assets Test | $75,000,000 (stock issued after July 4, 2025); $50,000,000 before | Adjusted for inflation for years after 2026 [1]. |
| Per-Issuer Gain Cap | $15,000,000 (after July 4, 2025) or $10,000,000 (before), or 10 times basis if greater | The $15,000,000 is adjusted for inflation in later years [1]. |
| Active Business Test | At least 80% of assets by value used in qualified trades or businesses | [1] |
| §1045 Rollover | Stock held more than 6 months; reinvest within 60 days | [2] |
What Is Qualified Small Business Stock?
Qualified small business stock (often called QSBS) is stock in a domestic C corporation that meets the tests in IRC §1202, which allows a taxpayer other than a corporation to exclude part or all of the gain on its sale [1]. The stock must be acquired at its original issue, in exchange for money, property other than stock, or services, not bought from another shareholder [1].
The company must be a qualified small business: its aggregate gross assets cannot exceed a set amount at any time before and immediately after the stock is issued, and at least 80% of its assets by value must be used in the active conduct of a qualified trade or business during substantially all of the holding period [1].
The One Big Beautiful Bill Act (Public Law 119-21) changed the rules for stock acquired after July 4, 2025. The gross-asset limit rose from $50,000,000 to $75,000,000, the per-issuer cap rose from $10,000,000 to $15,000,000, and a tiered exclusion replaced the single 5-year rule: 50% after 3 years, 75% after 4 years and 100% after 5 years [1]. Stock acquired after September 27, 2010 and on or before July 4, 2025 keeps the earlier rules, including a 100% exclusion after more than 5 years [1].
Many businesses cannot qualify. Section 1202 excludes businesses performing services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage, any business whose principal asset is the reputation or skill of its employees, and banking, insurance, farming, natural resource extraction and hotels or restaurants [1].
How Does Qualified Small Business Stock Work?
- A founder, employee or investor acquires stock directly from a C corporation at original issue, while its gross assets are within the limit [1].
- The company operates a qualified trade or business and uses at least 80% of its assets in it during substantially all of the holding period [1].
- The holder keeps the stock for the required period — 3, 4 or 5 years for stock acquired after July 4, 2025 [1].
- On sale, the excluded portion of the gain is limited per issuer to the greater of the dollar cap or 10 times the holder's basis in the stock sold [1].
- A holder who sells QSBS held more than 6 months can instead elect under IRC §1045 to roll the gain into new QSBS bought within 60 days, deferring the gain [2].
- The sale and the exclusion are reported on Form 8949 and Schedule D [3].
The Good: What Are the Benefits of Qualified Small Business Stock?
- Up to 100% of the gain on qualifying stock can be excluded from federal income tax [1].
- The per-issuer cap applies to each taxpayer and each company, and the 10-times-basis alternative can allow more [1].
- For newer stock, a partial exclusion is available after only 3 or 4 years [1].
- The §1045 rollover lets holders who sell early reinvest in other QSBS and defer the gain [2].
The Bad: What Are the Drawbacks of Qualified Small Business Stock?
- Only C corporations qualify; S corporations, partnerships and LLCs taxed as partnerships do not [1].
- Many service businesses and some industries are excluded entirely [1].
- Stock bought from another shareholder on the secondary market does not qualify [1].
- The company has to keep meeting the active business test during substantially all of the holding period, which the holder may not control [1].
- State income tax treatment can differ from the federal rules.
The Ugly: What Are the Serious Risks of Qualified Small Business Stock?
- Records are the weak point: if the company cannot show its gross assets at issuance or its business activity, the exclusion can be denied years later, with tax, interest and a 20% accuracy-related penalty on the underpayment [1][4].
- Certain redemptions by the company around the time of issuance can disqualify stock, a trap that holders may not learn about until a sale [1].
- A company that shifts into an excluded field, such as consulting or financial services, can lose qualification for all holders [1].
Who Uses Qualified Small Business Stock?
Who It's Commonly Used By
Who It's Generally Not Suited For
- Owners of S corporations, partnerships or LLCs not taxed as C corporations [1].
- Professional service firms in excluded fields, such as law, accounting, health or consulting [1].
- Investors buying shares from other shareholders [1].
- Holders who expect to sell within 3 years and have no plan to roll over the gain [1][2].
What Are the Key Rules & Requirements for Qualified Small Business Stock?
- The stock must be acquired at original issue from a domestic C corporation [1].
- The company's aggregate gross assets cannot exceed $75,000,000 for stock issued after July 4, 2025, or $50,000,000 for earlier stock, at any time before and immediately after issuance [1].
- At least 80% of the company's assets by value must be used in a qualified trade or business [1].
- Stock acquired after July 4, 2025 qualifies for 50%, 75% or 100% exclusion after 3, 4 or 5 years [1].
- Excluded gain per issuer is limited to the greater of $15,000,000 ($10,000,000 for earlier stock) or 10 times basis [1].
- Only taxpayers other than corporations can claim the exclusion [1].
- Gain on QSBS held more than 6 months can be rolled over into new QSBS bought within 60 days [2].
What Are Common Mistakes & Red Flags With Qualified Small Business Stock?
- No record of the company's gross assets on the date stock was issued [1].
- Converting an LLC to a C corporation without tracking the asset values at conversion.
- Buying shares from a founder instead of from the company [1].
- Assuming a services company qualifies without checking the excluded fields [1].
- Company redemptions of stock close to the time new stock is issued [1].
- Selling before 3 years without planning a §1045 rollover [2].
Frequently Asked Questions
What Changed for QSBS in 2025?
For stock acquired after July 4, 2025, Public Law 119-21 added a tiered exclusion of 50% after 3 years, 75% after 4 years and 100% after 5 years, raised the gross-asset limit to $75,000,000 and raised the per-issuer cap to $15,000,000 [1].
Can an LLC or S Corporation Issue Qualified Small Business Stock?
No. Only stock of a domestic C corporation can qualify [1]. An LLC or S corporation that converts to a C corporation can issue qualifying stock only after the conversion, and the stock still has to meet every other test [1].
Which Businesses Are Not Eligible for QSBS?
Section 1202 excludes service businesses in fields including health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage, as well as banking, insurance, farming, natural resource extraction and hotels or restaurants [1].
What Is a Section 1045 Rollover?
A non-corporate holder who sells QSBS held more than 6 months can elect to defer the gain by buying other QSBS within 60 days of the sale. The deferred gain reduces the basis of the new stock [2].
Sources
- 26 U.S. Code §1202 — Partial Exclusion for Gain From Certain Small Business Stock — Legal Information Institute, Cornell Law School
- 26 U.S. Code §1045 — Rollover of Gain From Qualified Small Business Stock to Another Qualified Small Business Stock — Legal Information Institute, Cornell Law School
- Publication 550 (2025), Investment Income and Expenses — Internal Revenue Service
- 26 U.S. Code §6662 — Imposition of Accuracy-Related Penalty on Underpayments — Legal Information Institute, Cornell Law School
Primary sources only: the Internal Revenue Code, Treasury regulations and official agency guidance. Read how Zentavos researches these reports.