Qualified small business stock (QSBS) is stock in a domestic C corporation that can exclude up to 100% of your gain from federal tax when you sell, under Section 1202.
- Newer shares: for shares acquired after July 4, 2025, the exclusion is 50% after 3 years, 75% after 4, and 100% after 5, capped at the greater of $15 million or 10 times your basis per company.
- Older shares: generally need more than five years and start from a $10 million cap.
- Not automatic: the company, the issuance, and your holding period must all meet Section 1202’s rules, so owning startup stock alone is not enough.
How much can the QSBS exclusion save?
The benefit applies to the gain, not the sale proceeds. If qualifying shares cost $100,000 and sell for $1.1 million, the potential exclusion concerns the $1 million gain.
How the cap works:
- Size: it generally uses the greater of an applicable dollar limit or 10 times the adjusted basis of qualifying shares sold during the year.
- Scope: it is calculated per taxpayer, per issuer, with adjustments for prior exclusions.
- Married filing separately: each spouse uses half the dollar limit.
- Installments: selling in several installments does not reset the dollar limit each year.
The current Section 1202 statute sets out those limits.
How do you qualify for the QSBS exemption?
Start with three tests. Each needs records; a company’s informal assurance that it is a startup is not proof.
- Company test.
- The issuer must be a domestic C-corporation and meet the active-business rules during substantially all of your holding period.
- Its aggregate gross assets must have stayed within the applicable $50 million or $75 million limit at all times before the issuance and immediately after it.
- At least 80% of its assets, by value, generally must support a qualifying active business.
- Many service businesses, including health, law, and financial services, are excluded, as are banking, farming, natural resource extraction, and hotels and restaurants.
- Issuance test. Original issuance for money, eligible property, or services is generally required. An ordinary secondary-market purchase does not qualify. Certain transfers, such as gifts and inheritances, have special carryover rules.
- Holding test. For shares acquired on or before July 4, 2025, the exclusion generally requires more than five years. Shares acquired after that date can receive partial exclusions at three and four years, and a full exclusion at five years.
The asset test is not the company’s headline fundraising valuation. It generally uses cash and the adjusted tax basis of other assets, with special rules for contributed property. If the company’s gross assets passed the limit at any point before your shares were issued, those shares fail the test.
An option grant does not start the stock’s holding period: you must first acquire shares. Transfers, reorganizations, and redemptions can introduce additional rules.
How did the 2025 tax law change QSBS?
The One Big Beautiful Bill Act (OBBBA) created a more flexible framework for QSBS shares acquired after July 4, 2025:
- Tiered holding exclusions. Newer stock qualifies for a 50% exclusion after 3 years and 75% after 4 years, before reaching the full 100% at 5 years.
- Higher gains cap. For qualifying stock acquired after July 4, 2025, the dollar limit increased to $15 million, with inflation adjustments beginning after 2026. The alternative limit based on 10 times basis and prior exclusions also matter.
- Higher asset threshold. For stock issued after July 4, 2025, the gross-asset ceiling rose from $50 million to $75 million, also indexed for inflation after 2026. This test follows the issuance date, while the exclusion tiers follow the applicable acquisition-date rules.
Older shares keep their applicable rules:
- Acquired after September 27, 2010 and on or before July 4, 2025: can generally receive the 100% exclusion after more than five years.
- Earlier acquisitions: can have lower exclusion percentages, and for stock acquired before September 28, 2010, part of the excluded gain can be an alternative minimum tax preference.
- Dollar limit: the older dollar limit generally starts at $10 million; the alternative 10-times-basis limit and prior exclusions still matter.
What happens to the gain you can’t exclude?
A 50% exclusion does not mean a 50% reduction in your total tax bill. Section 1202 gain that is not excluded is taxed at up to 28%, above the 20% top rate on most long-term capital gains, and the 3.8% net investment income tax can apply on top.
Compare a proposed sale at three, four, or five years using the actual acquisition records and expected proceeds.
For stock acquired after September 27, 2010, the excluded portion is subject to neither the alternative minimum tax nor the net investment income tax.
State tax can still apply
A federal exclusion does not establish a state exclusion.
- Nonconforming states: California, Pennsylvania, Mississippi, and Alabama do not conform to Section 1202, so a gain that is entirely free of federal tax can be fully taxable at the state level.
- California: taxes capital gains as ordinary income, so the full gain is taxed at California’s ordinary rates even when federal tax is zero; the California tax calculator shows the amount.
- New Jersey: moved the other way and conforms for tax years beginning on or after January 1, 2026.
Other states can apply their own variations, so check the rules in each state taxing the sale. Your state of residence on the sale date generally decides which state taxes the gain.
What does QSBS save on a $10 million gain?
Consider a founder who acquired original-issuance QSBS for $100,000 in 2020 and sold more than five years later for $10.1 million, a $10 million capital gain:
- Without QSBS: assuming the entire gain otherwise faces 20% capital-gains tax plus 3.8% NIIT, the illustrative federal tax is $2,380,000.
- With QSBS: assuming all eligibility tests are met, no prior issuer exclusion reduces the available cap, and the 100% exclusion applies, the full $10 million gain is excluded from federal income tax, bringing the federal bill on the gain down to $0.
What if you need to sell before the holding period ends?
An acquisition, a tender offer, or a personal cash need can arrive before your three or five years are up. A Section 1045 rollover can defer the gain.
How the rollover works:
- Eligibility: if you held the QSBS more than six months, you can elect to defer the gain by buying replacement QSBS within 60 days of the sale.
- Carryover: your holding period carries into the new shares, and their basis is reduced by the deferred gain.
- The catch: the rollover only works if you find qualifying replacement stock within those 60 days.
See IRS Publication 550 for the reporting, and raise a forced early sale with a tax professional while the transaction terms are still being negotiated.
How does QSBS fit your broader equity strategy?
Before an exercise or sale, collect:
- the issuance date
- the purchase price
- grant and exercise records
- transfer history
- evidence of the issuer’s eligibility
Ask the company for support for the asset and active-business tests. Keep records for each lot separately; two grants at the same company may fall under different rules.
Acquiring shares can start a valuable holding period, but exercising early commits cash to a risky asset.
- Restricted shares may also require a timely 83(b) election: with the election, the holding period generally starts at transfer; without it, the clock usually waits until the shares vest. The election also sets your basis, which feeds the 10-times-basis limit.
- Options: the clock starts at exercise, not at grant or vesting; see the difference between ISOs and NSOs for how each is taxed at exercise.
Weigh the tax benefit against the amount you could lose and how long your cash may be tied up.
QSBS generally keeps its status when given as a gift, which is why some founders give shares to family members or trusts. A gift of highly appreciated shares has its own income, gift, estate, and documentation consequences, so model it before any shares change hands.
Nino records the equity grants you enter in a grant form and connects brokerage accounts, updating balances daily.
- Software plans start at $20/mo.
- Advisor plans add a human CPA and financial planner, with federal and state tax filing included, from $300/mo billed annually; the CPA prepares your return, and nothing is filed until you approve it.
See equity compensation planning for founders and early employees. If a liquidity event is close, the tax and cash checklist for an equity liquidity event covers the transaction year.