What is QSBS (Section 1202) and how does it work?

Qualified Small Business Stock (QSBS) under Internal Revenue Code Section 1202 lets non-corporate shareholders exclude up to 100% of capital gain on the sale of qualified shares — capped at the greater of $10 million or 10× the shareholder’s basis — if the stock is held more than five years and the issuing company meets the qualification rules at issuance and throughout the holding period.

QSBS treatment under Section 1202 is one of the most valuable tax incentives available to founders, early employees, and angel investors in U.S. C-corporations. A correctly qualifying sale at the five-year mark can produce zero federal capital-gains tax on up to $10 million of gain (or 10× basis, whichever is greater) per shareholder, per company.

The qualification rules at a glance

To produce QSBS treatment, the following must all be true:

• Domestic C-corporation: The issuing company must be a U.S. C-corp at issuance and during substantially all of the holding period. LLCs and S-corps do not qualify.
• Gross-asset cap: The corporation must have $50 million or less in aggregate gross assets at the time of issuance and immediately after (the “$50M test”). Note: the OBBBA expanded this threshold for stock issued after July 4, 2025 — check current rules.
• Active business requirement: 80% of the corporation’s assets must be used in a qualified active trade or business. Holding companies, finance/banking, professional services (health, law, accounting, etc.), farming, hospitality, and certain other categories are excluded.
• Original issuance: The stock must be acquired directly from the corporation in exchange for cash, property (other than stock), or services. Secondary purchases generally do not qualify.
• 5-year holding period: The stock must be held for more than five years before sale to claim full exclusion. Section 1045 rollovers can preserve qualification through interim transactions.

What the exclusion is worth

For stock acquired after September 27, 2010 (and prior to the OBBBA tier rules taking effect), 100% of qualifying gain is excluded from federal capital-gains tax, up to the per-shareholder/per-company cap. For most state purposes, conformity varies — Florida has no state income tax so this is moot for Florida residents, but California, for instance, does not conform.

Common ways founders lose QSBS

The most frequent ways we see QSBS lost: (1) operating as an LLC and converting to a C-corp too late, breaking the original-issuance requirement; (2) failing the active-business test by holding too much cash or non-business assets; (3) accidentally crossing $50M in gross assets before the equity round closes; (4) secondary purchases that don’t qualify (though selling to a related party can sometimes work via tacking rules); and (5) M&A consideration paid in stock that doesn’t itself qualify, leaving the seller with a poor result.

For more depth

See our QSBS planning resource for an extended walkthrough of structuring decisions, stacking strategies, and the Section 1045 rollover. For founder-side equity planning, see Seed & Early-Stage Financing. For sell-side counsel where QSBS is a deal feature, see Sell-Side M&A Advisory.