QSBS After the 2025 Rewrite: A Guide for Founders

By Daniel Hiltzik, CPA · Updated August 15, 2026

The two sets of rules, side by side

Everything in section 1202 now turns on one date. This is the table to keep.

	Acquired on or before July 4, 2025	Acquired after July 4, 2025
Held 3 years	No exclusion	50%
Held 4 years	No exclusion	75%
Held 5 years or more	100%	100%
Per-issuer cap on excluded gain	$10 million	$15 million, indexed after 2026
Company gross assets at issuance	$50 million	$75 million

If you’re a startup founder preparing for an exit, there’s one tax benefit you absolutely need to understand: Qualified Small Business Stock, or QSBS. Thanks to Section 1202 of the Internal Revenue Code, you could potentially exclude up to 100% of your capital gains from federal taxation—saving millions of dollars when you sell your company.

And here’s the exciting news: the One Big Beautiful Bill Act signed into law on July 4, 2025, just made this benefit significantly more valuable and accessible. The changes are substantial enough that even if you thought your company was too large to qualify, or if you were frustrated by the previous five-year holding requirement, it’s time to take another look.

 

What Is QSBS and Section 1202?

Section 1202 was enacted in 1993 to encourage investment in small businesses by offering substantial tax incentives to founders and early investors. The provision allows eligible shareholders to exclude capital gains realized from selling qualified small business stock (QSBS) from their federal taxable income.

In practical terms, this means that when you sell your startup and realize a gain, you might not owe any federal capital gains tax on that profit. Section 1202 can create an effective tax rate savings of up to 23.8% for federal income tax, combining the standard capital gains rate and the net investment income tax.

Let’s put this in perspective. Imagine you founded a company, invested $1 million of your own money for equity, and ten years later sold your stake for $21 million—a $20 million gain. Without Section 1202, you’d face federal taxes of approximately $4.76 million (at the 23.8% combined rate). With QSBS treatment, you could potentially pay $0 in federal taxes on that entire gain.

 

The Big Beautiful Bill: Major Changes to QSBS

On July 4, 2025, President Trump signed the One Big Beautiful Bill Act into law, introducing several changes to IRC section 1202 that broaden the availability of QSBS benefits to eligible shareholders and expand the amount of gain that can be excluded. These changes represent the most significant expansion of Section 1202 since 2010, when the exclusion was permanently increased to 100%.

Here are the three changes that matter:

1. Reduced Holding Period Requirements

Previous Rule: You had to hold your QSBS for more than five years to qualify for any exclusion—an all-or-nothing proposition that created significant market distortions.

New Rule (for stock issued after July 4, 2025): Investors can now benefit from a 75% exclusion for stock held for at least four years and a 50% exclusion after just three years of holding QSBS, while maintaining the 100% exclusion for the five-year holding period.

This graduated approach eliminates the cliff effect that previously discouraged sales of stock held for less than five years. Importantly, the OBBB doesn’t impose an AMT preference on the new 50% and 75% phased-in gain exclusions on newly issued stock, making these intermediate exclusions particularly attractive.

2. Increased Asset Threshold

Previous Rule: Companies could only issue QSBS if their aggregate gross assets never exceeded $50 million before and immediately after the stock issuance.

New Rule (for stock issued after July 4, 2025): The Act increases the aggregate gross asset threshold to $75 million with annual adjustments for inflation for tax years beginning after 2026.

This 50% increase in the threshold means many more companies can now qualify as a “qualified small business.” Corporations that previously surpassed $50 million of gross assets but stayed under $75 million may be able to issue QSBS again, creating a refreshed opportunity for companies in this range.

3. Higher Gain Exclusion Cap

Previous Rule: The maximum gain exclusion was capped at the greater of $10 million or 10 times your adjusted basis in the stock.

New Rule (for stock issued after July 4, 2025): The Act increases the $10 million limitation from $10 million to $15 million, subject to reduction for amounts previously or concurrently excluded under section 1202. For tax years beginning after 2026, the $15 million per issuer limitation will be adjusted annually for inflation.

While the 10x basis limitation remains unchanged, the expanded asset threshold creates new possibilities. With the $75 million gross asset cap, the potential maximum exclusion through the 10x basis rule theoretically increases to $750 million.

 

Understanding the QSBS Requirements

To benefit from Section 1202, your stock must satisfy multiple requirements—some at the corporate level and others at the shareholder level. Let’s break down each one.

Corporate-Level Requirements

1. Domestic C Corporation Structure

Only domestic C corporations qualify for the QSBS exclusion. S corporations don’t qualify, although LLCs that have elected to be taxed as C corps may qualify.

This is perhaps the most critical requirement. If you’ve structured your startup as an LLC or S corporation (common for pass-through tax benefits), you’ll need to convert to C corporation status before issuing qualifying stock. Conversion is possible, and the QSBS benefits can apply to appreciation after the conversion date.

2. Aggregate Gross Assets Test

Your company must meet specific size limitations based on when the stock was issued:

• For stock issued before July 5, 2025: Aggregate gross assets cannot exceed $50 million at any time before and immediately after the stock issuance.
• For stock issued on or after July 5, 2025: The threshold increases to $75 million (indexed for inflation beginning in 2027).

The term “aggregate gross assets” means the amount of cash plus the adjusted tax basis of other property held by the corporation. Importantly, contributed property is valued at fair market value rather than the contributor’s adjusted basis, which can be a critical planning consideration.

This test must be satisfied both before and immediately after the stock issuance, so careful timing and valuation are essential.

3. Active Business Requirement

The corporation must use at least 80% of the fair market value of its assets on the active conduct of a qualified trade or business. This means your company can’t just be a holding company or investment vehicle—it needs to be actively operating a business.

This 80% test is measured by the fair market value of assets, not tax basis, and must be satisfied for “substantially all” of your holding period (typically interpreted as at least 80% of the time you hold the stock).

4. Qualified Trade or Business

Not all businesses qualify. Section 1202 specifically excludes certain industries, including:

• Professional services (health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services)
• Banking, insurance, financing, leasing, investing, or similar business
• Farming
• Mineral extraction (oil and gas)
• Hotels, motels, and restaurants

These exclusions are strict and broadly interpreted, so if your startup operates in or near any of these sectors, careful analysis is essential.

Shareholder-Level Requirements

1. Eligible Shareholder Type

Any shareholder who owns qualified small business stock may benefit from the Section 1202 exclusion, including investors, employees (if they’re U.S. residents), and trusts and estates.

However, C corporations cannot benefit from Section 1202. The exclusion is available only to individuals, trusts, and estates. If you hold QSBS through a partnership or S corporation, the gain can potentially flow through to you as an individual, but additional requirements must be met.

2. Original Issuance Requirement

You must acquire the stock directly from the corporation (not from another shareholder) in exchange for cash, property other than stock, or as compensation for services rendered.

This means if you purchase shares from a founder or another investor in a secondary transaction, those shares won’t qualify for QSBS treatment in your hands, even if they were originally issued as QSBS. However, there are some exceptions for inherited stock and gifts that can preserve QSBS status.

3. Holding Period

The holding period requirement now depends on when your stock was issued:

For stock issued on or before July 4, 2025:

• Must hold for more than five years
• 100% exclusion available (for stock issued after September 27, 2010)

For stock issued after July 4, 2025:

• Hold for more than 3 years: 50% exclusion
• Hold for more than 4 years: 75% exclusion
• Hold for more than 5 years: 100% exclusion

For purposes of determining when such stock is acquired by a taxpayer, any tacked holding period under Code Section 1223 is taken into account, which means certain stock conversions and restructurings may allow you to include prior holding periods.

4. Redemption Restrictions

Significant redemptions of stock cannot be made in the year proceeding or following a stock issuance. This prevents companies from issuing QSBS and then immediately buying back stock from other shareholders, which would effectively reduce the risk for new investors.

The rules here are technical and involve both dollar thresholds and percentage tests, so if your company is planning any redemptions around the time of a new equity issuance, work with a tax advisor to ensure compliance.

Calculating Your QSBS Exclusion: The Two-Part Formula

The amount of gain you can exclude under Section 1202 is subject to a per-issuer cap based on a two-part formula. You get the benefit of whichever is greater:

The Standard Cap

Each taxpayer enjoys a minimum $10 million exclusion (or $15 million for QSBS issued after July 4, 2025) for gain triggered by the sale or exchange of a particular QSBS Issuer.

This cap is calculated per taxpayer, per issuer. If you qualify for QSBS in multiple companies, you get a separate $10 million or $15 million cap for each one. Additionally, you can multiply this benefit through gifting—each recipient gets their own cap.

The 10x Basis Cap

Alternatively, you can exclude up to 10 times your aggregate adjusted basis in the QSBS sold.

This planning strategy is sometimes referred to as “stuffing,” i.e., “stuffing” a QSBS Issuer with money or property in exchange for QSBS that adds to a taxpayer’s aggregate QSBS tax basis.

Here’s an example of how these work together:

Let’s say you’re a founder who contributed $2 million to start your company. Years later, you sell your stake for $100 million, realizing a $98 million gain. If your stock qualifies for QSBS:

• Standard cap (stock issued after July 4, 2025): $15 million
• 10x basis cap: 10 × $2 million = $20 million

You’d be able to exclude $20 million of gain (the greater of the two), which at a 23.8% combined federal rate represents approximately $4.76 million in tax savings.

If instead you had contributed $10 million to the company:

• Standard cap: $15 million
• 10x basis cap: 10 × $10 million = $100 million

Now you could potentially exclude the entire $98 million gain, saving over $23 million in federal taxes.

Section 1045: The QSBS Rollover Strategy

Sometimes you might need to sell QSBS before meeting the holding period requirement, or you might want to diversify into other investments while preserving tax deferral. That’s where Section 1045 comes in.

Section 1045 is usually used when a taxpayer sells QSBS before satisfying Section 1202’s applicable holding period requirement. This provision allows you to roll over gains from the sale of QSBS into new QSBS investments, deferring the tax until you ultimately sell the replacement QSBS.

Key rules for Section 1045 rollovers:

• You must have held the original QSBS for more than six months
• You must purchase replacement QSBS within 60 days of the sale
• You can only defer gain up to the amount you reinvest
• The holding period from the original QSBS carries over to the replacement stock

This can be a powerful tool for angel investors and portfolio managers who want to maintain QSBS benefits while rebalancing their investments.

State Tax Considerations: Don’t Forget Your State

While the federal QSBS exclusion is incredibly valuable, it’s crucial to understand that not all states conform to Section 1202. As of July 2025, the following states do not conform to the federal QSBS exclusion, meaning gain is fully taxable under state income tax law: Alabama, California, Mississippi, New Jersey, and Pennsylvania; and the following are partially conforming: Hawaii and Massachusetts.

If you live in California, for example, you could exclude $15 million of federal gain under Section 1202 but still owe California state income tax on that entire amount at rates up to 13.3%. On a $15 million gain, that’s nearly $2 million in state taxes.

State Tax Planning Strategies

One planning strategy gaining traction is the use of non-grantor irrevocable trusts located in no-income-tax jurisdictions. Properly formed and administered, these trusts can own QSBS and potentially avoid both federal and state capital gains tax, assuming all Section 1202 requirements are met. States to consider for trust situs may include Alaska, Delaware, Nevada, South Dakota, and Wyoming.

These strategies require careful planning and must be implemented well before a liquidity event to be effective. Work with qualified tax and estate planning advisors to evaluate whether this approach makes sense for your situation and to ensure proper implementation.

Common QSBS Pitfalls and How to Avoid Them

Section 1202 offers incredible benefits, but the requirements are complex and unforgiving. Here are the most common mistakes founders make:

1. Wrong Entity Structure

Many startups begin as LLCs or S corporations for simplicity or to take advantage of pass-through taxation in the early years. If you wait too long to convert to C corporation status, you could miss out on QSBS benefits entirely.

Solution: If you anticipate significant growth and a future exit, consider starting as a C corporation or converting early in your company’s lifecycle. Remember that QSBS benefits only apply to appreciation after the stock is issued as qualifying C corporation stock.

2. Exceeding the Asset Threshold

The gross assets test must be satisfied before and immediately after every stock issuance. If your company raises a large funding round that pushes you over the threshold, any stock issued in or after that round won’t qualify.

Solution: Time your equity issuances strategically. If you’re approaching the $75 million threshold, consider alternative financing structures or the timing of when you close on investments.

3. Failing the Active Business Test

Letting too much cash accumulate on the balance sheet without actively deploying it in the business can cause you to fail the 80% active business test.

Solution: Regularly monitor your asset composition and have a plan for deploying capital raised. If you’re accumulating significant cash reserves, consider whether investments in working capital, equipment, or other operational assets would help you satisfy the test.

4. Prohibited Redemptions

Stock buybacks around the time of an issuance can disqualify the entire issuance from QSBS treatment.

Solution: Be extremely careful about any stock redemptions in the one-year period before and two-year period after an issuance. The rules here are technical, so always consult with a tax advisor before proceeding with any redemption.

5. Inadequate Documentation

The IRS has been increasingly scrutinizing QSBS claims. Without proper documentation proving that all requirements were met, you could face challenges during an audit.

Solution: Maintain detailed records showing:

• Corporate formation and C corporation status
• Gross assets calculations at each issuance
• Active business test compliance throughout the holding period
• Original issuance documentation
• Proof of holding periods

Consider obtaining a Section 1202 representation letter from your tax advisor and potentially a contemporaneous opinion on QSBS qualification.

Recent IRS Scrutiny and Enforcement

The IRS has become more focused on Section 1202 compliance in recent years. They’ve been examining taxpayers’ claims more closely, particularly around:

• Whether stock was truly acquired at original issuance
• Whether the gross assets test was properly calculated
• Whether the active business requirement was satisfied throughout the holding period
• Whether the qualified trade or business requirements were met

Given the substantial tax savings at stake—potentially millions or tens of millions of dollars—it’s worth investing in proper planning and documentation upfront. An ounce of prevention through good tax planning is worth considerably more than a pound of cure in an IRS audit.

Practical Steps for Founders

If you’re a startup founder looking to maximize your QSBS benefits, here’s your action plan:

For New Startups

1. Structure as a C corporation from day one if you anticipate significant growth and a potential exit scenario. While C corporations face double taxation on earnings, the QSBS benefits on exit can far outweigh this disadvantage.
   
2. Document everything related to your corporate structure, assets, and business activities from the beginning. This creates a clean record for QSBS qualification.
   
3. Plan your capitalization carefully to maximize the 10x basis benefit. The more you can contribute in exchange for stock, the higher your potential exclusion.
   
4. Consider creating a QSBS maximization strategy that involves family members, trusts, or other entities to multiply the per-taxpayer exclusion limits.

For Existing Startups

1. Evaluate whether you qualify for QSBS under current rules. Look at your entity structure, gross assets, business activities, and when stock was issued.
   
2. If you’re not a C corporation, consider converting before your company value increases substantially. The sooner you convert, the more future appreciation will qualify for QSBS treatment.
   
3. If you’ve exceeded the old $50 million threshold but are under $75 million, you may be able to issue new QSBS after July 4, 2025—consider fresh funding rounds or equity compensation to take advantage of this.
4. Review your holding period status. If you’re approaching an exit and have stock issued after July 4, 2025, understand that you now have graduated exclusion options at three, four, and five years.
   
5. Plan for state taxes if you’re in a non-conforming state. Evaluate whether establishing a trust or other planning strategies make sense given the amounts involved.

Before a Liquidity Event

1. Confirm QSBS status with your tax advisors well in advance of any sale. Don’t wait until you’re in the middle of negotiations.
   
2. Obtain documentation from your company’s tax advisors confirming QSBS qualification. Many acquirers now ask for this during due diligence.
   
3. Model the tax impact under different scenarios. Understand exactly how much you’ll save and what your after-tax proceeds will be.
   
4. Consider timing if you’re close to but haven’t yet met a holding period threshold. Sometimes waiting a few more months changes the result by an order of magnitude.

What QSBS Is Actually Worth to a Founder

Section 1202 represents one of the most valuable tax incentives in the Internal Revenue Code. With the recent enhancements under the One Big Beautiful Bill Act, the benefits are now more accessible and more valuable than ever before.

For qualifying founders and investors, QSBS can transform a successful exit from a taxable event that triggers millions in federal tax liability into a completely tax-free transaction. The potential savings—up to 23.8% of your gain at the federal level—can be life-changing.

However, these benefits don’t happen automatically. They require careful planning, proper structuring, and meticulous compliance with complex requirements. The worst time to discover that your stock doesn’t qualify for QSBS treatment is after you’ve already sold it.

If you’re a startup founder, make Section 1202 planning a priority today. Work with experienced tax advisors who understand QSBS inside and out. The investment in proper planning will pay for itself many times over when you eventually exit your company.

The message is clear: with the right planning and structure, you can build a valuable company and keep substantially more of the wealth you create. That’s the power of qualified small business stock.

---

 

Navigating Section 1202 and the QSBS exclusion can be complex — but it could also mean substantial tax savings when you exit. Schedule a call with Hiltzik CPA to ensure your startup qualifies and your strategy is structured for maximum benefit.

Frequently asked questions

Related reading

• Equity compensation: RSUs, options and ESPP
• Entity formation
• Tax preparation and planning
• The SALT deduction cap and the phase-down band

General information, not advice for your situation. Sources: 26 U.S.C. 1202 for the exclusion percentages, the per-issuer limitation and the gross assets test, and 26 U.S.C. 1045 for the rollover.