The QSBS founder tax exemption lets you sell stock in a qualifying startup and exclude up to $15 million of the profit from federal capital gains tax. That ceiling applies to qualified small business stock issued after July 4, 2025; shares issued on or before that date are capped at $10 million. Hit all the requirements and the federal tax on a successful exit can go to zero. Miss one and the whole benefit can vanish, sometimes retroactively.
The rules under Section 1202 of the Internal Revenue Code are specific about three things: what kind of company you held stock in, how you got the stock, and how long you kept it. Everything else flows from those.
Does Your Company Qualify
The company has to be a domestic C corporation. S corporations, partnerships, and LLCs taxed as partnerships are out. Entity type is the first filter and it is absolute.
Then the company has to pass two tests at the moment it issues your stock.
The Size Test
The corporation’s total gross assets cannot exceed a specific ceiling at any point before or immediately after it issues the stock to you. For stock issued on or before July 4, 2025, the ceiling is $50 million. For stock issued after that date, it rises to $75 million and is indexed for inflation starting after 2026. Gross assets means cash plus the fair market value of all property the corporation holds, not net assets after liabilities. If the company owns more than 50 percent of a subsidiary, that subsidiary’s assets count too.
Important: the test only applies at issuance. A company can grow far past the ceiling later without disqualifying stock that was already issued.
The Active Business Test
At least 80 percent of the corporation’s assets must be used in the active conduct of a qualified business during substantially all of the time you hold the stock. Sitting on investments or real estate as a primary activity doesn’t count.
And several industries are excluded no matter how actively they operate:
- Professional services: law, health, accounting, consulting, engineering, architecture, financial services, brokerage, and athletics
- Finance and real estate: banking, insurance, leasing, and investing
- Hospitality and extraction: hotels, restaurants, farming, and mining
If your company falls into one of these categories, no amount of structuring makes the stock qualify. The benefit is aimed at technology, manufacturing, retail, and similar businesses.
How You Acquired the Stock Matters
You have to have acquired the stock at original issuance, directly from the corporation. Buying from another shareholder or on a secondary market doesn’t count. The statute lets you pay for the shares three ways: cash, property other than stock, or services performed for the company.
That last one is what makes this provision work for founders. Stock grants, restricted stock awards, and equity issued as part of a compensation package all count as original issuance so long as the corporation issues the shares directly to you.
Options, Warrants, Convertibles, and SAFEs
Shares you get by exercising stock options or warrants qualify, but the five-year clock does not start when the option was granted. It starts when you exercise and actually buy the shares. Founders with piles of unexercised options need to plan around that gap.
Convertible debt generally keeps its qualifying status when it converts, and the holding period from the original note tacks onto the new stock. SAFEs are murkier. If a SAFE is treated as stock from the start, the holding period begins at issuance; if it’s treated as an open transaction, the clock doesn’t start until conversion. The IRS has not issued definitive guidance on SAFE classification, so get professional advice before you count on a particular start date.
How Long You Hold It and How Much You Can Exclude
For stock issued after July 4, 2025, the One Big Beautiful Bill Act introduced a tiered holding structure:
- Three years but less than four: 50 percent exclusion
- Four years but less than five: 75 percent exclusion
- Five years or more: 100 percent exclusion
For stock issued on or before July 4, 2025, the full 100 percent exclusion still requires more than five years of holding, and nothing partial is available for shorter periods. The tiered structure gives newer founders some benefit if they need to sell early, which the older rule didn’t offer.
If you gift the stock or pass it through an estate, the recipient inherits your holding period. A founder who held three years and then gifted shares hands the recipient a three-year head start.
The Per-Issuer Cap
The exclusion is not unlimited. For stock acquired on or before July 4, 2025, you can exclude the greater of $10 million or ten times your adjusted basis in the stock sold, per company, over your lifetime. For stock acquired after that date, the figure is $15 million (or ten times basis, if larger), indexed for inflation starting in 2027.
“Per issuer” is the key phrase. If you founded two separate qualifying companies, each one has its own cap. The cap is also cumulative across tax years: if you excluded $8 million of gain from Company A last year, you have $7 million of exclusion left for Company A stock, not a fresh $15 million.
Stacking the Exclusion
Each taxpayer gets their own per-issuer cap. On a joint return, each spouse counts as a separate taxpayer, which effectively doubles the household cap. Some founders go further and gift shares to family members or to irrevocable nongrantor trusts before a sale; each recipient who independently holds qualifying stock claims their own exclusion. The IRS can collapse multiple trusts into one if they share substantially the same grantor and primary beneficiary and a principal purpose is tax avoidance, so the strategy has real limits and needs real planning.
Tax on the Gain the Exclusion Doesn’t Cover
If the exclusion doesn’t wipe out your entire profit, what happens to the rest depends on your tier.
For stock qualifying for the 50 or 75 percent exclusion, the non-excluded portion is taxed at a maximum federal rate of 28 percent instead of the standard long-term capital gains rate. That rate is built into Section 1202 and applies regardless of your income bracket. For stock at the 100 percent tier, there’s no leftover gain, so the 28 percent rate never comes up.
Gain fully excluded under Section 1202 is also outside the 3.8 percent net investment income tax, because excluded amounts never enter gross income. Any non-excluded portion is subject to the NIIT if your modified adjusted gross income crosses the threshold.
One older wrinkle: for stock purchased before September 28, 2010, seven percent of the excluded gain is treated as an alternative minimum tax preference item. Stock issued after that date isn’t subject to the add-back.
Selling Before Five Years: The Section 1045 Rollover
If you need to sell qualifying stock before you reach the holding threshold, Section 1045 lets you defer the gain by reinvesting in another qualifying company. The rules are tight:
- You must have held the original stock at least six months
- You must buy replacement qualifying stock within 60 days of the sale
- The replacement company must independently meet every QSBS requirement
- You must buy the replacement for cash or property, not for services
The 60-day deadline is absolute. No extensions. The gain you defer reduces your basis in the replacement stock, so the tax is postponed rather than erased. The payoff is that your original holding period carries over to the new shares, putting you closer to the five-year mark than you’d be starting fresh.
State Taxes Can Undo Part of the Win
Section 1202 is federal. Whether your state follows it is a separate question, and the answer can be expensive. A handful of states, including some of the highest-tax ones, do not conform to the federal exclusion. In those states, your full gain is taxable at ordinary state capital gains rates even when your federal return shows zero. State rates in non-conforming jurisdictions can exceed 13 percent, meaning a $10 million federally tax-free exit could still produce a seven-figure state bill. Check your state’s current conformity before a sale, because positions have shifted in recent years.
Buybacks That Can Retroactively Disqualify Your Stock
Stock repurchases by the corporation can destroy Section 1202 eligibility even after everything else lines up.
If the corporation buys back more than a minimal amount of stock from you or a related person during a four-year window centered on your issuance date, your shares lose qualifying status. “More than minimal” means purchases exceeding $10,000 that also represent more than two percent of the stock held by you and related persons.
A separate rule targets large redemptions from anyone. If the corporation repurchases stock worth more than five percent of its total outstanding shares during a two-year window around your issuance date, and those purchases exceed both $10,000 and two percent of all outstanding shares, your stock can be disqualified even if you had nothing to do with the buyback. Founders on the board should watch any repurchase program carefully; a routine corporate action can wipe out an enormous tax benefit.
Reporting and Records
You report the sale on IRS Form 8949, Part II, with Code Q in column (f) flagging the Section 1202 exclusion and the excluded gain entered as a negative number in column (g). The totals flow to Schedule D. Your broker’s Form 1099-B will show gross proceeds but will not apply the exclusion for you; that adjustment is on you.
Keep the paper trail. The IRS can examine Section 1202 claims years after filing and the burden of proof is on you. Hold onto the stock purchase agreement, board resolutions authorizing the issuance, and records of the corporation’s gross assets at the time of issuance. Evidence that the company met the active business test during your holding period matters too. A letter from the company’s CFO or tax counsel confirming QSBS eligibility at the time of sale is standard practice and saves real pain in an audit.