What Is a Qualified Small Business Stock (QSBS)?

Qualified small business stock, or QSBS, is stock in a domestic C corporation that meets the requirements of Internal Revenue Code Section 1202. If you acquired the shares directly from a company whose aggregate gross assets never exceeded $75 million, and the company runs a qualifying active business, you can exclude a large portion of your capital gain from federal income tax when you sell. Whether the exclusion is 50%, 75%, or 100% depends on when you bought the stock and how long you held it. The One Big Beautiful Bill Act, signed on July 4, 2025, expanded the benefit substantially: it raised the asset ceiling, lifted the per-company gain cap, and introduced a graduated exclusion that starts paying off at just three years.

What the Exclusion Is Worth

The tax payoff is the reason this section of the code matters. For stock acquired after July 4, 2025, the exclusion scales with your holding period:¹

Three years: 50% of the gain excluded
Four years: 75% excluded
Five or more years: 100% excluded

For stock acquired after September 27, 2010 and on or before July 4, 2025, the exclusion is 100% only after more than five years of holding.¹ That 100% exclusion also sidesteps the alternative minimum tax, so the qualifying gain is genuinely tax-free at the federal level. Older vintages of QSBS carry lower exclusion percentages of 50% or 75%.

How Much Gain You Can Actually Exclude

The exclusion has a ceiling, applied separately for each company whose stock you sell. The cap is the greater of two numbers: a fixed dollar amount, or ten times your adjusted basis in the stock sold during the year.¹ The fixed amount is $15 million for stock acquired after July 4, 2025, and $10 million for stock acquired on or before that date. Both the $15 million cap and the $75 million asset limit will be adjusted for inflation for tax years beginning after 2026.

The ten-times-basis alternative can dwarf the dollar cap. Put $3 million into a startup and sell your shares later for $40 million, and your excludable gain is $30 million rather than $15 million. Because the limit applies per issuer, holding QSBS in several companies creates separate exclusion pools.

What the Company Has to Look Like

Three things about the issuing company determine whether its stock can be QSBS at all: entity type, size, and what the business actually does.

Domestic C Corporation

Only domestic C corporations can issue QSBS.¹ S corporations, partnerships, and LLCs are out. The company must be organized in the United States or under state law, and it needs to keep C corporation status during substantially all of your holding period. Converting to an S corp or redomiciling abroad can retroactively kill the treatment.

Many startups launch as LLCs and later convert to a C corporation when they raise venture capital. Stock issued after the conversion can qualify, but shares held before the conversion do not become QSBS automatically. The clock starts when the C corporation issues the qualifying stock.

The $75 Million Asset Ceiling

A corporation qualifies as a small business under Section 1202 only if its aggregate gross assets never exceeded $75 million. The test applies at two points: at all times before the stock is issued, and immediately after issuance, counting whatever the company receives in the transaction.¹ Crossing the line at either point permanently disqualifies that tranche. There is no cure.

The $75 million figure applies to stock issued after July 4, 2025. Earlier stock is measured against the prior $50 million limit, and that older limit still governs whether those shares qualify.

Aggregate gross assets means cash plus the adjusted basis of everything else the company owns, which is generally lower than fair market value for a growing business. A company can be worth far more than $75 million and still qualify. One anti-abuse wrinkle: property contributed to the corporation in exchange for stock is treated as having a basis equal to its fair market value at the time of contribution, not its historical cost.¹

Active Business Use of Assets

The company must actively use at least 80% of its assets, measured by value, in one or more qualified trades or businesses during substantially all of your holding period. Holding companies sitting on passive investments do not qualify. Assets used in research, experimentation, or startup activities count as active-business assets, which gives early-stage companies room to burn cash on product development.¹

Cash held for reasonably required working capital also counts, as does money reasonably expected to be spent within two years on research or working capital increases.² That matters for startups that raise a large round and park it in short-term investments while they deploy it.

Industries That Can Never Qualify

Some businesses are barred from QSBS treatment no matter how small they are or how they are structured. The statute excludes any trade or business whose principal asset is the reputation or skill of one or more employees, plus these named categories:¹

Health, law, engineering, architecture, accounting, and actuarial science
Performing arts, consulting, athletics, and financial or brokerage services
Banking, insurance, financing, leasing, and investing
Hotels, restaurants, and farming
Oil, gas, and other depletable minerals

Software companies, SaaS businesses, and hardware manufacturers are not on the list. The line that matters is whether the value of the company lives in proprietary technology, processes, or products, or in the personal talents of specific people. If a business drifts into an excluded category during your holding period, the stock can lose its QSBS status.

You Have to Buy It Directly From the Company

The shares must come to you at original issuance. Buying QSBS on a secondary market from another shareholder does not qualify, even if the stock was QSBS in the seller’s hands.¹ You can pay with money, with property other than stock, or by providing services to the company.

Limited exceptions exist. Stock transferred by gift or at death generally keeps its QSBS status, and the recipient tacks the original holder’s holding period. Certain partnership distributions and tax-free reorganizations or Section 351 exchanges can also preserve status, though the excludable gain in those cases may be capped at what you would have recognized without the tax-free exchange.¹

Redemptions That Can Silently Kill Your Status

Corporate buybacks can retroactively destroy QSBS status for shareholders who had nothing to do with the repurchase. Section 1202 has two redemption traps.

The first targets buybacks from you or a related party such as a spouse, minor child, or an entity you control. If the corporation repurchases stock from that circle within roughly two years before or after your shares were issued, and the amount is more than de minimis, your shares can be disqualified.³

The second is broader. If the corporation repurchases stock from anyone and the total value of the repurchased shares exceeds 5% of the aggregate value of all the company’s stock, every share issued during the surrounding window can lose eligibility.³ A de minimis exception applies unless the repurchase both exceeds $10,000 and represents more than 2% of outstanding stock. Standard venture financing documents typically restrict buybacks to avoid tripping these rules by accident.

Selling Before You Hit the Holding Period

If you sell QSBS after holding it more than six months but before the exclusion kicks in, Section 1045 offers a partial escape. You can elect to defer the gain by reinvesting the proceeds in new QSBS within 60 days. The deferred gain reduces your basis in the replacement stock, so the tax is postponed rather than erased. If the replacement stock eventually satisfies the full Section 1202 holding period, you may never pay tax on the original gain. The rollover is available only to non-corporate taxpayers, and only to the extent the amount reinvested equals or exceeds what you realized.

Reporting the Sale and Keeping Records

You report a QSBS sale on Form 8949. Enter the transaction normally, then enter the excluded portion as a negative number in column (g) using Code Q. For a Section 1045 rollover, use Code R and enter the postponed gain as a negative number in the same column.⁴

The corporation must agree to submit reports to the IRS and to shareholders as required.¹ The burden of proving QSBS eligibility sits on the taxpayer claiming the exclusion. Keep documentation from the time of purchase: the company’s gross assets at issuance, its C corporation status, a description of the business, the price you paid, and the date you acquired the stock. Reconstructing those facts years after a startup’s founding round is far harder than capturing them when the round closes.

1
Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock
2
Office of the Law Revision Counsel. 26 U.S. Code 1202 – Partial Exclusion for Gain From Certain Small Business Stock
3
eCFR. 26 CFR 1.1202-2 – Qualified Small Business Stock; Effect of Redemptions
4
Internal Revenue Service. Instructions for Form 8949