What is qualified small business stock (QSBS)? Definition, how it works and examples
The Section 1202 exclusion that can take the federal tax off a startup gain — what makes stock qualify, how the exclusion is sized, and where holders lose it.
The short answer
What is QSBS? Qualified small business stock is stock that a US C corporation with no more than $75 million of gross assets issues directly to you, and that lets you exclude part or all of the gain from federal income tax when you sell it, under Section 1202 of the Internal Revenue Code. For a founder, an early employee or an early investor, it can be the largest single tax item they ever meet: up to $15 million of gain per company, or ten times what they paid, with no federal tax.
What is Section 1202 of the Internal Revenue Code?
Section 1202 is the part of the federal tax code that defines qualified small business stock and grants the gain exclusion — which is why advisers speak of QSBS and Section 1202 as one thing, and why the QSBS tax question is always a federal one first. It applies to taxpayers other than corporations — individuals, trusts and estates, and individuals who hold through a partnership or S corporation. A corporation selling the same shares gets nothing from it. The idea is a trade.
How does QSBS tax treatment work?
When you sell qualifying shares, you report the sale as usual and subtract the excluded part of the gain. On the federal return that is a negative adjustment with code Q on Form 8949. There is no application and no ruling in advance: you claim the exclusion, and the company’s records and yours have to support it if the IRS asks. The exclusion percentage For stock acquired after 4 July 2025 the exclusion grows with the holding period: 50% of the gain after three years, 75% after four, 100% after five.
What is QSBS stock in a startup, and who actually holds it?
Qualified small business stock is mostly held by the people who were there first: founders who bought common stock at formation, employees who exercised options while the company was small, and seed and early-round investors who bought preferred stock directly from the company. The cap table of a successful startup often has QSBS and non-QSBS shares of the same class side by side, because the size test is applied on each issuance date. Gross assets are measured as cash plus the tax basis of everything else the company holds. A company that has just raised a large round counts the cash.
How much is the QSBS tax exemption worth? A worked example
An early investor buys $500,000 of preferred stock directly from a Delaware C corporation in a round that closes in September 2025. After the round the company holds $40 million of assets. Years later the investor sells the shares for $10.5 million — a gain of $10 million. The cap is the greater of $15 million and ten times basis ($5 million), so the whole gain is eligible. Sale years differ only in how long the shares were held. Three years of holding take about a third off the bill; five take all of it. The cap matters on larger exits.
QSBS thresholds: old rules and new rules side by side
Common mistakes with QSBS status
Assuming every startup share qualifies The company must have been a C corporation under the asset ceiling on the issuance date and run a qualified business for substantially all of your holding period. An LLC or S corporation share never qualifies. Counting from the grant date An option is not stock. The holding period and the asset test start when the shares are issued on exercise. Buying on the secondary market Shares bought from another holder are not acquired at original issue and do not qualify, whatever they were in the seller’s hands.
The terms this page uses
Qualified small business stock (QSBS) Stock of a domestic C corporation, issued directly to the holder when the company’s gross assets were within the Section 1202 ceiling, whose gain can be partly or fully excluded from federal tax. Section 1202 The section of the Internal Revenue Code that defines QSBS and sets the exclusion percentage, the per-issuer cap and the company tests. Original issue Acquiring stock from the company itself — for money, property other than stock, or as pay for services — rather than from another holder.
Questions about QSBS
What is QSBS eligible stock? Stock of a US C corporation that you acquired directly from the company, when its gross assets were within the ceiling — $75 million for stock issued after 4 July 2025 — and that you have held for the minimum period. The company must also run a qualified active business while you hold the shares. Do the 2025 changes apply to shares I already own? Not to shares acquired on or before 4 July 2025. Those keep the old rules: more than five years of holding, a $10 million cap and, for stock acquired after 27 September 2010, a 100% exclusion.
What is QSBS eligible stock?
Stock of a US C corporation that you acquired directly from the company, when its gross assets were within the ceiling — $75 million for stock issued after 4 July 2025 — and that you have held for the minimum period. The company must also run a qualified active business while you hold the shares.
Do the 2025 changes apply to shares I already own?
Not to shares acquired on or before 4 July 2025. Those keep the old rules: more than five years of holding, a $10 million cap and, for stock acquired after 27 September 2010, a 100% exclusion. Shares acquired after that date, including on a later option exercise, follow the new rules.
Does QSBS create an AMT adjustment?
Not for stock acquired after 27 September 2010. For older stock, 7% of the excluded gain is still an AMT preference item. The AMT on exercising incentive stock options is a separate question — see the page on AMT.
Can I claim QSBS on shares held through an SPV?
Only if the vehicle itself acquired the shares at original issue from a qualifying company and passes the gain through to you under the pass-through rules. A vehicle that bought its shares from existing holders on the secondary market does not hold QSBS.
Where every figure on this page comes from
Every percentage, cap and date was checked against the US Code and the IRS on 1 October 2026 and reflects federal law as amended on 4 July 2025. The worked example is illustrative arithmetic on those rules, not market data. State tax treatment differs and is not covered.