QSBS

A founder sells her shares for $40M, and her gain is almost all of it. Without a special rule, the federal tax on that gain is approximately $9.5M. With one section of the tax code, it can be $5.9M. That section is Section 1202, and the shares that it covers are QSBS: qualified small business stock.

What QSBS is

QSBS is stock for which the conditions of Section 1202 of the Internal Revenue Code are true. When you sell QSBS, part or all of your gain has no federal income tax, up to a cap for each company. Your gain is the sale price minus your basis, which is usually what you paid for the stock.

These conditions must be true for the stock and the company:

The company is a domestic C corporation. An LLC or an S corporation does not qualify.
You got the stock at original issue: directly from the company, for money, property, or work. Shares that you buy from a different holder do not qualify.
The gross assets of the company are within the limit of the gross assets test, before the issue and immediately after it.
At least 80% of the company’s assets are in a qualified active business.
The business is not in an excluded field.

The excluded fields are health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, and financial and brokerage services. Also excluded are businesses whose primary asset is the reputation or skill of their employees, and banking, insurance, farming, mining and oil, hotels, and restaurants. Most software startups are not in these fields, but ask a tax professional about your business.

Two sets of rules

On July 4, 2025, the One Big Beautiful Bill Act changed Section 1202. The date when you acquired the stock decides which rules apply:

	Acquired on or before July 4, 2025	Acquired after July 4, 2025
Exclusion	100% after more than 5 years. Nothing before.	50% at 3 years, 75% at 4 years, 100% at 5 years
Dollar limit for each company	$10M	$15M, with an inflation change after 2026
Or, if greater	10 × your basis	10 × your basis
Gross assets limit	$50M	$75M

The 100% exclusion under the earlier rules applies to stock acquired after September 27, 2010. Married persons who file separate returns get half of the dollar limits: $5M and $7.5M.

Predict first

A founder got QSBS-eligible stock in March 2025. She sells it in October 2028, 3.6 years later. What part of her eligible gain does she exclude?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

The cap for each company

Each holder can exclude gain from one company only up to a cap. The cap is the greater of two numbers:

Cap = the greater of  the dollar limit ($15M, or $10M for earlier stock)
                      10 × the basis of the shares that you sell that year

The 10x rule gives founders little, because their basis is very small. It is important to investors who pay cash:

Founder: basis $3,000         10 × $3,000 = $30,000      Cap = $15M
Angel:   basis $2,000,000     10 × $2M    = $20M         Cap = $20M

The tax on a sale

Three parts of the gain have three different federal rates:

The excluded gain has no federal income tax.
The eligible gain that is not excluded has a 28% rate, plus the 3.8% net investment income tax.
The gain more than the cap is a usual long-term capital gain, at a top rate of 20% plus 3.8%.

A frequent mistake is to use the 20% rate for this part. At a 50% exclusion, the effective federal rate on eligible gain is 50% × 28% = 14%, or 15.9% with the 3.8% tax. At 75%, it is 7%, or 7.95% with the 3.8% tax.

Worked example · step 1 of 4

A founder sells new-rules stock after 3 years

1
Find the gain
The founder paid $3,000 for 3,000,000 shares. She sells them for $40M.
```
Gain = $40,000,000 − $3,000 = $39,997,000
```

If she waits two more years, the excluded gain becomes $15M, and the tax falls to $5,949,286:

Holding period at the sale	Excluded gain	Federal tax
Less than 3 years	$0	$9,519,286
3 years	$7,500,000	$8,334,286
4 years	$11,250,000	$7,141,786
5 years or more	$15,000,000	$5,949,286

These numbers use the top federal rates and ignore state taxes. Now try your own numbers.

Calculator

QSBS: the federal tax on your sale

Set when you got the stock, how long you held it, what you paid, and what you sell it for.

When you got the stock

Years held before the sale3

What you paid for the stock

Your basis. For founders, often a few thousand dollars.

What you sell it for

Conditions that the calculator cannot test

The company is a US C corporation

Not an LLC, not an S corporation.

You got the stock directly from the company

Shares bought from a different holder do not qualify.

At least 80% of the assets are in a qualified active business

Not health, law, consulting, finance, hotels, and other excluded fields.

Gross assets stayed at $75M or less before and just after the issue

Cash plus the tax basis of other assets, not the valuation.

Gain: $40M
Excluded from tax: $7.5M; 50% of $15M
Federal tax: $8.33M; 20.84% of the gain
Less tax with QSBS: $1.19M

Federal tax on this sale

Without QSBS: $9.52M
With QSBS: $8.33M

At 3 years, 50% of the eligible gain is excluded. The eligible gain stops at $15M, the greater of $15M or 10 × your $3K basis.

The $7.5M of eligible gain that is not excluded pays 31.8%. The $25M more than the limit pays 23.8%. You pay $8.33M, not $9.52M.

Select “On or before July 4, 2025” and move the years to 5. Nothing is excluded. Move to 5.25 years, and the full $10M cap applies. Then select “After July 4, 2025” again and set the basis to $2M. The cap becomes the greater of $15M or $20M.

Work it out

You got QSBS after July 4, 2025, for $1,000. You sell it after exactly 4 years, with a $10M gain. What is your federal tax at top rates?

Work it out

An investor pays $3M cash for new-rules QSBS. After 5 years, it sells all of the shares in one tax year for $40M. How much gain can it exclude?

The gross assets test

The gross assets test is about the size of the company’s balance sheet, not its valuation. Gross assets are the company’s cash plus the adjusted tax basis of its other property. Property that a shareholder contributes counts at its fair market value at the time of the contribution.

For stock issued after July 4, 2025, gross assets must be $75M or less at all times before the issue, and also immediately after it. The amount immediately after includes the money from the issue itself:

Cash before the round           $40M
New round                       $30M
Gross assets just after         $70M   (not more than $75M: the new shares can be QSBS)

Cash before the round           $60M
New round                       $30M
Gross assets just after         $90M   (more than $75M: the new shares are not QSBS)

The test looks back. If the company had more than the limit at any time, it cannot issue QSBS after that time, even if its assets fall again. But a company with a $1B valuation can still issue QSBS, if its cash and asset basis were never more than $75M.

Inflation and the 2027 values

For tax years that start after 2026, the $15M dollar limit and the $75M gross assets limit increase with inflation, rounded to the nearest $10,000. If you already used all of your cap for a company, a later increase does not give you more cap for that company. The IRS lists the 2027 inflation revenue procedure in its 2026-2027 guidance plan. As of November 4, 2026, we found no IRS release with the 2027 values, so this lesson uses $15M and $75M.

When the clock starts

The holding period starts when you acquire the stock. That date is simple for stock that you buy for cash. It is harder for founder stock that vests, for options, and for SAFEs. The lesson on the 83(b) election and the lesson on exercise and taxes give the background. Ask a tax professional when your QSBS clock started, before you set the date of a sale.

Quiz · question 1 of 5

Test what you learned

Under the new rules, a holder sells after 3 years and gets a 50% exclusion. What is the effective federal rate on the eligible gain, without the 3.8% tax?

In this lesson you will learn