Qualified small business stock (QSBS) lets you exclude up to 100% of the federal capital gain on the sale of startup stock: up to $15 million of gain per company for stock issued after July 4, 2025. The catch is that every requirement must be satisfied from the day the stock is issued, which means QSBS is planned years before a liquidity event, never after one.

Section 1202 of the tax code is the most generous capital gains break available to founders, early employees, and startup investors. It is also one of the easiest to lose through inattention. Here is how it works, what changed in 2025, and what has to be true for your shares to qualify.

What is QSBS?

QSBS is stock in a qualifying small domestic C corporation that you acquired at original issuance (directly from the company, not bought from another shareholder) and held for the required period. When you sell at a gain, Section 1202 lets you exclude a percentage of that gain from your federal gross income. The excluded gain is also exempt from the alternative minimum tax (IRC Section 1202).

What changed under the One Big Beautiful Bill Act?

The One Big Beautiful Bill Act (enacted July 4, 2025) rewrote the economics of QSBS for newly issued stock. Two parallel regimes now exist, divided by the date your stock was issued:

The new tiers apply only to stock issued after July 4, 2025. If your shares were issued earlier, the old five-year, $10 million rules still govern them. The law also includes anti-abuse provisions limiting the ability to swap pre-enactment stock for post-enactment stock to chase the better terms.

The tradeoff hidden in the new tiers: gain that is not excluded is taxed at a 28% rate (not the usual 20% top long-term rate) plus the 3.8% net investment income tax. That produces effective federal rates of about 15.9% for a three-year hold, 7.95% for four years, and 0% for five years. The tiers give you real flexibility on exit timing, but selling early is not free.

Who qualifies for QSBS treatment?

Five requirements must all be met:

1. C corporation. The issuer must be a domestic C corporation when the stock is issued and for substantially all of your holding period. S corporation stock never qualifies, and LLC or partnership interests do not either. Converting to a C corporation starts the clock only on stock issued after the conversion.

2. Original issuance. You must acquire the stock directly from the company (or through an underwriter), not purchase it secondhand from another shareholder. Gifts and inheritances generally carry the original holder's qualification and holding period.

3. Gross assets under the ceiling. The company's aggregate gross assets must be at or under the threshold both immediately before and immediately after your stock is issued: $50 million for pre-July 2025 stock, $75 million for later stock.

4. Active business. During substantially all of your holding period, at least 80% of the company's assets must be used in the active conduct of a qualified trade or business.

5. Qualified trade or business. Certain businesses are excluded outright: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, banking, insurance, financing, leasing, investing, farming, mining and oil and gas, and hotels and restaurants. A SaaS company generally qualifies; a law firm does not.

One more trap: disqualifying redemptions. If the company redeems more than a de minimis amount of its stock from you (or related parties) within the two years before or after your stock is issued, your QSBS treatment can be destroyed. Founders taking money off the table around a financing need to check this before the wire goes out.

How does the $15 million cap actually work?

The cap is per taxpayer, per issuing company: the greater of $15 million of gain or 10 times your adjusted basis in the stock. A founder with near-zero basis in $20 million of sale proceeds excludes $15 million and pays tax on $5 million. An investor who put in $2 million and sells for $25 million excludes the full $23 million gain under the 10x-basis prong ($20 million), because it exceeds $15 million.

Because the cap is per taxpayer, families multiply it by gifting shares before a sale: each recipient gets their own per-issuer cap. This stacking technique is a documented planning strategy, and it only works if the gifts happen while the valuation is low, which means years before an exit, not during one.

What if you have to sell before the holding period is met?

Section 1045 provides a rollover: if you sell QSBS held for more than six months and reinvest the proceeds in new QSBS of a different company within 60 days, you defer the gain. Your holding period tacks, so progress toward the exclusion clock carries over, and you make the election on your return for the year of sale. This is the escape hatch for early secondary sales and for founders who exit one startup and immediately fund the next (Carta QSBS rollover guide).

What should founders and early employees do now?

• Confirm your issuance date. Everything about your QSBS math, the tiers, the cap, and the asset threshold, flows from whether your stock was issued before or after July 4, 2025.

• Document original issuance. Keep board consents, stock purchase agreements, and 83(b) filings. The IRS can ask you to prove the stock was original-issue years after the fact.

• Watch the asset threshold at every financing. A hot startup can blow past the gross-asset ceiling in a single round, closing the QSBS window for later hires permanently.

• Plan gifts early. Stacking only works with low valuations. Once an acquisition offer sets the price, the gifting window has closed.

• Do not assume your state conforms. Several states, including California, do not follow the federal QSBS exclusion, so a 0% federal rate can still come with a full state tax bill.

Updated October 14, 2026.

This article is free educational content, not tax advice for your specific situation. If you want a plan built around your actual numbers, that is what our paid tax planning engagements do.