QSBS (Section 1202): What Startup Founders Should Know

By Kyle Westaway · Last updated October 14, 2026

Qualified small business stock (QSBS) is stock in a US C corporation that, if a long list of requirements is met, lets the holder exclude some or all of the gain from federal income tax when they sell. Under Section 1202 of the tax code as amended in July 2025, stock issued after July 4, 2025 can qualify for a 50% exclusion after three years, 75% after four and 100% after five, capped for each stockholder at the greater of $15 million or ten times their basis in the shares sold. Most of the requirements depend on how the company is formed and run, so founders protect eligibility through company decisions made years before any sale. Whether your stock qualifies, and what it means for you, is a question for your tax advisor.

Key takeaways

• Only stock in a US C corporation can be QSBS. LLC interests and S corp stock never are.
• The company must have $75 million or less in gross assets when the stock is issued ($50 million for stock issued on or before July 4, 2025) and must run a qualifying business for substantially all of your holding period.
• You must get the stock directly from the company, for cash, property or services. Shares bought from another stockholder don’t qualify.
• For founders with vesting, an 83(b) election starts the holding period when the shares are issued. For option holders, it starts at exercise.
• Company buybacks, large cash balances, and drifting into an excluded business like consulting can quietly disqualify stock.

What is QSBS?

Section 1202 was written to encourage investment in small operating companies. If you acquire qualifying stock when the company is issuing it and hold it long enough, some or all of your gain on a sale can be excluded from federal income tax, up to a cap that applies separately to each stockholder and each company. Because founders typically buy their stock for almost nothing at formation, QSBS can matter most to them, which is one reason founders who expect to raise venture money form a C corporation from the start. See C Corp vs LLC.

What changed in July 2025?

The tax law signed on July 4, 2025 expanded QSBS for stock issued after that date. Stock issued earlier keeps the old rules.

Many founders and early investors now hold both kinds of stock in the same company, so keep records showing which shares were issued when.

What makes stock qualify?

Some requirements apply to the company and some to the holder.

The company must be a domestic C corporation when the stock is issued and for substantially all of your holding period. Its gross assets, measured as cash plus the tax basis of its other assets, can’t have exceeded the limit at any time before the issuance or immediately after it, counting the money raised. At least 80% of its assets, by value, must be used in an active qualified business. The law excludes service businesses in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage, and any business whose main asset is the reputation or skill of its employees, along with banking, insurance, financing, leasing, investing, farming, mining and oil and gas, and hotels and restaurants. Most software, hardware, biotech and consumer product startups are qualified businesses.

The holder must acquire the stock at original issue, directly from the company, in exchange for money, property other than stock, or services. The holder can’t be a C corporation. Stock received as a gift or inheritance keeps the original holder’s status and holding period.

When does my holding period start?

It starts when you own stock, which isn’t always when you think.

Founder stock with vesting. If you file an 83(b) election, the holding period starts when the shares are issued. If you don’t, it generally starts for each slice of shares only as that slice vests. See 83(b) Election.

Stock options. An option isn’t stock. The holding period starts when you exercise, so early exercise with an 83(b) election can start the clock sooner. See Early Exercise Stock Options.

SAFEs and convertible notes. A convertible note is debt, so the clock generally starts when it converts into stock. Whether a SAFE counts as stock from the day it’s bought is unsettled, and the cautious view is that the clock starts at conversion.

An LLC that converts. The holding period starts at the conversion, not when the LLC was formed.

How does the cap work?

The cap applies per stockholder and per company: the greater of the dollar limit or ten times the holder’s basis in the shares sold. For founders who paid almost nothing, the dollar limit is the one that matters.

Example, for illustration only. A founder buys 4,000,000 shares at $0.00001 per share in March 2026, pays $40 and files an 83(b) election. The company meets every requirement until it’s acquired in 2032, and the founder’s gain on the shares is $30,000,000. Ten times the founder’s $40 basis is $400, so the dollar cap applies: $15,000,000, as adjusted for inflation after 2026. Having held the shares for more than five years, the founder may exclude gain up to that cap, and the rest is taxed under the normal rules. If the sale had come after three or four years, the lower percentage would apply. Each co-founder has a separate cap. Actual results depend on facts and rules this example ignores, including state taxes.

What can founders do to protect eligibility?

Most QSBS problems come from decisions made long before a sale, by people who weren’t thinking about QSBS. These steps keep the option open:

• Form as a Delaware C corporation and don’t elect S corp status.
• Have every founder file an 83(b) election within 30 days of the date the shares are issued.
• Record the company’s gross assets at each financing and issuance, especially before a round that could push it over the limit.
• Talk to your lawyer before any buyback of stock, other than repurchases from departing employees or directors.
• Keep most of your assets in the business, and get advice before holding large cash reserves for years or investing in other companies or real estate.
• Watch for revenue shifting toward consulting or services, which can change the company’s business classification.
• Keep a QSBS file: formation records, the asset figures, and board minutes describing the business, so you can give stockholders a statement when they ask.
• Plan the sale’s structure with a tax advisor before you sign a letter of intent.

What are the most common traps?

Redemptions. If the company buys back stock from you or a person related to you within two years before or after your shares are issued, or buys back more than 5% of its stock within one year before or after, stock issued in those windows can lose QSBS status. There are exceptions for small purchases and for repurchases tied to an employee’s or director’s departure, but a buyback of an investor’s or co-founder’s shares outside those exceptions needs advice first.

Selling too early. A sale before three years gets no exclusion. If you’ve held the stock for more than six months, you may be able to defer the gain by reinvesting the proceeds in other QSBS within 60 days.

State taxes. States decide for themselves. California, Pennsylvania, Alabama and Mississippi don’t follow the federal exclusion, Oregon stopped following it for tax years beginning on or after January 1, 2026, Illinois stopped following it for tax years ending on or after December 31, 2026, and Hawaii and Maine follow it only in part. New Jersey started following it for tax years beginning on or after January 1, 2026. State rules are changing quickly, and your state of residence when you sell matters.

Converting late. An LLC that converts to a corporation must have $75 million or less in gross assets at conversion, valued at fair market value. The conversion can give owners a higher starting basis, but appreciation before the conversion stays taxable. S corp stock never qualifies, even after the election ends. See S Corp vs LLC and How to Value Startup Stock.

Some founders also explore advanced planning, such as giving shares to family members or trusts to create additional caps. Those strategies are complex, can draw IRS scrutiny and belong with a tax advisor.

For the equity basics behind QSBS, see Restricted Stock Purchase Agreement, Why Do VCs Require a Delaware C Corp? and I Just Incorporated My Startup.

To set up your company so QSBS stays available, see our Delaware C Corp startup package or contact us.