For founders and early employees of a C-corporation, Section 1202 can exclude some or all of the federal gain on selling qualified small business stock (QSBS). Legislation enacted in July 2025 made the benefit larger and faster for stock issued after July 4, 2025. Because eligibility depends on facts at issuance and throughout the holding period, the time to document it is now, not at exit.
The basics
To qualify, stock generally must be:
- Issued by a domestic C-corporation,
- Acquired at original issuance (for money, property or services), not bought from another shareholder,
- From a company whose aggregate gross assets were under the threshold at and immediately after issuance,
- In an active qualified trade or business during substantially all of the holding period. Software companies generally qualify; certain service fields such as accounting, consulting, financial services, health and law are excluded.
What changed for stock issued after July 4, 2025
| Item | Before | Stock issued after July 4, 2025 |
|---|---|---|
| Holding period for exclusion | 5 years for 100% | 50% at 3 years, 75% at 4 years, 100% at 5 years |
| Per-issuer gain cap | Greater of $10 million or 10x basis | Greater of $15 million (indexed from 2027) or 10x basis |
| Gross asset test | $50 million | $75 million (indexed from 2027) |
Unexcluded gain under the partial tiers is taxed at a special rate, so the tiered exclusion is valuable but not equivalent to full exclusion.
What to document
- Gross assets at each issuance date (balance sheet support).
- The active business test: what the company does and how assets are used.
- Stock issuance records, including 83(b) elections for restricted stock.
- Any redemptions around issuance dates, which can disqualify stock.
- For converted LLCs, the fair value of assets at conversion.
State treatment
Not every state follows Section 1202. California, for example, does not. Model state tax separately.
How we help
We keep the gross asset and active business support with the cap table records, flag transactions that could affect eligibility (redemptions, asset-heavy acquisitions, entity changes) before they happen, and coordinate with your counsel on the equity documents.
Situations that put QSBS at risk
- Redemptions. Significant stock buybacks from shareholders within certain windows around an issuance can disqualify stock issued in that window.
- Excess investment assets. Holding too much of the company's value in investments not used in the business can fail the active business requirement.
- Changing what the company does. A shift into an excluded service field can affect qualification.
- Holding stock through the wrong entity. Stock held through certain pass-through entities keeps QSBS treatment only under specific rules; stock held through a corporation does not qualify for the individual exclusion.
- Gifting and transfers. Gifts and transfers at death generally carry QSBS status to the recipient; sales between shareholders do not.
Planning ideas founders discuss with their advisors
- Timing an exit with the new tiered holding periods in mind for stock issued after July 4, 2025.
- Considering how the per-issuer cap applies to each shareholder, including trusts and family members.
- Section 1045 rollovers, which can defer gain when QSBS is sold and the proceeds are reinvested in other QSBS within a set period.
These are legal and tax planning decisions that depend on facts, and they should be made with counsel. Our role is to keep the financial records that prove eligibility and to model the outcomes.
Sources
Questions founders ask
Does stock issued before July 5, 2025 get the new rules?
No. Stock issued on or before July 4, 2025 stays under the prior rules, including the five-year holding period and the previous caps.
Does an LLC qualify?
No. QSBS must be stock of a domestic C-corporation. An LLC that converts to a C-corp can issue qualifying stock from the conversion date, with the holding period starting then.
