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Section 1202 QSBS in 2026: The OBBBA Update, Eligibility, and the $15M Exclusion Worked Out

By chrisomo

Section 1202 QSBS is the federal tax provision that lets shareholders of a Qualified Small Business exclude up to 100% of the gain on the sale of their stock, capped at the greater of a per-issuer dollar limit or 10 times their adjusted basis. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, lifted that per-issuer cap from $10 million to $15 million and raised the aggregate gross assets ceiling from $50 million to $75 million for stock acquired after the signing date. For founders, early employees, and angel investors, the rule remains one of the largest single tax breaks in the Internal Revenue Code.

What is Section 1202 QSBS?

Section 1202 of the Internal Revenue Code, enacted by the Revenue Reconciliation Act of 1993, creates an exclusion from federal income tax for the gain a non-corporate shareholder recognizes on the sale of Qualified Small Business Stock (QSBS) held for more than five years. The statute’s original purpose was to channel investment toward small operating companies that struggled to attract capital after the loss of the General Utilities doctrine in 1986. For most of the 1990s and 2000s the provision was modest, excluding only 50% of gain and carrying an AMT preference that ate into the benefit. Two subsequent amendments (the American Recovery and Reinvestment Act of 2009, then the Small Business Jobs Act of 2010 made permanent by the PATH Act of 2015) raised the exclusion to 75% and then to 100%, and the OBBBA of 2025 raised the dollar ceiling and the asset threshold.

The exclusion is per shareholder, per issuer, and per taxable year. A founder who sells QSBS in two separate companies in the same year can stack two full exclusions. A founder who gifts QSBS to a non-grantor trust before sale can sometimes stack a third. The exclusion applies to federal income tax only; state conformity is uneven (California, for example, does not conform).

The mechanics are straightforward in the abstract. The shareholder sells the stock, calculates the gain, and then excludes the lesser of (a) the per-issuer cap or (b) the actual gain, up to the applicable exclusion percentage. The excluded portion never appears on the shareholder’s Form 1040 as taxable income. The non-excluded portion is taxed at a special 28% rate under Section 1(h)(7), not the 20% long-term capital gains rate that would otherwise apply.

Who qualifies?

Qualification is bilateral: both the issuing corporation and the shareholder must meet specific tests at specific moments.

Corporate-level tests

The issuing corporation must be a domestic C-corporation, not an S-corporation, partnership, or LLC taxed as a partnership. Conversions matter: if an LLC converts to a C-corp and then issues stock to a founder, the holding period and basis start at conversion, and only the post-conversion stock can qualify. The corporation’s aggregate gross assets, measured at any point from August 10, 1993 through and immediately after the issuance of the relevant stock, must not exceed $50 million for stock acquired on or before July 4, 2025, or $75 million for stock acquired after that date (per OBBBA). “Aggregate gross assets” means cash plus the adjusted basis of other property, with contributed property valued at fair market value at contribution. Gross assets are measured at the parent level on a consolidated basis under Section 1202(d)(3) when the corporation has subsidiaries.

Throughout substantially all of the shareholder’s holding period, the corporation must conduct an active qualified trade or business. Section 1202(e)(3) carves out a list of disqualified businesses: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, banking, insurance, financing, leasing, investing, farming, mining or other extractive activities, and any hotel, motel, restaurant, or similar business. The result is that QSBS is functionally designed for technology, manufacturing, and product companies, not for professional services. At least 80% of the corporation’s assets (by value) must be used in the active conduct of one or more qualified trades or businesses.

Shareholder-level tests

The shareholder must be a non-corporate taxpayer, which includes individuals, trusts, estates, and pass-through entities (S-corps, partnerships) that flow the gain to non-corporate owners. The stock must have been acquired at original issuance, directly from the corporation or through an underwriter, in exchange for money, property (other than stock), or services. Stock purchased on the secondary market is not QSBS. Stock acquired by gift, inheritance, or distribution from a partnership is treated as held by the donee from the original holder’s acquisition date (the holding period “tacks”), which is what makes the packing-and-stacking strategies work.

The shareholder must hold the stock for more than five years to claim any exclusion. There is no partial credit for shorter holds. However, Section 1045 lets a shareholder roll over QSBS gain into replacement QSBS within 60 days, with the original holding period tacking, which provides a way to preserve the clock when a portfolio company is acquired before the five-year mark.

How Section 1202 QSBS is calculated

The exclusion is computed in five steps.

Step one: confirm the stock is QSBS. Verify the corporation’s status at the issuance date (C-corp, qualified business, gross assets test), verify original issuance to the current holder or to a predecessor whose holding period tacks, and verify the five-year-plus holding period. Document these facts contemporaneously; corporate counsel customarily issues a QSBS opinion letter at financing close.

Step two: determine the applicable exclusion percentage. Look at the acquisition date. Stock acquired between August 11, 1993 and February 17, 2009 gets a 50% exclusion. Stock acquired between February 18, 2009 and September 27, 2010 gets 75%. Stock acquired on or after September 28, 2010 gets 100%. The exclusion percentage is locked in by the original issuance date and travels with the stock through gifts and inheritances.

Step three: calculate the per-issuer cap. The cap is the greater of (a) $10 million ($15 million for stock acquired after July 4, 2025), reduced by the aggregate amount of gain on the same issuer’s stock that the shareholder has excluded in prior years, or (b) 10 times the shareholder’s aggregate adjusted basis in the QSBS sold during the year. The 10x basis rule is what lets later-stage employees and Series B investors get meaningful exclusions even when their basis is significant.

Step four: apply the exclusion percentage to the lesser of actual gain or the per-issuer cap. The excluded amount is not reported as income. The non-excluded amount is reported as Section 1202 gain on Form 8949 with code Q.

Step five: tax the non-excluded portion at 28%. The Section 1(h)(7) rate applies. For pre-September 28, 2010 stock, an additional AMT preference equal to 7% of the excluded gain is added back under Section 57(a)(7), which can claw back part of the benefit at the AMT level.

Section 1202 exclusion caps by acquisition date

The cap and exclusion percentage are tied to the acquisition date of the stock, not the sale date. The OBBBA changes apply only to stock acquired after July 4, 2025.

The aggregate gross assets ceiling on the issuer also tracks the acquisition date: $50 million for stock acquired on or before July 4, 2025, and $75 million for stock acquired after that date. A corporation that grew past $50 million in 2022 but was still under $75 million at a 2026 capital raise can issue post-OBBBA QSBS even though it could not have issued pre-OBBBA QSBS at the same moment.

Worked example: founder sells $50 million in 2026

Consider a founder of a Delaware C-corporation that develops industrial automation software. The relevant facts:

• The corporation was incorporated in January 2020 with $4 million in seed funding.
• At founding, the founder purchased 100,000 shares of common stock at $0.001 per share for total cash consideration of $100. This is her aggregate adjusted basis.
• At the moment of issuance, the corporation’s aggregate gross assets were approximately $5 million, well under the $50 million pre-OBBBA threshold.
• The corporation conducts an active qualified trade or business (industrial software is not on the disqualified list).
• In April 2026, after a six-year and three-month hold, the founder sells all 100,000 shares in a secondary tender offer for $50 million.

Step one: confirm QSBS status. C-corp at issuance, gross assets well under threshold, active qualified trade or business throughout the holding period, original issuance to the founder, more than five years held. Status confirmed.

Step two: determine the exclusion percentage. Stock acquired in January 2020, which is after September 28, 2010. Exclusion percentage is 100%. No AMT preference.

Step three: calculate the per-issuer cap. Here is the nuance practitioners often miss. The OBBBA raised the cap to $15 million, but only for stock acquired after July 4, 2025. The founder’s stock was acquired in January 2020. It is pre-OBBBA stock. The applicable per-issuer cap remains $10 million, regardless of when the sale occurs. The 10x basis alternative is 10 multiplied by $100, which is $1,000. The cap is the greater of $10 million or $1,000, so the cap is $10 million.

Step four: apply the exclusion. Total gain on sale is $50,000,000 minus $100 basis, which equals $49,999,900. The excludable amount is the lesser of (a) actual gain ($49,999,900) or (b) the per-issuer cap ($10,000,000). The lesser is $10,000,000. Apply the 100% exclusion percentage. The founder excludes $10,000,000 in full.

Step five: tax the non-excluded portion. Non-excluded Section 1202 gain is $49,999,900 minus $10,000,000, which equals $39,999,900. This is taxed at the Section 1(h)(7) rate of 28%. Federal tax owed: approximately $11.2 million. Net Investment Income Tax of 3.8% also applies to the non-excluded portion, adding about $1.52 million. State tax depends on the founder’s residency and that state’s conformity rules.

Comparison without QSBS. Had the stock not qualified, the full $49,999,900 would have been taxed at the 20% long-term capital gains rate plus 3.8% NIIT, for federal tax of approximately $11.9 million. The QSBS exclusion saved the founder roughly $2.8 million in federal income tax in this scenario. The savings appear smaller than the $10 million headline because the comparison is 28% on the non-excluded portion versus 20% on the full amount; the rate differential offsets some of the exclusion benefit.

Could the founder have done better? Yes, through packing and stacking. Had the founder, well before the sale and the start of negotiations, gifted 20,000 of her shares to a non-grantor trust for her children, the trust would hold its own QSBS with its own $10 million cap. The founder’s remaining 80,000 shares would still get the full $10 million cap. On a $50 million sale, the trust’s share would be $10 million, of which $10 million is excludable (capped). The founder’s share would be $40 million, of which $10 million is excludable. Total excluded: $20 million instead of $10 million. The pre-sale gift must be a completed gift for tax purposes (no retained powers), and the trust must be non-grantor (so its income is not attributed back to the founder). Most practitioners require the gift to predate any signed letter of intent to avoid an anticipatory assignment of income challenge.

Recent changes: the OBBBA 2025 update

The OBBBA, signed by the President on July 4, 2025, contained two changes to Section 1202 that operate prospectively on stock acquired after the signing date.

Per-issuer cap raised from $10 million to $15 million. Section 1202(b)(1)(A) is amended to substitute $15,000,000 for $10,000,000. The 10x basis alternative is unchanged. The amendment applies only to stock acquired after July 4, 2025. Stock acquired before that date continues to use the $10 million cap, even if sold years later.

Aggregate gross assets threshold raised from $50 million to $75 million. Section 1202(d)(1) is amended to substitute $75,000,000 for $50,000,000. The measurement methodology is unchanged: cash plus adjusted basis of other property, with contributed property at FMV at contribution, measured at and immediately after issuance and at any time from August 10, 1993 to issuance. The amendment lets a wider band of companies issue QSBS, including later-stage rounds at companies that have already grown past the old ceiling.

The OBBBA did not change the five-year holding period, the disqualified business list, the exclusion percentage tiers, or the 28% rate on non-excluded gain. It also did not change the AMT preference on pre-September 28, 2010 stock. Practitioners expecting a broader rewrite did not get one. The legislative history suggests the conference committee considered shortening the holding period to three years but dropped the proposal in the final text.

For founders considering when to incorporate or when to time a new capital raise, the post-OBBBA window is meaningfully more generous. A company at $60 million in gross assets that could not issue QSBS in June 2025 can issue QSBS to a Series C investor in August 2025. That investor’s QSBS will carry the $15 million cap and the 100% exclusion percentage. The investor’s five-year clock starts at issuance, so the soonest a qualified exit could occur is August 2030.

Common pitfalls

Treating LLC interests as QSBS. LLCs taxed as partnerships cannot issue QSBS. A conversion to C-corp resets the basis and the holding period. The pre-conversion LLC units carry no QSBS character. Founders who delay the C-corp conversion to preserve pass-through losses sometimes find they have no QSBS at exit.

Failing the active business test mid-hold. The corporation must conduct an active qualified business “during substantially all” of the shareholder’s holding period. A pivot into a disqualified business (a consulting practice acquired as a sideline, a foray into financial services) can taint the stock. The 80% asset use rule is also continuous: a company that accumulates excess cash and parks it in investments can fail the 80% test even while operating an otherwise qualified business.

Buying secondary stock. Stock purchased from another shareholder in a secondary transaction is not QSBS in the buyer’s hands. Only original issuance qualifies. Employees who exercise stock options receive original issuance; employees who buy shares from a founder in a tender do not.

Gifting after signing. A gift to a non-grantor trust executed after the company signs a letter of intent or a merger agreement risks being recharacterized as an anticipatory assignment of income. The donor is treated as having earned the gain before the gift, and the donee inherits the gain rather than the QSBS exclusion. Practitioners generally require the gift to predate any deal-stage activity by a meaningful margin and to be supported by an independent appraisal.

Forgetting the 28% rate. The non-excluded portion of Section 1202 gain is taxed at 28%, not 20%. On large sales where the cap binds, this can erase a portion of the headline benefit. Practitioners modeling QSBS savings should compare the actual tax burden to a no-QSBS counterfactual at the full 23.8% long-term capital gains + NIIT rate, not assume the entire gain saves 23.8 points.

Missing the AMT preference on old stock. Pre-September 28, 2010 QSBS carries a 7% AMT preference equal to 7% of the excluded gain. For a founder excluding $10 million of pre-2010 QSBS, $700,000 is added back at the AMT level, which at a 28% AMT rate is approximately $196,000 of additional tax. The benefit is still significant but smaller than the 50% or 75% headline suggests.

State non-conformity. California does not conform to Section 1202; the entire gain is taxed as ordinary income for California purposes. Several other states have partial or delayed conformity. Founders should run a state-specific calculation, not assume the federal exclusion travels to their state return.

FAQ

Does Section 1202 apply to S-corporations?

No. Only domestic C-corporations can issue QSBS. An S-corp that converts to a C-corp can begin issuing QSBS on the conversion date, but stock issued before conversion does not qualify and the holding period for any post-conversion stock starts at issuance.

What is the five-year holding period and can it be tacked?

The shareholder must hold the QSBS for more than five years before sale to claim any exclusion. Section 1202 allows tacking from a predecessor in three situations: gifts, inheritances, and distributions from a partnership to a partner. Rollovers under Section 1045 also tack. There is no partial credit for holds shorter than five years.

What happens if the corporation grows past the $75 million asset ceiling after stock is issued?

Nothing. The aggregate gross assets test is measured at and immediately after issuance, and at any time before issuance going back to August 10, 1993. Growth after issuance does not retroactively disqualify the stock. The corporation’s status as a “qualified small business” can change for future issuances, but already-issued QSBS retains its character.

Can a venture fund hold QSBS?

Yes, indirectly. A partnership that holds QSBS can flow the exclusion through to non-corporate partners under Section 1202(g). Each partner is treated as having held the partner’s share of the QSBS for the partnership’s holding period, provided the partner was a partner when the QSBS was acquired and remained so through the sale. The cap applies at the partner level.

What is the difference between Section 1202 and Section 1045?

Section 1202 excludes QSBS gain on sale. Section 1045 lets a taxpayer roll over QSBS gain into replacement QSBS within 60 days, deferring recognition and tacking the holding period from the original stock. The two provisions are complementary: 1045 preserves QSBS status when a portfolio company is acquired before the five-year mark, and 1202 then excludes the gain when the replacement stock is eventually sold after the combined holding period exceeds five years.

How is Section 1202 gain reported?

The sale is reported on Form 8949 with code Q in column (f) and the excluded amount as a negative adjustment in column (g). The non-excluded portion flows to Schedule D. The 28% rate is applied via the Schedule D Tax Worksheet. For pre-September 28, 2010 stock, the AMT preference is reported on Form 6251.

Are SAFEs and convertible notes QSBS?

Not directly. A SAFE or convertible note is not stock until it converts. The conversion is treated as an exchange, and the QSBS clock starts at conversion, not at the original SAFE or note issuance. Investors using SAFEs to fund pre-seed companies should be aware that the five-year clock does not start until a priced round triggers conversion.

Does the OBBBA $15 million cap apply to stock I bought in 2022?

No. The amendment applies only to stock acquired after July 4, 2025. Pre-OBBBA stock retains the $10 million cap, even if sold after the OBBBA effective date. The same is true of the $50 million gross assets threshold: it stays at $50 million for pre-OBBBA stock.

What states do not conform to Section 1202?

California is the largest non-conforming state and taxes the full gain. Other partially or non-conforming states include New Jersey, Mississippi, Alabama, and Pennsylvania (for some flavors of the rule). Most other states with an income tax conform fully or by automatic IRC reference. Founders should obtain a state-specific opinion before relying on the federal exclusion.

For more on tax-side diligence in an M&A deal, see our guide to the quality of earnings report. For the parallel federal incentive for technology-heavy companies, see our R&D tax credit guide. For framework-level tax planning context, see our playbook and regulatory hub.