QSBS (Qualified Small Business Stock, Section 1202)

Qualified Small Business Stock under IRC Section 1202 may allow founders, employees, and early investors to exclude up to $10 million or 10 times original basis of capital gain from federal tax when the stock is sold, provided strict qualification rules are met.

Who may qualify

The stock must be:

• Issued by a domestic C-Corporation (not an LLC or S-Corp)
• Acquired at original issuance (not on the secondary market)
• Held for at least 5 years before sale
• From a company with less than $50M in aggregate assets at the time of issuance
• From an active trade or business (most professional service businesses are excluded)

How the exclusion works

If you qualify, the gain you exclude on sale escapes federal income tax entirely. The exclusion applies per-issuer and per-taxpayer, with the larger of:

• $10 million of gain, or
• 10 times your adjusted basis in the stock

State treatment varies — California, for example, does not conform to Section 1202.

Rolling: Section 1045

If you sell before hitting the 5-year holding period, Section 1045 may let you roll the proceeds into another QSBS-eligible company and preserve the holding clock. Tight 60-day window.

Common pitfalls

• Forgetting to document the company's gross-asset level at the time of stock issuance
• Assuming an LLC or S-Corp converted to C-Corp later qualifies (it generally doesn't for stock issued before the conversion)
• Triggering disqualification by hitting the redemption-test rules (the company can't have redeemed significant stock around the issuance date)

Why founders care

For a founder who built a company from $0 to a $50M exit and held the original stock for 5+ years, Section 1202 can mean the difference between paying ~30% federal + state on the gain versus paying $0 federal on the first $10M. The math compounds for early employees with concentrated positions, and Section 1045 rolling allows preserving QSBS through serial-entrepreneur transitions.