Qualified Small Business Stock (QSBS)
Qualified Small Business Stock (QSBS) is stock in a qualifying domestic C corporation that meets the requirements of Section 1202 of the Internal Revenue Code, allowing non-corporate investors who acquire and hold the stock for more than five years to exclude up to 100% of the capital gain from federal income tax, subject to a per-issuer gain exclusion limit of the greater of $10 million or 10 times the taxpayer's adjusted basis.
Section 1202 of the Internal Revenue Code was enacted in 1993 to encourage investment in small businesses by providing a substantial capital gains tax exclusion to qualifying investors. The exclusion was increased from 50% to 100% for stock acquired after September 27, 2010, and this 100% exclusion remains in effect for 2025. Gain excluded under Section 1202 is also not subject to the alternative minimum tax (AMT) for stock acquired after the 2010 effective date.
To qualify for QSBS treatment, the stock must meet several requirements. The issuing corporation must be a domestic C corporation (not an S corporation, partnership, or LLC). At the time of issuance, the corporation must have had aggregate gross assets of $50 million or less (including proceeds of the offering). The stock must be acquired by the taxpayer at original issuance — purchased directly or through certain pass-through entities — in exchange for money, property, or services. The taxpayer must be a non-corporate investor. The stock must be held for more than five years before sale.
The corporation must also be an active business in a qualified trade or business. Service businesses in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services are explicitly excluded. Similarly excluded are businesses involved in banking, insurance, leasing, financing, investing, farming, hotels, restaurants, and mining.
The per-issuer exclusion cap is significant: the greater of $10 million or 10 times the taxpayer's adjusted basis in the stock. For a founder who received stock at minimal cost basis, the 10x basis cap can be extremely small, making the $10 million floor the binding constraint. For an investor who paid $2 million for QSBS, the cap is $20 million. Gains above the applicable cap are taxed as normal long-term capital gains.
Spouses, trusts, and S corporations can also hold QSBS, subject to specific rules. Gain from QSBS held through a partnership or S corporation may also qualify, subject to limitations.
QSBS can be rolled over tax-free under Section 1045 if the taxpayer has held the stock for more than six months and reinvests the proceeds into other QSBS within 60 days. This allows investors to maintain the exclusion eligibility even if an early liquidity event occurs before the five-year holding period is complete.