IRC §1202 Qualified Small Business Stock: the OBBBA tiered holding period, the $15 million per-issuer exclusion cap, the $75 million gross-assets threshold, and the C-corporation and active-business requirements

IRC §1202 is one of the most powerful tax incentives available to startup founders, early employees, and investors in small businesses. It allows noncorporate taxpayers to exclude from gross income a substantial portion (up to 100%) of the capital gain on the sale of Qualified Small Business Stock (QSBS). On a successful exit, the difference between qualifying for the §1202 exclusion and not qualifying can be measured in millions of dollars.

The provision was originally enacted as part of the Omnibus Budget Reconciliation Act of 1993 to encourage investment in small businesses. It received limited legislative attention for more than a decade, but the One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, substantially expanded the benefits and brought §1202 back to the forefront of startup and small business tax planning.

The OBBBA changes apply to QSBS issued after July 4, 2025. Stock issued on or before that date retains the pre-OBBBA framework. The two-track structure (pre-OBBBA and post-OBBBA) means that the applicable rules depend on when the stock was issued, which is a critical threshold question for any §1202 analysis.

What does IRC §1202 do?

IRC §1202 allows noncorporate shareholders of eligible C corporations to exclude up to 100% of capital gains from selling Qualified Small Business Stock. The exclusion is capped per issuer at the greater of $15 million (post-OBBBA) or 10 times the taxpayer's adjusted basis in the stock, and requires a minimum holding period of 3 to 5 years depending on the issuance date.

§1202 permits eligible noncorporate shareholders of stock in certain C corporations to exclude from gross income a percentage (up to 100%) of their gain from the sale or exchange of QSBS, subject to per-issuer caps and holding-period requirements.

The exclusion is from federal capital gains tax. The unexcluded portion of the gain (if any) is taxed at a 28% rate plus the 3.8% net investment income tax (NIIT), rather than the standard long-term capital gains rates.

For a founder who built a company from scratch, holds QSBS, and sells for a gain, the §1202 exclusion can eliminate federal capital gains tax on up to the greater of $10 million (pre-OBBBA) / $15 million (post-OBBBA) or 10 times the basis in the stock. For a successful exit, this is a substantial benefit.

What are the QSBS rules for stock issued on or before July 4, 2025?

For QSBS issued on or before July 4, 2025, a binary five-year holding period applies: the taxpayer must hold for more than five years to receive any exclusion. Stock acquired after September 27, 2010, qualifies for 100% exclusion. The per-issuer cap is the greater of $10 million or 10 times basis, and corporate gross assets must not exceed $50 million at issuance.

For QSBS issued on or before July 4, 2025, the framework is:

Binary 5-year holding period. The taxpayer must hold the QSBS for more than 5 years to qualify for the exclusion. The holding period is binary: hold for more than 5 years and get the applicable exclusion percentage, or hold for less and get nothing (unless a §1045 rollover is used to defer the gain into new QSBS).

Exclusion percentage by acquisition date. The percentage of gain that can be excluded depends on when the shares were acquired:

For the substantial majority of current QSBS (acquired after September 27, 2010), the 100% exclusion applies if the 5-year holding period is met.

$10 million per-issuer exclusion cap. The exclusion is capped at the greater of $10 million per issuer OR 10 times the taxpayer's basis in the stock.

$50 million aggregate gross assets cap. The corporation's aggregate gross assets cannot exceed $50 million at all times before and immediately after the stock issuance.

How did the OBBBA change §1202 QSBS rules for stock issued after July 4, 2025?

The OBBBA, enacted July 4, 2025, replaced the binary five-year holding period with a tiered structure (50% at 3 years, 75% at 4 years, 100% at 5 years), raised the per-issuer exclusion cap from $10 million to $15 million with inflation indexing after 2026, and increased the gross-assets threshold from $50 million to $75 million for stock issued after that date.

For QSBS issued after July 4, 2025, the OBBBA introduced three major taxpayer-favorable changes:

Tiered holding period. The binary 5-year cliff is replaced with a tiered structure:

The tiered structure makes early exits substantially more attractive than under the pre-OBBBA framework. A founder who sells at the 3-year mark now gets a 50% exclusion rather than nothing. The math still favors holding to 5 years if possible (the jump from 75% to 100% exclusion on a large gain is worth millions), but the tiered structure provides partial benefit for shorter holding periods.

Increased per-issuer cap to $15 million. The $10 million per-issuer exclusion cap is increased to $15 million. The cap will be adjusted annually for inflation for tax years beginning after 2026. The 10x basis alternative is unchanged; the cap remains the greater of $15 million or 10 times basis.

Increased gross-assets threshold to $75 million. The corporate aggregate gross assets cap is increased from $50 million to $75 million. The $75 million limit applies only to QSBS issued on or after July 5, 2025; stock issued before that date must have met the old $50 million limit at the time of its original issuance.

The OBBBA changes generally apply to QSBS that is newly issued after July 4, 2025 (not stock received by gift or in a tax-free exchange before that date). The expanded thresholds and tiered holding period make §1202 substantially more valuable for stock issued under the new framework.

Which QSBS eligibility requirements did the OBBBA leave unchanged?

The OBBBA did not change the core eligibility requirements for QSBS. The issuing company must be a domestic C corporation. Stock must be acquired at original issuance in exchange for money, property, or services. At least 80% of corporate assets must be used in an active qualified trade or business, and certain industries (law, accounting, health, consulting, financial services, hospitality, farming, and mining) remain categorically excluded.

The OBBBA expanded the benefits but did not change the core eligibility requirements. The following requirements apply to both pre-OBBBA and post-OBBBA QSBS:

Domestic C-corporation. Only stock issued by a domestic C-corporation can qualify as QSBS. S-corporations and standard LLCs are pass-through entities and do not meet the corporate structure requirement. This is the threshold structural requirement; founders who want QSBS treatment must operate as a C-corporation (which has its own tax tradeoffs, including the corporate-level tax and the potential for double taxation on dividends).

Original issuance. The stock must be acquired by the taxpayer at its original issuance (directly or through an underwriter) in exchange for money, property (other than stock), or services. Stock acquired in the secondary market (purchased from another shareholder) does not qualify. The holding period generally starts on the date the stock was originally issued to the taxpayer; for stock acquired via option exercise, the holding period begins on the date of exercise.

Gross assets test. The corporation's aggregate gross assets cannot exceed the threshold ($50 million pre-OBBBA / $75 million post-OBBBA) at all times before and immediately after the stock issuance. Once the corporation grows beyond the threshold, newly issued stock is no longer QSBS (though previously-issued QSBS retains its status). This means QSBS is generally available only for stock issued while the company is still relatively small.

Active business test. 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 during substantially all of the taxpayer's holding period. The active business test ensures that §1202 benefits companies actually operating businesses, not passive investment vehicles.

Excluded businesses. Certain businesses are categorically excluded from QSBS treatment. The excluded businesses are those where the principal asset is the reputation or skill of one or more employees, including:

Law, accounting, health, consulting, financial services, brokerage services, and similar professional service businesses.

Banking, insurance, financing, leasing, investing, and similar businesses.

Mining and natural resource extraction businesses (those eligible for percentage depletion).

Hospitality businesses (operating hotels, motels, restaurants, or similar).

The excluded business list means that §1202 primarily benefits product companies, technology companies, manufacturing businesses, and similar enterprises, rather than professional service firms or passive investment businesses.

How does the §1045 rollover work for QSBS?

Under IRC §1045, a taxpayer who sells QSBS before meeting the required holding period can defer the gain by reinvesting the proceeds in new QSBS within 60 days of the sale. The original stock must have been held for more than six months, and the election must be made on the taxpayer's return. The prior holding period tacks onto the replacement stock.

For QSBS sold before the holding-period requirement is met, IRC §1045 allows the taxpayer to defer the gain by rolling it into new QSBS within 60 days of the sale.

The §1045 rollover is the safety valve for QSBS sold early. Under the pre-OBBBA binary framework, selling before the 5-year mark meant getting no exclusion; the §1045 rollover allowed the taxpayer to defer the gain (and tack the holding period) by reinvesting in new QSBS. Under the OBBBA tiered framework, the §1045 rollover is still useful for sales before the 3-year mark (where no exclusion is available) and for managing the holding-period tiers.

The original QSBS was held for more than 6 months.

The gain is reinvested in new QSBS within 60 days of the sale.

The taxpayer makes the §1045 election on the tax return.

How does the QSBS stacking strategy multiply the per-issuer exclusion cap?

The §1202 per-issuer exclusion cap applies per taxpayer. By gifting QSBS to children, trusts, or other family members before a sale, a founder can multiply the total exclusion well beyond the single $15 million (post-OBBBA) cap. Each recipient receives their own per-issuer exclusion, and the donor's holding period generally tacks to the recipient for gifted shares.

The $15 million (post-OBBBA) per-issuer cap is per taxpayer. This creates a planning opportunity: thoughtful gift transfers of QSBS to other taxpayers (children, trusts, family members) can multiply the total exclusion potential.

The founder gifts portions of the QSBS to children, to trusts for the benefit of family members, or to other taxpayers.

Each recipient has their own $15 million per-issuer exclusion cap.

On the eventual sale, the aggregate exclusion across all the taxpayers can substantially exceed the single $15 million cap that would apply if the founder held all the stock.

The recipient must satisfy the holding-period requirements (the holding period generally tacks for gifts, so the recipient gets credit for the founder's holding period).

The gift must be a completed gift for tax purposes (with the attendant gift tax considerations).

The trusts must be structured as separate taxpayers for the per-issuer cap to apply separately.

The stacking strategy is sophisticated and requires coordination with estate planning, gift tax planning, and the §1202 holding-period rules. For founders with QSBS and appreciation potential, the stacking strategy can multiply the §1202 benefit substantially.

Which states do not conform to the federal §1202 QSBS exclusion?

Several major states, including California, New York, and Massachusetts, do not conform to the federal §1202 exclusion. Founders in these states still owe state income tax on gains excluded at the federal level. California's top rate of approximately 13.3% can significantly reduce the net benefit. Confirming state conformity is an essential step before relying on the federal exclusion.

The §1202 exclusion applies to federal capital gains tax. Many states do not conform to the federal QSBS rules and still impose state income tax on the excluded gain.

The notable non-conforming states include California, New York, and Massachusetts. A founder in California who excludes $15 million of gain from federal tax under §1202 still owes California income tax on that $15 million (at California's top rate of approximately 13.3%).

For founders in non-conforming states, the §1202 benefit is partial; it eliminates the federal tax but not the state tax. Some founders engage in pre-sale residency planning (relocating to a state without income tax, or to a state that conforms to §1202) to capture the full benefit, though such planning has complexity and timing requirements.

The state conformity analysis is a critical part of any §1202 planning. Confirming whether the relevant state conforms, whether it follows the inflation indexing, and whether it imposes its own limitations is essential before relying on the federal exclusion.

How does §1202 coordinate with other small business tax provisions?

An §83(b) election starts the QSBS holding period at grant rather than vesting. Section 1045 provides a rollover for QSBS sold before meeting the holding period. The §199A qualified business income deduction applies only to pass-through entities, not C corporations, making §199A and §1202 mutually exclusive at the entity level.

The §1202 framework operates in coordination with several other Halstonberg small business provisions:

§83(b) elections are relevant for founders and employees who receive restricted stock. The §83(b) election starts the QSBS holding period earlier (at grant rather than vesting) and can be coordinated with the §1202 planning.

§1045 rollovers provide the deferral mechanism for QSBS sold before the holding-period requirement is met. (Note: §1045 is a different rollover than the §1031 like-kind exchange, which applies to real property.)

Cost segregation studies and other real estate provisions operate independently of §1202; QSBS applies to operating-company stock, not real estate.

§199A QBI deduction applies to pass-through entities, not C-corporations. The §199A and §1202 frameworks are mutually exclusive at the entity level; a business operating as a pass-through gets §199A but not §1202, and a business operating as a C-corporation gets §1202 (for qualifying stock) but not §199A.

What practical steps should founders take for §1202 planning?

Founders and investors seeking the §1202 exclusion should structure as a domestic C corporation from the outset, track the holding period from original issuance or option exercise, verify the active business and excluded-business requirements, confirm state conformity, and maintain thorough documentation of eligibility. For appreciation, the stacking strategy can multiply the exclusion cap through gifts to family members or trusts.

The C-corporation requirement is the threshold decision. QSBS requires a domestic C-corporation; if you operate as an LLC or S-corporation, you don't get QSBS treatment. Founders planning for a §1202 exit should structure as a C-corporation from the outset (or convert before the gross-assets threshold is crossed).

For stock issued after July 4, 2025, the OBBBA framework applies. The tiered holding period (50% at 3 years, 75% at 4 years, 100% at 5 years), the $15 million per-issuer cap, and the $75 million gross-assets threshold are the operative parameters.

For stock issued on or before July 4, 2025, the pre-OBBBA framework applies. The binary 5-year holding period and the $10 million / $50 million thresholds control.

The holding period starts at original issuance (or option exercise). For the OBBBA tiered framework, the 3-year, 4-year, and 5-year marks each affect the exclusion percentage.

Confirm the active business test and the excluded-business analysis. If your business is in an excluded category (law, accounting, health, consulting, financial services, etc.), §1202 is not available regardless of the other requirements.

For founders with appreciation potential, consider the stacking strategy. Gifting QSBS to children or trusts can multiply the total exclusion beyond the single $15 million per-issuer cap. The strategy requires coordination with gift tax and estate planning.

The §1202 exclusion is federal only; California, New York, Massachusetts, and other non-conforming states still tax the gain.

The taxpayer bears the burden of proving §1202 eligibility. Records of the original issuance, the gross-assets test at issuance, the active business test compliance, and the holding period are essential. The IRS Topic No. 409 provides the official guidance on QSBS.

For stock acquired before December 31, 2025 under the OBBBA framework, the 3-year clock can begin immediately. Taking action before year-end can make a meaningful difference in timing future gain exclusions.

The §1202 framework is a permanent feature of the tax code, enhanced by the OBBBA. For founders and investors in qualifying C-corporations, it is one of the most powerful tax-saving tools available. The execution requires careful attention to the C-corporation requirement, the holding-period tiers, the active business test, and the state conformity analysis; the benefits, when properly captured, can be substantial.