Sam Brotman, J.D., LL.M. (Taxation), MBA
Managing Attorney, Brotman Law · San Diego, CA
Last updated: June 2026

What QSBS Is

Qualified Small Business Stock (QSBS) is a class of C-corporation stock that, when it qualifies under IRC § 1202, can be sold completely free of federal capital gains tax — up to the applicable exclusion ceiling.

Congress created the exclusion in 1993 to encourage investment in small businesses. The original exclusion was 50%. The 2010 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act expanded it to 100% for stock issued after September 27, 2010. That is the version most founders are dealing with today.

In practice, QSBS is most relevant to startup founders who received stock at incorporation, angel investors who bought in at the seed or Series A stage, and employees who received early stock grants — anyone who acquired original-issuance shares in a qualifying C-corporation before the company grew past $50M in gross assets.

The tax math is straightforward when it works. A founder who sells $12M worth of QSBS stock might owe zero federal tax on the first $10M and long-term capital gains rates on the remaining $2M. Under a pending expansion, that same founder could exclude the entire $12M. That is a real number worth planning around.

QSBS Requirements

To qualify for the IRC § 1202 exclusion, the stock and the issuing company must each meet several independent tests — and all of them must be satisfied.

Company-level requirements:

• C-corporation status. The issuing entity must be a domestic C-corporation at all times the investor holds the stock. S-corporations, LLCs, and partnerships do not issue QSBS.
• Gross assets at or under $50M. The corporation’s aggregate gross assets cannot exceed $50M immediately before or immediately after the stock issuance. This is measured at cost, not fair market value.
• Active business in a qualifying trade. The corporation must use at least 80% of its assets in the active conduct of a qualified trade or business. Excluded trades include the practice of law, health, accounting, financial services, engineering, athletics, and consulting. Technology, manufacturing, retail, and most other businesses qualify.
• Domestic corporation. Foreign corporations do not qualify.

Investor-level requirements:

• Original issuance only. The stock must be acquired directly from the corporation — not through a secondary market purchase or from another shareholder.
• Acquired in exchange for money, property, or services. Stock acquired through a redemption from a related party does not qualify.
• Non-corporate taxpayer. The exclusion is available to individual investors, trusts, and pass-through entities.

The 5-Year Holding Requirement

You must hold QSBS for more than five years to claim the exclusion. Sell before that and the exclusion disappears — though the § 1045 rollover may give you a path to preserve it.

The five-year clock starts on the date the stock is issued to you. For founders who receive stock at incorporation, that date is usually the incorporation date. For employees who receive stock options, the clock starts when the option is exercised, not when it is granted.

Exclusion Limits Under Current Law

Under current IRC § 1202, the maximum gain you can exclude per company per taxpayer is the greater of $10M or ten times your adjusted basis in the stock.

The three exclusion tiers are based on the issuance date of the stock:

• 50% exclusion: stock issued before February 18, 2009
• 75% exclusion: stock issued between February 18, 2009 and September 27, 2010
• 100% exclusion: stock issued after September 27, 2010

For most founders and startup investors today, the relevant tier is 100%. Gains above the ceiling are taxable at the normal long-term capital gains rate.

QSBS and the One Big Beautiful Bill

The One Big Beautiful Bill Act (OBBBA), which passed the House in 2025 and is pending in the Senate, would be the most significant expansion of IRC § 1202 since 2010.

The key changes proposed under the OBBBA:

• Exclusion ceiling raised from $10M to $50M per investor per issuer. The ten-times-basis alternative is preserved and becomes the greater of $50M or 10× basis.
• AMT interaction eliminated. Under current law, QSBS gains excluded under § 1202 are still preference items for alternative minimum tax purposes. The OBBBA removes QSBS gains from the AMT preference calculation entirely.
• Net investment income tax (NIIT) eliminated for QSBS gains. The 3.8% NIIT under IRC § 1411 currently applies to QSBS gains. The OBBBA removes QSBS gains from the NIIT base.
• Entity conversion relief. The bill adds provisions allowing qualifying LLC-to-C-corp and S-corp-to-C-corp conversions to preserve QSBS eligibility for qualifying periods.
• Effective date: Retroactively to gains realized after December 31, 2025 — if enacted.

Under the expanded law, the stacking strategies below become significantly more powerful. A founder with a $50M exclusion and a spouse with a $50M exclusion, each with two children receiving gifts of shares under § 1202(h)(2), could be looking at $200M in federally-excluded gain.

California’s Non-Conformity Problem

California does not conform to IRC § 1202. The full gain on a QSBS sale is taxable in California at ordinary income rates — up to 13.3%.

This is not an obscure edge case. It is a predictable, material hit that every California-based founder needs to account for before an exit. A founder who excludes $10M federally still owes California up to $1.33M on that same gain. Under a $50M OBBBA exclusion, the California tax on the excluded gain could exceed $6.5M.

California’s non-conformity has been the law since § 1202 was enacted. The state has consistently declined to adopt the federal exclusion. There is no pending California legislation to change this.

The planning implication: if you are a California resident and a QSBS exit is on the horizon, residence at the time of sale controls. Some founders explore changing domicile to a zero-income-tax state before a liquidity event. That is a real option, but it requires a genuine change of domicile — California’s Franchise Tax Board aggressively audits “safe harbor” departures that look like exit-motivated moves.

QSBS Stacking Under IRC § 1202(h)(2)

IRC § 1202(h)(2) allows a QSBS holder to make gifts of qualifying stock to family members, each of whom gets their own independent per-taxpayer exclusion ceiling — currently $10M per recipient per company, or $50M under the OBBBA if enacted.

The mechanics: a founder who holds QSBS with a gain well above $10M can gift shares to a spouse, children, or other family members before the sale. Each recipient takes the gifted shares with the donor’s original acquisition date and adjusted basis, and each gets their own exclusion. The gift itself does not trigger income tax — the exclusion travels with the shares to the recipient.

The timing requirement is the critical constraint. The gift must be completed before the sale or before a binding agreement to sell. A gift made after a letter of intent is signed is unlikely to shift the exclusion to the recipient. Document the gift properly with a signed gift instrument, share transfer on the cap table, and Form 709 if the value exceeds the annual exclusion.

The Section 1045 Rollover

If you sell QSBS before the five-year holding period expires, IRC § 1045 lets you roll the sale proceeds into replacement QSBS within 60 days and carry the original acquisition date to the new stock.

Requirements for a valid § 1045 rollover: (1) the stock sold must otherwise be QSBS — it meets all § 1202 requirements except the holding period; (2) you must reinvest in replacement QSBS within 60 days; (3) the replacement stock must be issued by a different qualified small business corporation; (4) the amount reinvested must be at least equal to the sale proceeds.

Common Disqualifying Mistakes

The most common QSBS disqualifications come not from fraud or planning errors, but from corporate changes and secondary transactions the investor did not realize affected their § 1202 eligibility.

• Company crossed the $50M gross asset threshold before your purchase. The $50M test is applied at the time of each stock issuance, not at the time of sale.
• Company converted from C-corp to S-corp. Any stock issued after an S-election is made does not qualify as QSBS.
• Stock acquired in a secondary transaction. Purchasing shares from another shareholder does not produce QSBS.
• Stock issued in connection with a redemption from a related party. IRC § 1202(c)(3) disqualifies stock issued as part of a redemption of related-party stock.
• Professional services company. A law firm, financial advisory practice, or consulting firm does not issue QSBS regardless of corporate form.

How Brotman Law Helps

We work with founders, early investors, and their CPAs to confirm QSBS eligibility, structure gifts before a sale, and handle California planning — before the exit closes.

Most QSBS planning is pre-transaction work. By the time a letter of intent is signed and a closing date is set, the most valuable moves — stacking gifts, confirming eligibility on each issuance tranche, evaluating the § 1045 rollover — have a closing window measured in days or weeks.

What we typically do in a QSBS engagement: review the company’s capitalization history to confirm the $50M gross asset test at each issuance date; confirm C-corporation status through the holding period; analyze whether the primary business activity qualifies under the active business test; structure and document gifting strategies under § 1202(h)(2); evaluate § 1045 rollover options; advise on California non-conformity and, where appropriate, residence planning in coordination with a CPA; and track OBBBA legislative progress.

Learn more about our tax advisory and planning services.

Frequently Asked Questions