Does your startup stock qualify for QSBS — and which regime is it on?

Section 1202 lets a taxpayer other than a corporation leave gain on the sale of qualified small business stock out of gross income entirely. Not taxed at a lower rate — excluded. That is the whole appeal, and it is why the tests are narrow and measured at moments most founders are not watching.

What the exclusion was, before 2025

For fifteen years the rule was blunt. Stock acquired after 27 September 2010 and held for more than five years got a 100% exclusion under § 1202(a)(4); held for four years and eleven months, it got nothing. There was no partial credit. The amount was capped per issuing corporation at the greater of $10,000,000 or ten times the aggregate adjusted bases of that company's qualified stock disposed of during the year, and the issuer had to have held no more than $50,000,000 of gross assets when the shares went out. Those three numbers are the three the 2025 amendments moved.

The four things § 1202 tests, and when it tests each one

Nothing about qualification is decided at the sale. Each test attaches to a moment, and most of them attach to the issuance — when the company is worth nothing and nobody is thinking about an exit.

The asset ceiling behaves as a point-in-time test should: a company that raises past it later has not poisoned shares already issued, it has simply lost the ability to issue more qualifying stock. The active-business requirement is the opposite, because § 1202(c)(2)(A) demands it during substantially all of the holding period.

What changed for stock acquired after 4 July 2025

The One Big Beautiful Bill Act (Pub. L. 119–21) rewrote § 1202(a)(1) and added two paragraphs. Section 1202(a)(6)(A) defines the "applicable date" as the date that paragraph was enacted, which was 4 July 2025. Section 1202(a)(5) then supplies a table — 50% at three years, 75% at four, 100% at five or more — and it reaches only stock acquired after the applicable date.

Read the right-hand column carefully, because most coverage of the amendment gets it backwards. At five years both regimes reach 100%. The new tiers are not a bigger prize at the finish line but a partial one available earlier, which changes what a founder can afford to do at a tender offer rather than what they eventually keep.

Two founders, one company, two regimes

The date line does not run between companies. It runs through cap tables that already exist. A company incorporated in 2024 that issued founder stock in March 2025, then sold restricted stock to a fourth engineer that September, now holds two populations of shareholder in the same class of the same company. The March shares get nothing at three years and 100% at five, capped at $10,000,000. The September shares get 50% at three, 75% at four, 100% at five, capped at $15,000,000.

Same company, same acquirer, same closing date, different arithmetic — and note which way it runs: the later holder is on the better terms. Nor is there a way to cross the line by restructuring. Under § 1202(f), stock acquired solely by converting existing QSBS in the same corporation keeps its character and holding period, so the ordinary preferred-to-common conversion at an exit moves nobody; under § 1202(h), a gift or a transfer at death hands the transferee the transferor's acquisition rather than a fresh one.

There is no QSBS clock running inside an LLC

This is the question people most often answer wrongly, and they answer it wrongly in the optimistic direction. QSBS is stock in a C corporation. An LLC membership interest is not stock, and an S corporation fails § 1202(c)(2)(A) while the election is in place. Years spent as either produce no holding period at all.

When an LLC converts, members exchange their interests for stock, and that exchange is the acquisition. Section 1202(i)(1) puts a floor under the result: where a taxpayer transfers property other than money or stock for shares, the basis of those shares is, for purposes of § 1202, in no event less than the fair market value of the property exchanged — so appreciation earned before the conversion sits outside the exclusion. The ceiling is tested at that moment too, and an LLC that waits until it holds more than $75,000,000 of assets issues stock that is not QSBS at all. If the choice between an LLC and a corporation is still open, this gets worse the longer it is deferred.

Original issue means from the company, not from a person

Section 1202(c)(1)(B) requires the stock to be acquired at its original issue, directly or through an underwriter, for money or other property (not including stock) or as compensation for services. Buy shares from a departing founder in a private secondary and they are not QSBS in your hands, however long you hold them and however clean the company is. The certificate is identical; the character is not, because it attaches to how you acquired the shares rather than to the shares.

Services do count, so founder stock issued for sweat and early restricted stock can both qualify — which is why the exercise date on an option grant matters, an option being no more than a right until it is exercised.

The redemption rules are the quiet disqualifier. Under § 1202(c)(3)(A), stock is not QSBS if the corporation bought any of its stock from you or a related person during the four-year period beginning two years before your issuance. Subparagraph (B) goes further: purchases exceeding 5% of the value of all the company's stock in a two-year window straddling an issuance taint that issuance for everybody. Treasury Regulation § 1.1202-2 gives the de minimis relief — a purchase counts only if it exceeds $10,000 and more than 2% of the relevant stock. A buy-back of a departing co-founder before a priced round is past both, and the buy-back terms are agreed years before anyone reads § 1202.

The cap is per issuer, and the 10× rule is often the larger number

Section 1202(b)(1) caps eligible gain from one corporation at the greater of the dollar limit or ten times the aggregate adjusted bases of that company's qualified stock disposed of in the taxable year, basis taken without regard to additions after the original issuance. For a founder holding stock issued at a nominal price the basis leg is worthless and the dollar limit governs; for an investor who put $5,000,000 into a qualifying round, ten times basis is $50,000,000 and $15,000,000 never binds. The cap is per issuer and per taxpayer, and gain excluded in earlier years reduces what remains.

What to keep, and why it has to be now

None of this is exotic; it is the ordinary output of an issuance done properly, and the reason to assemble it now is that nobody can assemble it later. Section 1202(d)(1)(C) also conditions qualification on the corporation agreeing to submit such reports as the Secretary may require, so the issuer carries part of the record too. A founder whose vesting and issuance paperwork is complete has done most of it.

Where this actually goes wrong

Almost never on the exclusion percentage. The failures are structural and early: three years of work inside an LLC before anyone converts; a co-founder bought out by the company months before a round, tainting every share issued in the window; stock bought from a leaver in a handshake secondary that was never original issue; a business that was a consulting practice all along and so was never a qualified trade.

This is the tax treatment of a disposal that may be years away, it turns on your own facts, and the section runs to eleven subsections with three separate effective-date hooks in the 2025 amendments alone. It is a question for a tax adviser long before it is one for an acquirer. What is worth doing without waiting is duller: date every issuance, keep the consent that authorised it, and know which side of 4 July 2025 each block of stock sits on. If employee equity is going out now, that date belongs in a column of the cap table, not a footnote.