What does QSBS actually do?
Qualified Small Business Stock, usually shortened to QSBS, is a category of corporate stock defined by federal tax law. Section 1202 of the Internal Revenue Code lets eligible taxpayers exclude a percentage of qualifying gain when they sell that stock after the required holding period. An exclusion removes eligible income from the federal tax calculation; it is not a payment from the government.
The benefit applies to gain: broadly, what you receive from selling the shares minus your tax basis, with applicable adjustments. It does not automatically shelter salary, option-exercise compensation, dividends, or a company's operating profits. Nor does calling an investment “startup stock” establish eligibility.
A founder, employee, or early investor may own QSBS. Each person's shares need their own review because different purchases, exercises, transfers, and issue dates can produce different results.
The basic requirements
The core tests in Section 1202(c)–(e) concern both the shareholder and the company:
- Eligible taxpayer. The exclusion is available to taxpayers other than corporations. Investments through partnerships and other pass-through entities have additional rules.
- Qualifying stock. The shares must generally be acquired at original issue from a domestic C corporation, for money, eligible property, or services. Buying another investor's shares generally fails this requirement, although specified gifts and other transfers can preserve qualifying status.
- Company size at issuance. Aggregate gross assets must satisfy the applicable limit before and immediately after issuance: $50 million for shares issued on or before July 4, 2025; $75 million for shares issued afterward, with inflation adjustments after 2026.
- Active business. During substantially all of the holding period, the company must be a C corporation and meet the active-business rules. Generally at least 80% of asset value must serve eligible business activities.
- Time and gain limits. You must meet the holding period, and only gain within the per-issuer limitation receives the applicable exclusion percentage.
Many service and financial businesses are excluded. A small company is not necessarily a qualified small business under this statute. Use the eligibility checklist to identify documents and issues to review.
How much can be excluded?
Acquisition date matters. For qualifying stock acquired from September 28, 2010 through July 4, 2025, the federal exclusion can reach 100% after a holding period of more than five years. Earlier stock can have lower percentages. For stock acquired after July 4, 2025, the law creates the following tiers. Acquisition date includes applicable holding-period carryover rules. Source: Section 1202(a).
| Holding period for post-July 4, 2025 stock | Exclusion of eligible gain |
|---|---|
| At least 3 years, less than 4 | 50% |
| At least 4 years, less than 5 | 75% |
| At least 5 years | 100% |
The eligible-gain cap generally uses the greater of a remaining dollar limit or ten times qualifying basis in shares of that issuer sold during the tax year. The baseline dollar limit is $10 million for older shares and $15 million for post-July 4, 2025 acquisitions; prior usage and other rules can reduce it. The newer amount is indexed after 2026. See the limits guide before treating either number as an automatic exemption.
A simple example
Suppose an individual bought qualifying shares directly from a company in January 2020 for $100,000 and sells them in September 2026 for $2.1 million. Ignoring selling costs, the gain is $2 million. If every qualification test is met, there are no disqualifying transactions, and sufficient limit remains, the more-than-five-year holding period and 100% exclusion can remove that $2 million from federal gross income under Section 1202.
This example assumes eligibility rather than proving it. A shorter holding period, different stock history, previous exclusions from the same company, or state taxes could change the outcome. The calculator helps explore scenarios; it cannot establish whether the shares qualify.
Compare state taxes on this $2 million gain. The example opens with California selected; choose your state to compare. It assumes qualifying shares and unused dollar-limit capacity, and uses simplified state rates.
Federal eligibility is only part of an exit
State treatment requires a separate check. Start with the state comparison and the guides for California, Oregon, and New York. Residency and income sourcing can matter as much as whether a state follows Section 1202.
Before an exit, gather issuance records, tax-basis records, company qualification evidence, and the proposed transaction documents. Ask a qualified tax adviser to assess those facts. QSBS can be valuable, but a stock certificate or a company's informal assurance is only a starting point.