Home / Sell-Side M&A / QSBS and Section 1202
Qualified Small Business Stock, or QSBS, lets founders and early investors exclude a large share of the capital gain when they sell C-corporation stock. For stock acquired after July 4, 2025, the exclusion is now tiered: 50 percent of the gain at a three-year hold, 75 percent at four years, and 100 percent at five years or more, capped per issuer at the greater of 15 million dollars, indexed for inflation from 2027, or ten times the basis in the stock. Stock acquired on or before July 4, 2025 keeps the prior rule: a full five-year hold for any exclusion, 100 percent at five years, capped at the greater of 10 million dollars or ten times basis. This is general information, not tax advice.
For a founder selling a C-corporation, QSBS is often the single largest driver of after-tax proceeds. A qualifying sale can take federal tax on a meaningful slice of the gain to zero. On a sale of any size, the difference between QSBS-eligible stock and ordinary capital gain can be worth millions, which is why the question of eligibility belongs at the start of a process, not at the closing table.
Stock qualifies as QSBS only if a set of conditions is met. The issuer must be a domestic C-corporation. The stock must be acquired at original issuance, in exchange for money, property, or services, not bought from another shareholder. At issuance the corporation’s aggregate gross assets must be at or below the threshold, raised by the 2025 law to 75 million dollars for stock issued after July 4, 2025, from the prior 50 million. And the company must use at least 80 percent of its assets in an active qualified business.
Certain businesses are excluded, including most professional services, finance, hospitality, and businesses whose principal asset is the reputation or skill of employees. Technology and software companies generally qualify, which is why QSBS is so relevant to founders in fintech, SaaS, cybersecurity, and AI.
The practical effect is that more companies qualify, the exclusion can begin before the old five-year cliff, and the protected amount is larger. The acquisition date of each tranche of stock now drives the analysis.
The tiered exclusion comes with a catch. The portion of the gain that is not excluded under the three-year or four-year tiers is taxed at the 28 percent rate that applies to section 1202 gain, not the 15 or 20 percent long-term capital gains rate that would otherwise apply. Selling at three or four years can therefore mean a higher rate on the taxable remainder.
Qualified Small Business Stock is C-corporation stock that meets the conditions of Internal Revenue Code section 1202. When it qualifies, a founder or early investor can exclude a large share of the capital gain on a sale from federal tax. It is one of the most valuable tax provisions available to founders of qualifying companies.
For stock acquired after July 4, 2025, the exclusion is tiered: 50 percent at a three-year hold, 75 percent at four years, and 100 percent at five years, capped per issuer at the greater of 15 million dollars, indexed for inflation from 2027, or ten times basis. Stock acquired earlier excludes 100 percent only at five years, capped at the greater of 10 million dollars or ten times basis.
The issuer must be a domestic C-corporation, the stock must be acquired at original issuance, the company’s aggregate gross assets at issuance must be at or below 75 million dollars for post-July 2025 stock, and at least 80 percent of assets must be used in an active qualified business. Most professional-services and financial businesses are excluded; technology and software companies generally qualify.
Under the new tiers, the part of the gain that is not excluded at three or four years is taxed at the 28 percent section 1202 rate, not the 15 or 20 percent long-term capital gains rate. For most founders, holding to five years, where 100 percent of qualifying gain is excluded, produces the better result.
QSBS applies to the sale of stock, so a stock sale preserves the exclusion. An asset sale, which buyers often prefer for tax reasons of their own, can forfeit it. Deal structure is therefore negotiated with the QSBS outcome in mind, which is a reason to plan before going to market. This is general information, not tax advice; confirm your position with a qualified tax advisor.
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