Qualified Small Business Stock (QSBS): A Planning Guide Under Section 1202

By Trevor Scotto, CPA, CFP®

Trevor Scotto is a CPA and CFP® and co-founder of Fiduciary Financial Group, where he focuses on tax-aware strategies, early retirement planning, and legacy and estate planning for high net worth families.

This article is for educational purposes only and does not constitute individualized tax, legal, or investment advice. Tax laws are subject to change. Whether stock qualifies as QSBS, and how much gain may be excluded, depends on your specific facts, including the issuing corporation, your acquisition history, and your holding period. Consult your own tax and legal advisors before acting on anything described here.

Qualified Small Business Stock (QSBS) is stock in a domestic C corporation that meets specific requirements under IRC Section 1202. When the stock qualifies and is held for the required period, a noncorporate taxpayer, meaning an individual, trust, or estate, may exclude a percentage of the gain from federal income tax when the stock is sold or exchanged, potentially up to 100 percent of the gain.

Congress enacted Section 1202 in 1993 to encourage investment in small businesses and startups. The exclusion was initially set at 50 percent, increased to 75 percent in 2009, and then to 100 percent for stock acquired after September 27, 2010. The OBBBA further expanded the benefit in 2025.

For executives and founders holding equity in a qualifying C corporation, understanding how Section 1202 interacts with your broader equity compensation planning is an important part of managing concentrated stock positions and eventual liquidity events.

The One Big Beautiful Bill Act (Public Law 119-21), signed into law on July 4, 2025, made three significant changes to Section 1202 for stock issued after July 4, 2025:

1. Tiered holding period. Instead of requiring a five-year hold before any exclusion applies, stock acquired after July 4, 2025 now qualifies for partial exclusions starting at three years. A 50 percent exclusion applies after three years, 75 percent after four years, and 100 percent after five years.
2. Increased per-issuer exclusion cap. The maximum gain exclusion per taxpayer per issuer increased from $10 million to $15 million, with annual inflation indexing beginning in 2027. The alternative 10-times-basis limitation remains available.
3. Increased aggregate gross asset threshold. The issuing corporation's aggregate gross asset limit increased from $50 million to $75 million, also indexed for inflation beginning in 2027. This means larger companies can issue qualifying stock.

These changes apply only to stock issued after July 4, 2025. Stock issued on or before that date remains subject to the prior rules.

For the 50 percent and 75 percent partial exclusions available at the three- and four-year marks, the non-excluded portion of the gain is taxed at a 28 percent federal capital gains rate rather than the standard 20 percent long-term rate, and the 3.8 percent net investment income tax applies to that non-excluded portion as well. Only gain that is fully excluded under Section 1202 escapes both of these additional layers.

Qualifying as QSBS requires meeting both stock-level and issuer-level requirements. Failing any single requirement can disqualify the stock entirely.

Eligible Issuer

The stock must be issued by a domestic C corporation. S corporations do not qualify. The corporation must have originally issued the stock after August 10, 1993. (IRC Section 1202(c)(1))

Aggregate Gross Assets Test

At all times before the stock issuance and immediately after, taking the issuance proceeds into account, the corporation's aggregate gross assets must not exceed $75 million for stock issued after July 4, 2025. For stock issued on or before that date, the threshold was $50 million. (IRC Section 1202(d)(1))

Aggregate gross assets means the corporation's cash plus the aggregate adjusted bases of its other property. Property contributed to the corporation is treated as having a basis equal to its fair market value at the time of contribution. (IRC Section 1202(d)(2))

Corporations in the same parent-subsidiary controlled group are treated as one corporation for this test. (IRC Section 1202(d)(3))

Original Issuance Requirement

The taxpayer must acquire the stock at original issuance, directly or through an underwriter, in exchange for money, property other than stock, or services provided to the corporation. Stock purchased on the secondary market does not qualify. (IRC Section 1202(c)(1)(B))

Certain transfers allow the transferee to step into the transferor's position, including gifts, transfers at death, and qualifying partnership distributions. (IRC Section 1202(h))

Active Business Requirement

During substantially all of the taxpayer's holding period, the corporation must be a C corporation and must satisfy the active business requirement. At least 80 percent of the corporation's assets, by value, must be used in the active conduct of one or more qualified trades or businesses. (IRC Section 1202(c)(2), (e)(1)) This is not simply a one-time test performed on the date shares are issued. Because the requirement applies across substantially all of the holding period, a company that qualifies at issuance but later drifts away from an active trade or business, for example by accumulating excess passive investments, could jeopardize the exclusion for shares issued during that period.

Startup activities, research and experimental activities, and in-house research activities can count as active qualified trade or business use. (IRC Section 1202(e)(2))

Which Businesses Are Excluded From QSBS?

A qualified trade or business excludes specific service and industry fields, including:

• Health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, and financial services
• Brokerage services
• Businesses where the principal asset is the reputation or skill of employees
• Banking, insurance, financing, leasing, and investing
• Farming
• Natural resource extraction businesses eligible for depletion
• Hotels, motels, restaurants, and similar businesses

(IRC Section 1202(e)(3))

Manufacturing, wholesale and retail trade, transportation, and technology companies generally qualify, provided they meet the other requirements. That said, whether a specific company qualifies is a facts-and-circumstances question, not a simple label. Some businesses combine qualifying and non-qualifying activities, and where the line falls often depends on details of the business model that deserve individual legal and tax analysis rather than a quick yes-or-no answer.

What Are the QSBS Asset and Redemption Traps?

A corporation fails the active business requirement if more than 10 percent of the value of its net assets consists of portfolio stock or securities in non-subsidiary corporations. (IRC Section 1202(e)(5))

The Code also limits nonbusiness real estate. Excess real estate holdings can prevent QSBS qualification. (IRC Section 1202(e)(7))

How Do Stock Redemptions Affect QSBS Eligibility?

Two redemption rules can disqualify stock:

1. Stock is not QSBS if the corporation purchased stock from the taxpayer or a related person during the four-year period beginning two years before the issuance date. (IRC Section 1202(c)(3)(A))
2. Stock is not QSBS if the corporation made significant redemptions exceeding 5 percent of the aggregate value of its stock during the two-year period beginning one year before issuance. (IRC Section 1202(c)(3)(B))

Gain Exclusion Percentages

For a noncorporate taxpayer, Section 1202 excludes a percentage of gain from gross income on the sale or exchange of QSBS.

Stock acquired after July 4, 2025 (new tiered structure):

(IRC Section 1202(a)(1), (a)(5))

Stock acquired on or before July 4, 2025 (prior rules):

The stock generally must be held for more than five years. The exclusion percentage depends on the acquisition date:

• 50 percent for stock acquired after August 10, 1993 and before February 18, 2009
• 75 percent for stock acquired after February 17, 2009 and before September 28, 2010
• 100 percent for stock acquired after September 27, 2010

(IRC Section 1202(a)(1), (a)(3), (a)(4))

How Much QSBS Gain Can You Exclude? The $15 Million and 10x Basis Rules

The amount of eligible gain that may be excluded for each issuer is limited to the greater of:

1. The applicable dollar limit, or
2. 10 times the taxpayer's aggregate adjusted basis in the QSBS of that issuer disposed of during the year.

The applicable dollar limit is $10 million for stock acquired on or before July 4, 2025, and $15 million for stock acquired after July 4, 2025. The $15 million limit is indexed for inflation for taxable years beginning after 2026. (IRC Section 1202(b))

The 10x basis rule is what makes the exclusion much larger than the headline dollar figure for many founders and early employees. A founder who acquired QSBS for $500,000 of basis could potentially exclude up to $5 million of gain under the 10x rule (10 times $500,000), even though that is below the $15 million cap. A founder or early investor with $2 million of basis could potentially exclude up to $20 million (10 times $2 million), which is above the $15 million dollar limit and therefore the more favorable of the two measures in that case. The 10x basis rule tends to matter most for founders or early investors who contributed meaningful cash, property, or services at a time when the company had a modest valuation.

It is worth being precise about what this limitation actually does. It caps the amount of gain that is eligible for exclusion. It does not, by itself, determine how much of that eligible gain is actually excluded. The applicable exclusion percentage (50, 75, or 100 percent, based on the holding period) and every other QSBS requirement described in this guide still have to be satisfied before any of that eligible gain is excluded from income.

The per-issuer limit is a lifetime limitation, reduced by prior eligible gain taken into account for that issuer. For married individuals filing separately, the dollar limit is halved: $5 million or $7.5 million, depending on the stock's acquisition date. (IRC Section 1202(b)(3))

28 Percent Capital Gains Rate on Non-Excluded Gain

Gain from the sale of QSBS that is not excluded under Section 1202 is generally taxed as 28 percent rate gain under IRC Section 1(h)(4)(A)(ii). This rate is higher than the standard 20 percent long-term capital gains rate. (IRC Section 1(h)(4)(A)(ii))

Net Investment Income Tax

Gain excluded under Section 1202 is not subject to the 3.8 percent net investment income tax (NIIT) under IRC Section 1411. The portion of gain that is not excluded remains subject to the NIIT. (IRC Section 1411(c)(1)(A)(iii))

For QSBS eligible for a 100 percent exclusion, this means the entire gain may be free from both federal income tax and the NIIT.

Alternative Minimum Tax

For QSBS acquired after September 27, 2010, excluded gain is not treated as an AMT preference item. For QSBS acquired on or before that date, 7 percent of the excluded gain may be an AMT preference item. (IRC Section 57(a)(7), Section 1202(a)(4)(C))

What Is a Section 1045 Rollover?

IRC Section 1045 provides an alternative to the Section 1202 exclusion for a shareholder who needs to sell before reaching the desired holding period. A noncorporate taxpayer who sells QSBS held for more than six months can elect rollover treatment if replacement QSBS is purchased within 60 days of the sale. Gain is recognized only to the extent that sale proceeds exceed the cost of the replacement QSBS.

Key features of the Section 1045 rollover:

• The original QSBS must be held for more than six months, far shorter than the three-to-five-year holding period for the Section 1202 exclusion.
• Replacement QSBS must be purchased within 60 days of the sale.
• Deferred gain reduces the basis of the replacement QSBS.
• The holding period of the original stock carries over to the replacement stock.

The Section 1045 rollover is primarily a deferral mechanism, not an exclusion. When combined with Section 1202, it can serve as a bridge: a taxpayer rolls over gain into replacement QSBS, holds the replacement stock until the Section 1202 holding period is met, and then may exclude the gain upon a qualifying sale. (IRC Section 1045)

Can You Gift QSBS to a Trust? What to Know About QSBS Stacking

The per-issuer exclusion limit applies at the taxpayer level, not at the level of the original block of stock. Certain gifts of QSBS can preserve the donor's original acquisition manner and holding period for the recipient: if the donor acquired the stock at original issuance, the recipient is generally treated as having done the same. (IRC Section 1202(h)(1)(A))

Because the dollar limitation applies per taxpayer, gifting QSBS to separate taxpayers, for example a spouse, adult children, or an irrevocable non-grantor trust, can potentially increase the aggregate amount of gain eligible for exclusion across a family group. This general concept is sometimes referred to as QSBS stacking. It is not automatic, risk-free, or appropriate for everyone.

Non-grantor trusts are the most commonly discussed stacking vehicle, and they should be treated as an advanced strategy that requires coordinated tax and estate planning advice rather than a do-it-yourself step. A properly structured non-grantor trust is its own separate taxpayer for income tax purposes and may be entitled to its own exclusion limit on QSBS gain, but establishing one raises several considerations that deserve individual attention:

• Gift tax consequences: transferring QSBS into a trust is generally a taxable gift, which uses gift tax exemption or may trigger gift tax, depending on the value transferred and the donor's remaining exemption.
• Trust income tax consequences: a non-grantor trust files its own tax return and is taxed on its own income, including any QSBS gain it eventually recognizes, which changes who bears the tax and when.
• Control and estate planning considerations: funding a trust generally means giving up direct control over the shares, which needs to fit within the family's broader estate plan rather than being decided in isolation.
• Timing: the trust generally needs to hold the QSBS for the applicable holding period in its own right, so stacking is a strategy that has to be put in place well before a sale, not after one is already underway.
• Anti-abuse rules: the IRS has authority to prevent arrangements designed to avoid the per-issuer limitation (IRC Section 1202(k)), and IRC Section 643(f), the multiple-trust anti-abuse rule, can cause two or more trusts with substantially the same grantors and beneficiaries to be treated as a single trust for tax purposes if a principal purpose of the structure is tax avoidance.

This guide does not state, and readers should not assume, that a married couple filing a joint federal return automatically receives two independent full QSBS exclusion limits simply by virtue of filing jointly. Current guidance on that specific question is unsettled, and it should be verified against current IRS guidance and primary authority, together with your own tax and legal advisors, before any decision is made that assumes it.

Because gifting and trust strategies interact directly with a family's broader wealth transfer plan, they typically need to be coordinated with legacy and estate planning rather than considered in isolation.

Do Different Stock Lots Get Different QSBS Treatment?

Founders, employees, and investors frequently acquire shares in the same company on multiple dates, whether through separate financing rounds, staggered exercises, or additional purchases over time. Each block, or lot, of stock can have a different basis, a different holding period, and a different applicable exclusion percentage, particularly for a shareholder who owns both stock acquired on or before July 4, 2025 and stock acquired after that date.

If a taxpayer holds QSBS from the same issuer acquired on different dates, the specific identification method can generally be used to designate which shares are sold, rather than defaulting to a first-in-first-out assumption. (IRC Section 1202; Reg. 1.1012-1(c)) Because different lots can qualify for very different treatment, keeping records that distinguish each block of stock, including its acquisition date, basis, and holding period, can materially affect the tax result of a sale.

As a simplified illustration, suppose a founder holds two lots of QSBS in the same company. Lot A was acquired on June 1, 2020 for $1,000,000 of basis and has been held for more than five years, which under the prior rules qualifies for a 100 percent exclusion up to a $10 million per-issuer limit. Lot B was acquired on August 15, 2025 for $2,000,000 of basis and has been held for three years and two months, which under the new tiered rules qualifies for only a 50 percent exclusion, subject to a $15 million dollar limit or 10 times basis ($20 million), whichever is greater. Selling Lot A first may allow up to a 100 percent federal exclusion on that block, while selling Lot B results in only a 50 percent exclusion on that block. Which lot is sold, and when, can materially change the federal tax result, which is why specific identification and clean recordkeeping matter.

The corporation issuing QSBS generally must be a domestic C corporation, and stock in an S corporation cannot itself qualify as QSBS. That is a separate question, however, from whether an owner who holds an interest in a partnership or S corporation that in turn holds qualifying C corporation stock can benefit from Section 1202.

Section 1202 contains specific rules under which qualifying gain realized through certain pass-through entities, including partnerships and S corporations that hold QSBS, may potentially retain Section 1202 treatment for the entity's owners, provided the statutory requirements are satisfied, including that the owner held their interest in the pass-through entity at the time the pass-through entity acquired the QSBS. (IRC Section 1202(g)) This is a technical area with meaningful nuance, including how the holding period and basis rules apply to each individual owner, and it deserves individual analysis rather than a blanket assumption in either direction.

An option to purchase stock is not itself QSBS. Section 1202 applies to actual shares of stock, so the relevant holding period generally does not begin on the date an employee receives an option grant.

What generally matters for QSBS purposes is the date the underlying shares are actually acquired, which for many equity compensation arrangements is the exercise or issuance date rather than the grant date. The specific mechanics of how a given option or award interacts with the QSBS holding period can depend on the type of award and the terms of the plan, and that analysis is separate from, though related to, the broader tax planning that applies to options, restricted stock, and other equity compensation. Employees and founders who hold options in a company they believe may qualify under Section 1202 should confirm the acquisition date that will actually start their QSBS holding period before assuming any particular timeline applies.

Timing Matters

The OBBBA's tiered holding period structure rewards longer holds with higher exclusion percentages. Executives who acquired qualifying stock after July 4, 2025 can begin benefiting from partial exclusions after three years, though the full 100 percent exclusion requires a five-year hold.

What Documentation Should You Keep for QSBS?

QSBS planning works best when it begins well before a liquidity event, not after one. The corporation must agree to submit reports to the IRS and shareholders upon request to help establish QSBS status. (IRC Section 1202(d)(1)(C)) Beyond that corporate-level obligation, taxpayers and companies alike benefit from keeping their own contemporaneous records, because proving qualification five or ten years later can become difficult if the underlying documentation was never collected. Useful records generally include:

• Evidence of the original issuance and the exact acquisition date of each block of stock.
• The purchase price and resulting tax basis for each block.
• Documentation of the corporation's C corporation status at issuance and afterward.
• Records of the corporation's aggregate gross assets immediately before and immediately after the relevant stock issuance.
• Cap tables and financing round documentation.
• Evidence of the company's active business activities during the holding period.
• Records of any significant stock redemptions by the company.
• Records of subsequent stock issuances by the company.
• Documentation of any conversions, reorganizations, or other corporate transactions affecting the stock.
• Records of any gifts or other transfers of the stock.
• A clear record of the holding period and basis for each individual stock lot.

Taxpayers should maintain this documentation for each block of shares, particularly when shares were acquired at different times, since the holding period, basis, and applicable exclusion percentage can differ from one block to the next.

State Tax Conformity Varies

Not all states conform to the federal Section 1202 exclusion, and California is one of the most significant examples for our clients. Even gain that is fully excluded for federal purposes may still be taxable at the state level. The dedicated California section later in this guide covers that treatment in more detail, and executives and founders in other states should confirm their own state's conformity position with a tax advisor.

Choice of Entity

For new businesses, the combination of the 21 percent flat C corporation tax rate (IRC Section 11(b)) and the Section 1202 gain exclusion may make a C corporation structure preferable to a partnership or S corporation in some cases, particularly if the business expects to retain earnings and the stock will be held long-term. Each situation requires individual analysis.

This is one of the most important distinctions in this guide for founders, executives, and investors who live or previously lived in California. California currently does not conform to the federal QSBS gain exclusion under IRC Section 1202, and it does not conform to the federal Section 1045 QSBS rollover either. (California Franchise Tax Board, California Conformity to Federal Law) A gain that is potentially excluded in full for federal purposes may still be fully taxable for California purposes. QSBS treatment should never be described to a California taxpayer as making an exit completely tax free.

California once had its own state-level QSBS exclusion, separate from the federal provision. That state exclusion was struck down in Cutler v. Franchise Tax Board (2012) because its requirement that a company maintain a specified level of property and payroll in California was found to violate the dormant Commerce Clause of the U.S. Constitution. The provision was subsequently repealed effective January 1, 2016, and California has not reinstated a comparable state-level exclusion since.

In practice, this means a California resident, or a nonresident whose gain is otherwise sourced to California, generally must add back the federal QSBS exclusion on California Schedule CA (540), because California taxes capital gains as ordinary income, with a top marginal rate of 13.3 percent. A gain that is 100 percent excluded federally can still generate a substantial California tax bill.

Other states vary in how they treat QSBS. Some conform to the federal exclusion, some do not conform at all, and some have their own rules. Founders and investors who are considering a change of state residence around a liquidity event should discuss the timing and substance of that move carefully with their tax and legal advisors well in advance, since residency positions taken close to a transaction tend to draw scrutiny.

An owner who believes they hold QSBS should review that position before signing or closing a transaction, not after. Questions worth working through in advance generally include:

• Does the stock actually qualify as QSBS, based on the issuer's history and activities as well as the shareholder's own acquisition facts?
• If multiple stock lots exist, which lots should be sold, and in what order?
• When will each lot reach the three-, four-, or five-year threshold that determines its exclusion percentage?
• Could delaying the exit, even briefly, materially improve the exclusion available on a given lot?
• Is a Section 1045 rollover relevant, for example because a sale is happening before the desired holding period is reached?
• Are charitable gifts of some of the stock being considered as part of the plan?
• Is estate or gifting planning appropriate given the size of the position and the family's broader goals?
• Has the company maintained enough documentation to substantiate QSBS status if that is ever questioned?
• What federal and state tax would actually remain after the exclusion, once state conformity, including California's nonconformity, is factored in?

The larger point behind this list is that QSBS analysis works best inside a broader liquidity, investment, tax, and estate plan. Treating it as an isolated tax-return question after the transaction has already closed tends to foreclose several of the planning options described in this guide.

The following example is hypothetical and simplified for illustration only. It is not a projection or promise of any particular result.

Sarah, a hypothetical founder, acquires QSBS in a qualifying C corporation on September 1, 2025, contributing $2,000,000 of cash and property in exchange for her shares. She sells all of her stock on October 1, 2030 for $30,000,000, recognizing a gain of $28,000,000.

Because Sarah held the stock for more than five years, she meets the top tier of the tiered holding period and is potentially eligible for a 100 percent exclusion. Her exclusion limit is the greater of the $15,000,000 dollar limitation or 10 times her basis (10 times $2,000,000, or $20,000,000). Because $20,000,000 is greater than $15,000,000, her federal exclusion limit is $20,000,000.

Assuming all other QSBS requirements are satisfied, Sarah may potentially exclude up to $20,000,000 of her $28,000,000 gain for federal tax purposes. The remaining $8,000,000 would be subject to federal capital gains tax. If Sarah is a California resident, California's nonconformity described above means the entire $28,000,000 gain may still be taxable for California purposes at California's ordinary income tax rates, regardless of the federal exclusion.

One planning decision Sarah could have considered before the sale: gifting a portion of her QSBS to a properly structured non-grantor trust well in advance of the transaction, potentially creating a separate taxpayer with its own exclusion limit. That kind of stacking strategy, discussed earlier in this guide, requires careful analysis of gift tax consequences, trust structuring, and anti-abuse rules, and it needs to be evaluated years, not weeks, before an anticipated exit.

If you own private company stock that may qualify for QSBS, the best time to determine eligibility and evaluate planning opportunities is generally before a liquidity event is imminent, not in the weeks after a term sheet is signed. Once a transaction is underway, several of the planning options described in this guide, including gifting, trust structuring, and the timing of a sale relative to a holding-period threshold, become far more limited or unavailable.

Reviewing the company's qualification history, each shareholder's individual stock lots, the timing of a potential exit, federal and state tax exposure, estate planning, charitable planning, and post-sale investment strategy together, rather than one at a time, can materially change the outcome. Fiduciary Financial Group's CPA-integrated wealth management team works through these pieces alongside our tax planning and mitigation services, our equity compensation planning, and our legacy and estate planning services.

Our business owner and high net worth clients often hold concentrated equity positions similar to QSBS. If you are managing a similar position, our articles on capital gains tax on RSUs and stock options and exchange funds and long-short equity strategies for concentrated stock may also be useful background, and our Insights & News page has additional planning guides.

If you hold equity in a company that may qualify under Section 1202, we invite you to speak with our team so we can help coordinate the analysis with your tax and legal advisors.

What is Qualified Small Business Stock (QSBS)?

Qualified Small Business Stock, or QSBS, is stock in a qualifying domestic C corporation that meets the requirements of IRC Section 1202. When those requirements are satisfied and the stock is held for the required period, a noncorporate shareholder may exclude a percentage of the gain, potentially up to 100 percent, from federal income tax when the stock is sold.

How does the QSBS tax exclusion work?

The QSBS exclusion allows an eligible shareholder to exclude a percentage of the gain recognized on the sale of qualifying stock from federal taxable income, subject to a per-issuer dollar limitation or a 10 times basis limitation, whichever is greater. The exclusion percentage depends on the stock's acquisition date and holding period, and every other QSBS requirement described in this guide must also be satisfied.

What are the QSBS 2025 changes?

The One Big Beautiful Bill Act, signed into law on July 4, 2025, changed Section 1202 for stock acquired after that date. It introduced a tiered holding period (50 percent exclusion at three years, 75 percent at four years, 100 percent at five years), raised the per-issuer dollar limitation from $10 million to $15 million, and raised the issuing corporation's aggregate gross assets threshold from $50 million to $75 million. Stock acquired on or before July 4, 2025 remains subject to the prior rules.

How much QSBS gain can I exclude?

The amount of gain eligible for exclusion per issuer is limited to the greater of the applicable dollar limitation ($10 million or $15 million, depending on when the stock was acquired) or 10 times the taxpayer's aggregate adjusted basis in the QSBS sold. That limit determines how much gain is eligible for exclusion; the applicable exclusion percentage and all other QSBS requirements then determine how much of that eligible gain is actually excluded.

What is the QSBS 5 year rule?

A shareholder who holds QSBS for five years or more may potentially exclude 100 percent of the eligible gain, regardless of whether the stock was acquired before or after July 4, 2025. Under the prior rules, five years was also the minimum holding period required before any exclusion was available at all.

What is the QSBS 3 year rule?

For stock acquired after July 4, 2025, a holding period of at least three years, but less than four, can qualify for a 50 percent exclusion. The non-excluded portion of that gain is generally taxed at a 28 percent federal capital gains rate rather than the standard 20 percent rate, and the 3.8 percent net investment income tax applies to the non-excluded portion.

What is the QSBS 10x basis rule?

The 10x basis rule allows a shareholder to exclude gain up to 10 times their adjusted basis in the QSBS sold, if that amount is greater than the flat dollar limitation ($10 million or $15 million). This rule can produce an exclusion well above the headline dollar figure for founders and early investors who contributed significant cash, property, or services when the company had a modest valuation.

Does California recognize QSBS?

No. California does not conform to the federal QSBS exclusion under Section 1202 or to the Section 1045 rollover. Gain that is excluded for federal purposes generally must be added back on California Schedule CA (540) and is taxed as ordinary income at California rates of up to 13.3 percent.

Can I gift QSBS to a trust?

Certain gifts of QSBS can preserve the donor's original acquisition manner and holding period for the recipient, and because the exclusion limit applies per taxpayer, gifting to separate taxpayers, including a properly structured non-grantor trust, can potentially increase the total gain eligible for exclusion across a family. This is an advanced strategy with gift tax, trust income tax, control, and anti-abuse considerations that should be evaluated with tax and legal advisors well before a sale, not treated as a simple or automatic maneuver.

What is a Section 1045 rollover?

Section 1045 allows a noncorporate taxpayer who sells QSBS held for more than six months to defer the gain by purchasing replacement QSBS within 60 days of the sale. It is a deferral, not an exclusion: the deferred gain reduces the basis of the replacement stock, and the replacement stock has its own QSBS requirements to satisfy.

What happens if I sell QSBS before five years?

For stock acquired after July 4, 2025, selling after three or four years can still qualify for a partial exclusion (50 percent or 75 percent, respectively), though the non-excluded gain is taxed at a higher 28 percent federal rate plus the net investment income tax. For stock acquired on or before July 4, 2025, no exclusion is available unless the stock is held for more than five years, though a Section 1045 rollover may allow the gain to be deferred if replacement QSBS is purchased within 60 days.

• IRC Section 1202, Partial exclusion for gain from certain small business stock
• IRC Section 1045, Rollover of gain from qualified small business stock
• Public Law 119-21, the One Big Beautiful Bill Act (signed July 4, 2025)
• IRS, Instructions for Schedule D (Form 1040), Exclusion of Gain on Qualified Small Business (QSB) Stock
• California Franchise Tax Board, California Conformity to Federal Law

Additional statutory provisions referenced in this guide: IRC Section 1202(a)(5) (tiered holding period), Section 1202(b) (per-issuer limitation), Section 1202(c) (definition of QSBS), Section 1202(d) (qualified small business, gross asset test), Section 1202(e) (active business requirement and excluded businesses), Section 1202(g) (pass-through entity rules), Section 1202(h) (transfers by gift, at death, or from partnerships), Section 1202(k) (anti-abuse authority), Section 643(f) (multiple-trust anti-abuse rule), Section 1(h)(4)(A)(ii) (28 percent rate gain), and Section 1411 (net investment income tax).

This article is for informational and educational purposes only and should not be considered personalized tax, legal, or investment advice. QSBS qualification depends on the specific facts of each situation, including the issuing corporation's history, activities, and the shareholder's individual circumstances. Consult a qualified tax advisor and attorney before making decisions based on Section 1202 or Section 1045.