Qualified Small Business Stock (QSBS): The IRC 1202 Exclusion That Can Eliminate $10 Million in Capital Gains

By Yarik Yarosh, CPA ·September 5, 2026 ·6 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

IRC 1202 provides one of the most powerful tax benefits in the entire code: a 100% exclusion of capital gains on the sale of qualified small business stock (QSBS). For founders and early investors in eligible C-Corporations, this means up to $10 million in capital gains (or 10 times the adjusted basis, whichever is greater) can be completely excluded from federal income tax. The exclusion applies to stock acquired after September 27, 2010, held for at least 5 years. Unlike most capital gains strategies that defer tax (1031 exchanges, installment sales, opportunity zones), QSBS permanently eliminates the tax. The excluded gain is also exempt from the 3.8% net investment income tax (NIIT). For a founder who sells a startup for $15 million with a $500,000 basis, the QSBS exclusion can save over $2 million in federal taxes.

✓Key takeaway

QSBS requirements:

Requirement	Details
Entity type	Must be a C-Corporation (not S-Corp, LLC, or partnership)
Gross assets at issuance	$50 million or less (including the amount received for the stock issuance)
How stock was acquired	Original issuance (cash, property, or services; not purchased from another shareholder)
Holding period	At least 5 years
Active business test	At least 80% of assets must be used in an active trade or business during substantially all of the holding period
Exclusion amount	Greater of $10 million or 10x adjusted basis
Exclusion percentage	100% (for stock acquired after 9/27/2010)

Businesses that qualify vs. don’t qualify:

Qualifies for QSBS	Doesn’t Qualify
Technology / software	Any business providing services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage
Manufacturing	Banking, insurance, financing, leasing
Retail	Real estate
Wholesale distribution	Farming (when more than half of assets are farming)
Restaurants	Hotels and motels
Construction	Mining and oil & gas
E-commerce	Investment management
Biotech / pharmaceuticals	Any business where the principal asset is the reputation or skill of employees

Exclusion amount:

Basis in Stock	10x Basis	$10 Million Cap	Exclusion Amount
$100,000	$1,000,000	$10,000,000	$10,000,000 (cap wins)
$500,000	$5,000,000	$10,000,000	$10,000,000 (cap wins)
$2,000,000	$20,000,000	$10,000,000	$20,000,000 (10x wins)
$5,000,000	$50,000,000	$10,000,000	$50,000,000 (10x wins)

How does QSBS work for a startup founder?

Hypothetical example

Round numbers. A founder starts a software company as a C-Corp in 2020. They invest $200,000 in cash for 100% of the stock. The company has $200,000 in gross assets at issuance (well under $50 million). The company grows successfully.

Scenario: Sell in 2026 (after 5+ years) for $12,000,000

Item	Amount
Sale price	$12,000,000
Cost basis	$200,000
Total gain	$11,800,000
QSBS exclusion (greater of $10M or 10x $200K = $2M)	$10,000,000
Taxable gain	$1,800,000
Federal tax on taxable gain (20% LTCG + 3.8% NIIT)	$428,400

Without QSBS:

Item	Amount
Total gain	$11,800,000
Federal tax (23.8%)	$2,808,400

Metric	With QSBS	Without QSBS
Federal tax	$428,400	$2,808,400
Tax savings from QSBS		$2,380,000

Stacking QSBS across family members: The founder’s spouse and two adult children each invest $50,000 in the company at founding. Each person holds their own QSBS.

Shareholder	Basis	QSBS Exclusion	Excluded Gain
Founder	$200,000	$10,000,000	$10,000,000
Spouse	$50,000	$10,000,000	Up to $10,000,000
Child 1	$50,000	$10,000,000	Up to $10,000,000
Child 2	$50,000	$10,000,000	Up to $10,000,000
Total family exclusion			Up to $40,000,000

Each shareholder has their own $10 million exclusion (or 10x their basis). By having four family members each own QSBS at original issuance, the family can exclude up to $40 million in gains.

The gifting strategy: If the founder owns 100% but wants to multiply the exclusion, they can gift shares to family members BEFORE the 5-year holding period is complete. The recipient takes the donor’s holding period (tacking), so the gift does not restart the 5-year clock. Each recipient then has their own $10 million exclusion.

Step	Result
Founder owns 1,000 shares (basis $200)	Single $10M exclusion
Gift 250 shares to spouse (basis $50)	Spouse gets own $10M exclusion, tacked holding period
Gift 250 shares to trust for Child 1 (basis $50)	Trust gets own $10M exclusion
Gift 250 shares to trust for Child 2 (basis $50)	Trust gets own $10M exclusion
Total exclusion: $40 million

Important: gifts must use the lifetime exemption. The gift value is the FMV at the time of gift, which may be significant if the company has appreciated.

IRC 1045 rollover (selling before 5 years): If the founder needs to sell before the 5-year holding period, IRC 1045 allows a tax-free rollover into another QSBS within 60 days:

Requirement	Details
Holding period	At least 6 months (not 5 years)
Reinvestment	Must reinvest in another QSBS within 60 days
Effect	Holding period of old QSBS tacks onto new QSBS
Gain deferred	Gain deferred until the new QSBS is sold

This allows founders to “roll” their QSBS from one qualifying company to another, deferring gain until they find a stock they want to hold for the full 5 years.

State tax treatment varies:

State	QSBS Exclusion?
Federal	100% exclusion
California	Does NOT conform (full state tax on gain)
New York	Generally conforms (state exclusion available)
Florida	No state income tax
Texas	No state income tax
Massachusetts	Doesn’t conform
Most other states	Conform to federal exclusion

California’s nonconformity is significant: a California founder selling $10 million in QSBS pays $0 federal tax but approximately $1.33 million in California state tax (13.3% top rate).

Documentation requirements:

Document	Purpose
Stock certificates or cap table showing original issuance	Prove original issuance requirement
Corporate minutes authorizing the issuance	Corporate record of the transaction
Gross asset certification at time of issuance	Prove $50M limit was met
Business activity records	Prove 80% active business test
Holding period records	Prove 5-year requirement
Form 1040 Schedule D with QSBS exclusion notation	Reporting on the tax return

Illustrative numbers only, not a real client and not advice for your facts.

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Cite this page

Yarik Yarosh, CPA. "Qualified Small Business Stock (QSBS): The IRC 1202 Exclusion That Can Eliminate $10 Million in Capital Gains." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-qsbs-section-1202-exclusion-10-million

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.