Qualified Small Business Stock (QSBS): How to Exclude Up to $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 the most generous capital gains exclusion in the tax code: qualifying shareholders can exclude 100% of their gain on the sale of qualified small business stock (QSBS), up to the greater of $10 million or 10x their adjusted basis. For stock acquired after September 27, 2010, the exclusion is 100% (earlier acquisitions had lower exclusion percentages: 75% for stock acquired between February 18, 2009 and September 27, 2010, and 50% for stock acquired before February 18, 2009). The excluded gain is also exempt from the 3.8% net investment income tax (NIIT). A founder who invests $100,000 in a qualifying C-Corp, holds the stock for 5+ years, and sells for $5 million pays $0 in federal tax on the $4.9 million gain.

✓Key takeaway

QSBS requirements (ALL must be met):

Requirement	Details
Entity type	C-Corporation (not S-Corp, not LLC, not partnership)
Gross assets test	Corporation’s gross assets never exceeded $50 million (before and immediately after the stock issuance)
Holding period	Stock held for more than 5 years
Original issuance	Stock acquired directly from the corporation at original issuance (not purchased from another shareholder)
Acquisition method	Acquired for money, property (not stock), or services
Active business test	At least 80% of assets used in active conduct of a qualified trade or business
Qualified trade or business	NOT in an excluded industry (see below)

Excluded industries (stock from these businesses does NOT qualify):

Professional services (health, law, engineering, architecture, accounting, actuarial, performing arts, consulting, athletics, financial services, brokerage)
Banking, insurance, leasing, financing
Farming (including timber)
Mining, oil, and gas extraction
Hospitality (hotels, motels, restaurants)

Qualifying industries (examples):

Technology and software
Manufacturing
Retail and wholesale
Construction
Real estate development (but not holding/rental)
Transportation
Biotech and pharmaceutical

Exclusion amounts:

Stock Acquisition Date	Exclusion Percentage
After September 27, 2010	100%
February 18, 2009 to September 27, 2010	75%
Before February 18, 2009	50%

Maximum exclusion per taxpayer per issuer: Greater of:

$10 million, OR
10x the adjusted basis of the stock

If basis is $500,000: max exclusion = $10 million (10x = $5 million, but $10 million floor applies) If basis is $2 million: max exclusion = $20 million (10x = $20 million, exceeds $10 million floor)

How does QSBS planning work in practice?

Hypothetical example

Round numbers. A software developer starts a C-Corp. Invests $50,000 in cash for 100% of the stock.

Year 1-5: Building the business The C-Corp develops and sells software. Revenue grows from $200,000 to $2,000,000 over 5 years. Gross assets never exceed $50 million (not close). The company uses 95% of its assets in active business operations (well above the 80% threshold).

Year 6: Sale of the company for $8,000,000

Item	Amount
Sale price (stock sale)	$8,000,000
Adjusted basis	$50,000
Gain	$7,950,000
QSBS exclusion (100%, stock held 6 years, post-9/27/2010)	$7,950,000 (under $10M cap)
Taxable gain	$0
Federal tax	$0
NIIT (3.8%)	$0 (QSBS exclusion applies)
State tax	Varies (most states conform, some don’t)

Without QSBS (taxed as regular capital gains):

Item	Amount
Capital gain	$7,950,000
Federal tax (20% LTCG)	$1,590,000
NIIT (3.8%)	$302,100
State tax (5% example)	$397,500
Total tax	$2,289,600

QSBS saves $2,289,600 in taxes on this sale.

State conformity (important caveat):

State	Conforms to IRC 1202?
California	NO (does not allow QSBS exclusion)
New York	NO (does not allow QSBS exclusion)
Florida	No state income tax (QSBS irrelevant)
Texas	No state income tax (QSBS irrelevant)
Massachusetts	Partial (allows 50% exclusion for pre-2009 stock only)
Most other states	Yes (full conformity)

In California, the $7,950,000 gain would be taxed at 13.3% state rate = $1,057,350 state tax even with QSBS. This is a major planning consideration for California-based startups.

QSBS stacking (multiplying the exclusion): Each taxpayer gets a separate $10 million exclusion per issuing corporation. Strategies to stack:

Married filing jointly: Each spouse can exclude $10 million (total $20 million) if both are shareholders.
Gifting stock to family members: Gift QSBS-eligible stock to children or trusts before the sale. Each recipient gets their own $10 million exclusion. The holding period tacks (recipient inherits the donor’s holding period).

Example: Founder owns $30 million in QSBS stock.

Founder’s exclusion: $10 million
Spouse’s exclusion: $10 million (if stock is jointly held or gifted)
Gift to Trust A (for child 1): $10 million exclusion
Total exclusion: $30 million, $0 federal tax

IRC 1045 rollover: If QSBS is sold before the 5-year holding period, the gain can be rolled into new QSBS within 60 days (IRC 1045). The holding period of the original stock tacks to the new stock. This allows the taxpayer to sell one QSBS position and reinvest in another without triggering gain.

The C-Corp vs. S-Corp decision for startups:

Factor	C-Corp (QSBS eligible)	S-Corp (no QSBS)
Ongoing tax rate	21% corporate rate + shareholder tax on distributions	Pass-through (individual rates, 10-37%)
Exit tax (sale of stock)	$0 (QSBS exclusion)	Capital gains (15-20% + NIIT)
Break-even	Exit must generate $200K+ in QSBS-excludable gain to overcome the double-tax cost	Better for businesses distributing profits annually

For a business expected to be SOLD for a significant gain: C-Corp with QSBS planning can be dramatically better than S-Corp.

For a business expected to DISTRIBUTE profits annually (lifestyle business): S-Corp is better (avoids double tax on distributions).

Documentation to maintain QSBS status:

Stock purchase agreement showing original issuance
Board resolutions authorizing stock issuance
Proof of consideration paid (cash, property, or services)
Annual records showing gross assets under $50 million
Records showing 80%+ of assets in active business
Industry classification documentation (proving not in an excluded industry)
Holding period records (date of acquisition for each lot)

Maintaining these records is critical. If challenged, the burden is on the taxpayer to prove QSBS qualification.

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

What are the requirements to qualify for the QSBS exclusion?

Section 1202 allows up to 100% exclusion of gain on the sale of Qualified Small Business Stock, but the requirements are strict. The stock must be issued by a domestic C-Corporation with gross assets of $50 million or less at the time of issuance and at all times before the stock was issued. You must acquire the stock at original issuance (not on the secondary market) in exchange for money, property, or services. You must hold the stock for at least 5 years. The corporation must use at least 80% of its assets in an active trade or business (not investment management, banking, insurance, farming, mining, or hospitality), and it must remain a C-Corporation during substantially all of your holding period.

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Cite this page

Yarik Yarosh, CPA. "Qualified Small Business Stock (QSBS): How to Exclude Up to $10 Million in Capital Gains." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-qualified-small-business-stock-qsbs-exclusion

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

Qualified Small Business Stock (QSBS): How to Exclude Up to $10 Million in Capital Gains

How does QSBS planning work in practice?

What are the requirements to qualify for the QSBS exclusion?

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