Section 1202 QSBS: How to Exclude Up to 100% of Capital Gains on Qualified Small Business Stock

By Yarik Yarosh, CPA ·September 5, 2026 ·7 min read

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

For founders and early investors in small businesses, IRC 1202 offers a benefit that’s difficult to match anywhere else in the tax code: a 100% exclusion of capital gains on the sale of qualified small business stock. If a founder starts a C-Corp, invests $500,000, builds the business over five years, and sells their stock for $10,500,000, the entire $10,000,000 gain is excluded from federal income tax. No capital gains tax, no NIIT, no AMT. The benefit is so large that it fundamentally changes the calculus of entity selection for startups and growth businesses that expect a significant exit. The rules are technical (the corporation must meet the gross asset test, the active business test, and the excluded industry test at issuance, and the shareholder must hold original-issue stock for at least five years), but the planning opportunities are substantial. Multiple shareholders can each claim their own $10 million exclusion, stock can be gifted to family members who each get their own exclusion, and Section 1045 allows tax-free rollovers of QSBS gains into new QSBS if the five-year holding period has not been met.

✓Key takeaway

QSBS qualification requirements:

Requirement	Rule
Issuer	Domestic C-Corporation (not S-Corp, LLC, or partnership)
Gross assets	$50 million or less at time of issuance AND at all times before issuance
Active business	At least 80% of corporate assets used in a qualified trade or business
Original issuance	Stock must be acquired directly from the corporation (not purchased from another shareholder)
Consideration	Money, property (not stock), or services rendered to the corporation
Holding period	More than 5 years
Exclusion amount	Greater of: $10 million OR 10x the shareholder’s adjusted basis in the stock

Exclusion percentage by acquisition date:

Stock Acquired	Exclusion %	AMT Preference?
Before February 18, 2009	50%	Yes (7% of excluded gain)
February 18, 2009 to September 27, 2010	75%	No
After September 27, 2010	100%	No

How does QSBS work and how can you maximize the exclusion?

Hypothetical example

Round numbers. A founder starts a technology company as a C-Corp, contributing $200,000 in cash for stock in Year 1. The corporation’s gross assets at issuance are $200,000 (well under $50 million). After six years of growth, the founder sells all their stock for $15,000,000.

QSBS exclusion calculation:

Item	Amount
Sale price	$15,000,000
Adjusted basis	$200,000
Total gain	$14,800,000
QSBS exclusion cap: greater of $10M or 10x basis ($2,000,000)	$10,000,000
Gain excluded (100%)	$10,000,000
Remaining taxable gain	$4,800,000
Tax on remaining gain (23.8% LTCG + NIIT)	$1,142,400

Without QSBS:

Item	Amount
Total gain	$14,800,000
Tax (23.8%)	$3,522,400

QSBS tax savings: $2,380,000

Stacking strategy: multiple shareholders Each shareholder who holds QSBS gets their own $10 million exclusion. Planning opportunities:

Strategy	How It Works	Additional Exclusion
Spouse holds stock separately	Each spouse gets $10M exclusion	$10M
Gift stock to children (before sale)	Each child gets their own $10M exclusion; holding period tacks	$10M per child
Gift stock to trusts	Each trust gets its own $10M exclusion (if structured properly)	$10M per trust
Issue stock to key employees	Employees who receive original-issue stock get their own $10M	$10M per employee

Example: Founder gifts QSBS to spouse and two adult children before the sale:

Shareholder	Stock Basis	Stock Value at Sale	Gain	Exclusion (100%, up to $10M)	Taxable Gain	Tax
Founder	$80,000	$6,000,000	$5,920,000	$5,920,000	$0	$0
Spouse	$40,000	$3,000,000	$2,960,000	$2,960,000	$0	$0
Child 1	$40,000	$3,000,000	$2,960,000	$2,960,000	$0	$0
Child 2	$40,000	$3,000,000	$2,960,000	$2,960,000	$0	$0
Total	$200,000	$15,000,000	$14,800,000	$14,800,000	$0	$0

Result: the entire $14,800,000 gain is excluded (instead of $10,000,000 with a single shareholder).

Excluded industries (NOT eligible for QSBS):

Industry	Why Excluded
Health (medicine, dentistry)	Professional service
Law	Professional service
Engineering, architecture	Professional service
Accounting	Professional service
Actuarial science	Professional service
Performing arts	Professional service
Consulting	Professional service
Athletics	Professional service
Financial services (brokerage, investment management)	Professional service
Banking, insurance, leasing, financing	Financial
Farming (including raising/harvesting trees)	Natural resources
Mining, oil, gas	Natural resources
Hotels, motels, restaurants	Hospitality

Industries that DO qualify:

Industry	Notes
Technology / software	Qualifies (the most common QSBS issuer)
Manufacturing	Qualifies
Retail / wholesale (product companies)	Qualifies
Construction	Qualifies
Real estate development (active)	May qualify (but watch the 80% asset test; passive holding does not)
Biotech / pharmaceuticals	Qualifies
Media / publishing	Qualifies
E-commerce	Qualifies

Section 1045 rollover (if sold before 5 years):

Rule	Details
If QSBS is sold after holding 6 months but before 5 years	Gain can be rolled over into new QSBS within 60 days
New QSBS must meet all requirements	Including the $50M gross asset test
Basis in new QSBS	Reduced by the deferred gain (carryover)
Holding period	Tacks (includes the period the original QSBS was held)

Gross asset test ($50 million):

Rule	Details
Measured at	Time of stock issuance AND all times before issuance
Includes	Cash, equipment, property, investments at FMV
Includes	Aggregate assets of the corporation and any subsidiaries
Excludes	Doesn’t include contributed property at FMV if contributed for stock (uses basis instead)
Exceeding $50M after issuance	Doesn’t disqualify stock already issued (the test is at issuance, not at sale)

Planning considerations:

Action	Why
Start as a C-Corp (not LLC) if expecting a large exit	QSBS only applies to C-Corp stock
Document the gross asset test at each stock issuance	The $50M test must be provable years later
Issue stock early when assets are low	Easier to meet the $50M test
Hold for at least 5 years	The full exclusion requires 5+ years
Gift stock to family before the exit	Each donee gets their own $10M exclusion
Track original issuance carefully	Stock purchased from another shareholder does NOT qualify
Avoid mixing with excluded industries	The 80% active business test is ongoing
Consider converting LLC to C-Corp	Conversion counts as original issuance (the new stock is QSBS if requirements are met)

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.

Related guides:

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Cite this page

Yarik Yarosh, CPA. "Section 1202 QSBS: How to Exclude Up to 100% of Capital Gains on Qualified Small Business Stock." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-section-1202-qsbs-qualified-small-business-stock-exclusion

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