What is qualified small business stock (§1202)?

Qualified small business stock is stock in certain C corporations that, when held long enough, can let a founder or early investor exclude a large share of the gain on a later sale from federal tax. Eligibility depends on the company being a qualifying C corporation in an active business, on how the stock was acquired, and on the holding period. The rules reward patient, direct ownership.

For tax year 2025

$75 million (QSBS gross-assets ceiling (stock issued after Jul 4, 2025), 2025)
$50 million (QSBS gross-assets ceiling (stock issued on or before Jul 4, 2025), 2025)
more than 5 years (QSBS holding period, 2025)

Key points

Qualified small business stock under Section 1202 lets a founder or early investor exclude a large share of the gain on sale from federal tax.
The issuer must be a domestic C corporation running an active business, with gross assets under a size ceiling when the stock is issued.
Qualified small business stock must be acquired at original issue directly from the corporation for money, property, or services, not from another shareholder.
Stock issued after the One Big Beautiful Bill Act was signed in July 2025 uses a tiered exclusion that begins at a shorter holding period.
Businesses in health, law, consulting, financial services, and similar fields where the principal asset is the owners' skill do not qualify.

What is qualified small business stock?

Qualified small business stock is stock in a qualifying domestic C corporation that, when held long enough, lets a founder or early investor exclude a significant portion of the gain on a later sale from federal income tax. The rules sit in Section 1202 of the Internal Revenue Code, and the gain and its exclusion are reported on Form 8949 and Schedule D of Form 1040 in the year of sale.

The benefit is a reward for building or backing a real company and holding the stock. For the right company, it makes the choice of entity and the timing of stock issuance genuinely consequential, because an LLC taxed as a partnership or an S corporation cannot issue qualifying stock.

What conditions must the company and the stock meet?

Several conditions have to line up. The company must be a domestic C corporation, not an S corporation or a partnership, both when the stock is issued and generally throughout the holding period. It must be an active business rather than a passive holding company, meaning most of its assets are used in the active conduct of a qualified trade or business. The corporation's gross assets must stay under a size ceiling immediately before and after the stock is issued.

How you acquire the stock matters as much. The stock generally must be acquired at original issue, directly from the corporation, in exchange for money, property, or services, rather than purchased from another shareholder. That is why the benefit belongs to founders and early-round investors who put capital in when the company was small. Stock received when an LLC converts to a C corporation can qualify from the conversion date if the other tests are met, which is why the conversion decision is often timed with this rule in mind.

How long must the stock be held, and what changed in 2025?

The rules changed under the One Big Beautiful Bill Act, signed July 4, 2025. For stock issued after that date, the exclusion moved to a tiered structure: a partial exclusion begins at a shorter holding period and phases up to a full exclusion with continued holding, and both the per-issuer cap on excluded gain and the gross-asset ceiling were raised. Stock issued on or before that date keeps the prior rules, under which a multi-year hold was required before any exclusion applied.

Because the treatment now depends on exactly when each block of stock was issued, founders who hold shares from several rounds may have different rules applying to different blocks. Selling too early can forfeit the exclusion entirely, so the timing of a sale should be planned rather than reactive to an offer.

Who does the exclusion not apply to?

The exclusion is unavailable to businesses in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, and any field where the principal asset is the reputation or skill of its employees. Banking, insurance, farming, hotels and restaurants, and corporations holding too much real property are also excluded. A physician group or a consulting firm will not qualify no matter how it is structured.

It also does not apply to stock bought from another shareholder in a secondary sale, to stock in an S corporation or a partnership interest, or to a corporation that exceeded the gross-asset ceiling when the shares were issued. Founders who expect a future sale document their basis, keep records showing the company met the size and active-business tests at issuance, and revisit qualification as the company raises capital. Review your position with your advisor early and confirm which set of rules applies to each block you hold.