Equity, tax and compliance
QSBS (Section 1202) After the July 2025 Changes: What Founders and Angels Must Know
The short answer
Section 1202 lets non-corporate holders exclude gain on qualified small business stock (QSBS) from federal income tax. For stock acquired after July 4, 2025, the One Big Beautiful Bill Act (OBBBA) introduced a tiered exclusion of 50% after 3 years, 75% after 4 years and 100% after 5 years, raised the per-issuer cap to the greater of $15 million or 10 times basis, and raised the gross assets limit to $75 million, with both dollar amounts indexed for inflation after 2026. Stock acquired on or before July 4, 2025 keeps the prior rules: 100% exclusion only after more than 5 years, a $10 million cap and a $50 million asset test. The company must be a domestic C corporation in a qualifying active business, and the stock must be acquired at original issuance.
Key numbers
| Rule | Stock acquired after July 4, 2025 | Stock acquired before (post-September 2010) |
|---|---|---|
| Exclusion after 3 years | 50% | None |
| Exclusion after 4 years | 75% | None |
| Exclusion after 5 years | 100% | 100% (more than 5 years) |
| Per-issuer cap | Greater of $15M (indexed after 2026) or 10x basis | Greater of $10M or 10x basis |
| Aggregate gross assets limit at issuance | $75M (indexed after 2026) | $50M |
| Rate on non-excluded Section 1202 gain | Up to 28%, plus 3.8% net investment income tax where applicable | Not applicable at the 100% tier |
| Source | One Big Beautiful Bill Act (Pub. L. 119-21), July 4, 2025; Cooley alert, July 2025 | IRC Section 1202 before amendment |
Who can benefit
QSBS benefits individuals, trusts and estates, and pass-through entities (such as venture funds organized as partnerships) to the extent their partners qualify. Corporations cannot use the exclusion. Founders, early employees who hold shares, angel investors and fund partners are the main beneficiaries.
Requirements for the stock
- Domestic C corporation at issuance and during substantially all of the holding period. LLC interests and S corporation stock do not qualify; a later conversion to a C corporation starts the clock (and the asset test uses fair value of contributed assets).
- Original issuance: acquired from the company for money, property (other than stock) or services, not bought from another stockholder.
- Gross assets test: the company's aggregate gross assets (cash plus adjusted basis of property, with contributed property at fair value) must not exceed the limit ($75M for new stock) at any time before and immediately after the issuance, counting the cash raised in the round.
- Active business: at least 80% of assets (by value) used in a qualified trade or business during substantially all of the holding period.
- Excluded fields: services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, and any business whose principal asset is the reputation or skill of its employees; banking, insurance, financing, leasing, investing; farming; oil, gas and mining; hotels and restaurants. Software, hardware, biotech and most product companies qualify; "AI-enabled services" and consulting-heavy models need careful analysis.
- Redemption limits: significant company repurchases of stock within a window around the issuance (from the holder or related persons, or more than 5% of the stock in aggregate) can disqualify stock issued in that window.
How the tiers work
Ana, a founder, buys 4,000,000 shares for $400 on August 1, 2025 and files an 83(b) election. The company qualifies throughout. Assume her gain on sale is $10,000,000 (below the $15M cap).
| Sale date | Holding period | Excluded gain | Taxable Section 1202 gain |
|---|---|---|---|
| September 2028 | More than 3 years | $5,000,000 (50%) | $5,000,000, taxed at up to 28% plus NIIT where applicable |
| September 2029 | More than 4 years | $7,500,000 (75%) | $2,500,000, same rates |
| September 2030 | More than 5 years | $10,000,000 (100%) | $0 |
Waiting from year 3 to year 5 can save more than a million dollars of federal tax in this example. If her stock had been issued on July 1, 2025, a sale before the 5-year mark would get no exclusion at all, and her cap would be $10M.
The cap
The per-issuer cap limits the gain eligible for exclusion for each taxpayer per company: the greater of $15 million (reduced by gain excluded in earlier years from the same company) or 10 times the aggregate adjusted basis of the QSBS sold in the year. For founders with near-zero basis, the dollar cap controls. For an angel who invested $2 million in cash, 10x basis is $20 million, which exceeds the dollar cap. When gain exceeds the cap, model the interaction of the cap with the tier percentage carefully with a tax adviser.
Holding period traps
- Founder stock without an 83(b): for stock received in connection with services and subject to vesting, the QSBS holding period generally starts when the stock vests unless an 83(b) election is filed. File the 83(b).
- Options: the holding period starts at exercise, not grant. Early exercise with an 83(b) starts it sooner.
- Convertible notes: the stock received on conversion generally starts its holding period at conversion, and the gross assets test is applied then.
- SAFEs: the treatment is unsettled. Some practitioners treat a SAFE as equity from funding, so the clock could start at the SAFE purchase; the conservative view is that it starts at conversion. No IRS guidance resolves this as of late 2026.
- Convertible preferred to common: the holding period of the preferred carries over.
- Gifts and inheritance: the recipient generally takes the transferor's holding period and status.
- Contribution to a partnership: generally ends QSBS status for that stock.
Planning points
- Incorporate as a C corporation from the start if QSBS matters; avoid an LLC phase.
- Issue founder stock early, at low value, with 83(b) elections.
- Avoid redemptions of founder or investor stock near financings without tax review.
- Watch the gross assets test in large rounds: a round that takes assets above $75M can mean that stock issued in or after that round does not qualify, while earlier stock remains QSBS.
- Manage working capital: after the company's second anniversary, no more than 50% of assets may count as active business assets through working capital rules.
- Section 1045 rollover: QSBS held more than 6 months can be sold and the gain deferred by reinvesting in other QSBS within 60 days.
- Multiplying the cap: gifts to non-grantor trusts or family members can create separate caps; this is technical and should be planned before a sale is in view.
- Document qualification: ask the company for a QSBS representation or statement at each financing and keep it with your records. Many Series A closings now include a QSBS questionnaire.
State taxes
Several states do not follow the federal QSBS exclusion, most notably California, which taxes the full gain for its residents. A founder planning a move or an exit should consider state residency rules well in advance. Non-US holders should check their home-country rules: a gain excluded in the United States may be fully taxable where the holder resides.
Frequently asked questions
What changed for QSBS in July 2025?
For stock acquired after July 4, 2025, the One Big Beautiful Bill Act allowed a 50% exclusion after 3 years and 75% after 4 years (100% after 5), raised the per-issuer cap to $15M and the gross assets limit to $75M, both indexed for inflation after 2026.
Does my stock issued before July 2025 get the new rules?
No. Stock acquired on or before July 4, 2025 keeps the prior rules: a $10M cap, a $50M asset test and an exclusion only after more than 5 years.
Do SAFEs qualify for QSBS?
The stock received on conversion can qualify. When the holding period starts (at SAFE funding or at conversion) is not settled; take the conservative view unless you have advice that supports an earlier date.
Do stock options qualify for QSBS?
The shares acquired on exercise can qualify, with the holding period starting at exercise. The options themselves are not QSBS.
Is a Delaware C-Corp owned by non-US founders eligible?
The company can issue QSBS if it meets the requirements, regardless of who owns it. Whether the exclusion is useful depends on the holder being subject to US tax on the gain, which non-resident aliens often are not; their home country may tax the gain instead.
Does QSBS apply to state income tax?
It depends on the state. Many follow the federal exclusion, but some do not, including California.