QSBS in 2026: How the Section 1202 Exclusion Works Now

I get QSBS questions from founders, early employees and people who wrote a check to a friend’s startup years ago. The rule is generous but full of conditions, and the 2025 tax law left two sets of rules running side by side. This guide covers both.

If you want to run your own numbers while you read, my QSBS exclusion calculator applies the tiered percentages, the per-company cap and the 10x basis rule for you.

What QSBS is and why it matters

Section 1202 of the Internal Revenue Code lets a non-corporate shareholder (an individual, a trust, or a partnership or S corporation passing gain through to individuals) leave some or all of the gain from selling qualifying stock out of taxable income. “Excluded” means the gain never shows up as income on your federal return. It is not deferred. It is gone.

Congress created the rule in 1993 to steer money toward small businesses. For years the exclusion was only 50%, and the taxable half was hit at a 28% rate, which made the benefit modest. In 2010 Congress raised it to 100% for stock acquired after September 27, 2010, and that is when QSBS became one of the most valuable provisions in the tax code for founders and early investors.

The scale is real. A married founder in the top bracket who sells for a $15 million gain would normally owe 20% capital gains tax plus the 3.8% net investment income tax (NIIT), or about $3.57 million in federal tax. If the whole gain qualifies for a 100% exclusion, the federal bill on that gain can be zero.

The requirements: what makes stock “qualified”

Every one of these has to be true. Missing one usually means no exclusion at all.

1. The company is a domestic C corporation

The issuer must be a U.S. C corporation when the stock is issued and during substantially all of the time you hold it. S corporation stock and LLC or partnership interests are not QSBS. (Converting to a C corporation can start the clock, which I cover below.)

2. You got the stock at original issuance

You must acquire the stock directly from the company, in exchange for money, property (other than stock) or services. Shares bought from another shareholder on a secondary market do not qualify. Stock received as pay for services counts, which is why founders and employees can hold QSBS. There are exceptions for stock received by gift, at death or in certain tax-free reorganizations, which carry the original holder’s status with them.

Section 1202 also has anti-abuse rules that can disqualify stock if the company redeems (buys back) significant amounts of stock from you or other shareholders around the time your shares are issued. Your CPA or attorney should review any buybacks before and after an issuance.

3. The gross assets test

The company’s aggregate gross assets cannot exceed the limit at any time before the issuance and immediately after it. Gross assets generally means cash plus the adjusted tax basis of other property (not its market value).

• Stock issued after July 4, 2025: $75 million.
• Stock issued on or before July 4, 2025: $50 million.

The $75 million figure is indexed for inflation for taxable years beginning after 2026, rounded to the nearest $10,000. For 2026 it is $75 million. Once a company passes the limit, stock it issues after that point is not QSBS, but shares issued earlier keep their status.

4. The active business requirement and excluded fields

During substantially all of your holding period, at least 80% of the company’s assets (by value) must be used in the active conduct of a “qualified trade or business.” Many businesses are excluded by name:

• Services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage services
• Any business where the principal asset is the reputation or skill of one or more employees
• Banking, insurance, financing, leasing, investing or similar businesses
• Farming
• Oil, gas and mining businesses that claim depletion deductions
• Hotels, motels, restaurants and similar businesses

Software, manufacturing, consumer products, biotech research and many technology companies usually fit. Medical practices, law firms, consulting shops and investment firms usually do not. The “reputation or skill” clause is the gray area, and it is worth a written opinion from a tax attorney if your company is close to the line.

5. The holding period

• Stock issued after July 4, 2025: at least 3 years for a partial exclusion, 5 years for the full exclusion.
• Stock issued on or before July 4, 2025: more than 5 years, with no partial exclusion for a shorter hold.

Your holding period generally starts when you acquire the stock. For stock options, that is the exercise date, not the grant date. For restricted stock, it is usually the vesting date unless you filed a timely Section 83(b) election, which starts the clock at grant. If you receive the stock as a gift or inheritance, you take over the prior owner’s holding period.

Where people lose it

In my experience the exclusion is lost more often through paperwork and deal structure than through the big rules. Ask the company for a written QSBS representation (gross assets at issuance, active business, no disqualifying buybacks) and keep it with your purchase documents. Remember that Section 1202 applies to selling stock, so an asset sale may not deliver the benefit. And watch for a company drifting into an excluded field or piling up idle investment assets.

What the One Big Beautiful Bill Act changed

The One Big Beautiful Bill Act, signed July 4, 2025, rewrote Section 1202 for stock acquired after that date. Older stock keeps the old rules. Here is the side-by-side.

A few details matter here:

The tiers are a big deal for exits that come early. Under the old rules, a sale in year 4 got nothing. Under the new rules, it gets 75% of the capped gain excluded.

The part of the gain that is not excluded is taxed at up to 28%, not 20%. The tax code treats the non-excluded share of gain that was eligible for Section 1202 as “section 1202 gain,” which falls in the same 28% bucket as collectibles. So at the 50% tier, half the capped gain is excluded and the other half is taxed at up to 28% plus 3.8% NIIT. Gain above the cap is ordinary long-term capital gain at 0%, 15% or 20%, plus NIIT if it applies.

The dates are about when you acquired the stock. The tiered exclusion and $15 million cap apply to stock acquired after July 4, 2025. The $75 million gross assets test applies to stock issued after that date. If you own both old and new shares in the same company, the $15 million cap for the new shares is reduced by gain you already excluded on that company’s stock, so you do not get $10 million plus $15 million.

The per-company cap: $15 million or 10x basis, and AMT

The exclusion is limited per issuer, per taxpayer. For each company, the gain you can take into account in a year is the greater of:

1. The dollar cap: $15 million for stock acquired after July 4, 2025 ($10 million for older stock), reduced by gain you already took into account on that company’s stock in earlier years, or
2. 10 times your adjusted basis in the shares of that company you sold during the year.

For most founders who started with a few thousand dollars, the dollar cap is the one that applies. The 10x rule helps investors who put in real money. Someone who invested $2 million in a seed round may be able to exclude up to $20 million of gain on that stock, because 10 times $2 million is larger than $15 million.

The $15 million cap is indexed for inflation for taxable years beginning after 2026, rounded to the nearest $10,000. For 2026 sales it is a flat $15 million. Married people filing separately get half the dollar cap ($5 million for old stock, $7.5 million for new stock). On a joint return, the gain counted against the cap is split equally between spouses for later years.

AMT treatment

For stock acquired after September 27, 2010, including all stock under the new tiered rules, the excluded gain is not an alternative minimum tax (AMT) preference item. The 7% AMT add-back in Section 57(a)(7) now applies only to stock acquired on or before September 27, 2010. If you still hold stock from that era, the old 50% or 75% exclusion and the AMT add-back apply, and you should model the sale carefully with your CPA.

A large capital gain can still change your overall AMT picture, because it can reduce the AMT exemption through its phaseout, but the excluded QSBS gain itself is not added back.

State taxes: Pennsylvania does not follow Section 1202

Section 1202 is a federal rule. Each state decides whether to follow it.

Pennsylvania does not provide a QSBS exclusion. Pennsylvania personal income tax has no special treatment for capital gains, taxes gains from the sale of property under its own rules and does not mention Section 1202 among the federal provisions it adopts. A Pennsylvania resident who sells QSBS should expect to pay the flat 3.07% Pennsylvania personal income tax on the full gain, even if the federal gain is entirely excluded.

California also does not allow the exclusion, so residents pay California tax at ordinary income rates on the full gain. A handful of other states, including Alabama and Mississippi, are reported not to conform either. Many other states follow the federal exclusion, but some have not yet adopted the 2025 changes. Where you live on the day of sale is usually what matters, so a planned move should be discussed with your CPA well before a deal closes.

Stacking the cap with gifts to family and trusts

Because the cap applies per taxpayer, per company, a founder whose company is likely to be worth far more than $15 million can sometimes multiply the exclusion by giving shares away before a sale. Section 1202 says a person who receives QSBS by gift or at death steps into the giver’s shoes: the stock stays qualified, and the recipient inherits the original acquisition date and holding period.

How it can work:

• Gifts to children or other family members. Each recipient has their own $15 million (or 10x basis) cap for that company.
• Gifts to non-grantor trusts. A properly drafted non-grantor trust is a separate taxpayer with its own cap. A grantor trust is not, because its income is taxed to you, so it shares your cap.

Some cautions:

• Gifts use your lifetime gift and estate tax exemption once they exceed the annual exclusion of $19,000 per recipient in 2026. The lifetime exemption is $15 million per person for 2026. For early-stage stock with a low valuation, gifting can use very little exemption relative to the eventual sale price, which is part of the appeal. My article on the 2026 estate exemption explains how the exemption works now.
• Only gifts and transfers at death carry QSBS status. Selling shares to a family member, even at a discount, does not.
• The IRS can attack arrangements that look designed only to multiply caps, such as many near-identical trusts for the same beneficiaries. Section 1202 directs Treasury to write anti-abuse rules. Trust planning here needs an estate attorney who has done it before.
• Recipients get your low basis, so the 10x basis cap does not help them much. The $15 million dollar cap is usually the one doing the work.

Section 1045 rollovers: keeping the benefit if you sell early

Sometimes a sale happens before you reach the holding period. Section 1045 can let you defer the gain if:

• You held the QSBS for more than 6 months,
• You are not a corporation, and
• You buy other QSBS within 60 days of the sale and elect Section 1045 on your return.

You recognize gain only to the extent your sale proceeds exceed what you reinvest. The deferred gain reduces your basis in the new stock, and your holding period in the old stock carries over to the new stock for Section 1202 purposes. So a founder who sells after 2 years and rolls into another qualifying company may be able to reach the 3, 4 or 5 year mark later on the new shares.

Sixty days is very short to find, vet and close on a qualifying investment. If a sale might happen before your holding period, start that conversation early.

Converting an S corporation or LLC

Many businesses start as LLCs or S corporations, and owners ask whether converting to a C corporation creates QSBS. It can, but only going forward.

LLC taxed as a partnership. When an LLC converts to, or contributes its business to, a C corporation, the stock received is issued for property, so it can be QSBS if every other test is met at that moment (including the gross assets test, measured using the value of the contributed property). Two special rules apply:

• Your basis in the stock, for Section 1202 purposes, is the fair market value of what you contributed on the conversion date. Gain that built up before conversion is not excluded. Only growth after conversion can be.
• The holding period starts at conversion. That higher basis can also boost the 10x cap: an LLC worth $4 million at conversion gives you up to a $40 million cap based on 10x basis.

S corporation. Shares issued while the company was an S corporation are not QSBS, and revoking the S election does not fix them. The common route is for the S corporation to contribute its business to a new C corporation subsidiary, which issues fresh stock that may qualify, with the S corporation as the shareholder passing gain through to its owners. This involves reorganization rules, built-in gain issues and the pass-through holding requirements of Section 1202(g). It is a project for your CPA and attorney, and the right answer depends on whether you expect a sale within 5 years and whether the business is in a qualified field.

Converting also has a cost: a C corporation pays 21% federal corporate tax on profits, and dividends are taxed again to you. Whether QSBS outweighs that depends on how big and how soon the exit is. My business advisory work often starts with that exact comparison.

Worked example: a founder’s sale under the new and old rules

Let me put real 2026 rules to a single deal.

The facts: Dana and her spouse file jointly and live in Pennsylvania. Dana put $500,000 of cash into a new software C corporation for founder shares. The company always had gross assets well under the limit. A buyer pays $30 million for her shares, so her gain is $29.5 million. She is in the top federal bracket, so ordinary long-term gain is taxed at 20% plus 3.8% NIIT (23.8%), and the non-excluded section 1202 gain at 28% plus 3.8% (31.8%).

Her cap: the greater of the dollar cap or 10 x $500,000 = $5 million. The dollar cap wins. For simplicity I use $15 million for the new rules; for sales in 2027 or later the indexed figure will be a little higher.

Scenario A: shares issued after July 4, 2025 (new rules)

Scenario B: shares issued in 2018 (old rules), sold in 2026

Without QSBS at all

$29.5 million at 23.8% = $7,021,000 of federal tax.

What the numbers show

• Under the new rules, waiting from year 3 to year 5 saves Dana about $2.4 million of federal tax. Each tier is worth roughly $1.2 million on a deal this size.
• A 4-year exit under the new rules saves about $2.4 million compared with the same 4-year exit under the old rules, which offered nothing before 5 years.
• At 5 years, the new rules save $1.19 million more than the old rules, because the cap is $15 million instead of $10 million ($5 million x 23.8%).
• Pennsylvania taxes the whole $29.5 million in every scenario: 3.07% is about $905,650.
• If Dana had given shares to a non-grantor trust for her children years before the sale, the trust’s own cap could have sheltered most or all of the $14.5 million that was taxed above her cap, subject to the cautions above.

The real tax on a sale also depends on how the deal is structured, earnouts, installment payments and state rules. My article on the real tax rate on a business sale covers those pieces, and the business sale proceeds calculator estimates what you keep after taxes and fees.

How Modern Wealth can help

I help founders, early employees and investors decide what to do before a liquidity event: whether shares are likely to qualify, how holding period timing affects the after-tax result, whether gifting to family or trusts makes sense, and how the proceeds fit a long-term plan. I work alongside your CPA and attorney, who confirm eligibility, prepare the returns and draft any trust documents. You can read more about my tax planning service.

Frequently asked questions

How long do you have to hold QSBS?

For stock acquired after July 4, 2025, at least 3 years for a 50% exclusion, 4 years for 75% and 5 years for 100%. For stock acquired between September 28, 2010 and July 4, 2025, you need to hold it more than 5 years for the 100% exclusion, and there is no partial exclusion before that.

What is the QSBS limit in 2026?

The per-company cap is the greater of $15 million (for stock acquired after July 4, 2025) or 10 times your basis in the shares sold. For older stock, the dollar cap is $10 million. The $15 million cap begins indexing for inflation for taxable years beginning after 2026.

Does QSBS apply to LLCs or S corporations?

No. Only C corporation stock qualifies. An LLC or S corporation can convert or restructure into a C corporation, and stock issued at that point may qualify, but only gain that builds up after the conversion can be excluded.

Is QSBS gain subject to AMT or the 3.8% net investment income tax?

For stock acquired after September 27, 2010, excluded gain is not an AMT preference item. Excluded gain is also not subject to NIIT because it is not included in income. Gain that is not excluded, including gain above the cap and the taxable part of a 50% or 75% exclusion, can be subject to NIIT.

Do states tax QSBS gains?

Some do. Pennsylvania does not follow Section 1202 and taxes the full gain at its 3.07% personal income tax rate. California also does not allow the exclusion. Other states follow the federal rule, so check with your CPA based on where you will live when you sell.

What happens if I sell QSBS before the holding period?

You may be able to defer the gain under Section 1045 if you held the stock more than 6 months and reinvest the proceeds in other QSBS within 60 days. Otherwise, the gain is taxed as a normal capital gain.

This article is for general education and is not tax, legal or investment advice for your situation. Talk with your tax and legal advisors before acting.

Sources

• 26 U.S. Code § 1202, Partial exclusion for gain from certain small business stock (as amended by Pub. L. 119-21): https://www.law.cornell.edu/uscode/text/26/1202
• 26 U.S. Code § 1045, Rollover of gain from qualified small business stock to another qualified small business stock: https://www.law.cornell.edu/uscode/text/26/1045
• 26 U.S. Code § 57(a)(7), AMT preference for small business stock (as amended by Pub. L. 119-21): https://www.law.cornell.edu/uscode/text/26/57
• 26 U.S. Code § 1(h)(4) and (h)(7), 28-percent rate gain and section 1202 gain: https://www.law.cornell.edu/uscode/text/26/1
• Public Law 119-21 (One Big Beautiful Bill Act), section 70431: https://www.congress.gov/bill/119th-congress/house-bill/1
• IRS, “IRS releases tax inflation adjustments for tax year 2026, including amendments from the One, Big, Beautiful Bill” (annual gift exclusion and basic exclusion amount): https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2026-including-amendments-from-the-one-big-beautiful-bill
• Pennsylvania Department of Revenue, PA Personal Income Tax Guide, Net Gains (Losses) from the Sale, Exchange, or Disposition of Property: https://www.pa.gov/agencies/revenue/forms-and-publications/pa-personal-income-tax-guide/net-gains-losses-from-the-sale,-exchange,-or-disposition-of-property.html
• Pennsylvania Department of Revenue, Tax Cuts and Jobs Act and One Big Beautiful Bill Act conformity: https://www.pa.gov/agencies/revenue/resources/tax-law-policies-bulletins-notices/tax-cuts-and-jobs-one-big-beautiful-bill-acts

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