QSBS Qualification Requirements: Does Your Stock Qualify Under Section 1202?

What's at stake

Section 1202 of the Internal Revenue Code allows an eligible shareholder to exclude the gain from selling Qualified Small Business Stock (QSBS) from federal income tax — up to the greater of $10 million or 10 times adjusted basis per issuer for stock issued on or before July 4, 2025, or up to $15 million per issuer for stock issued after that date under the One Big Beautiful Bill Act (OBBBA).¹

At the 37% ordinary income rate (or 23.8% combined long-term capital gains + NIIT rate), a $10 million exclusion is worth $2.38–$3.7 million in federal tax. For founders with $25–50 million in gain, the difference between qualifying and not qualifying can exceed $5 million in a single transaction. The qualification analysis is not a formality.

The eight requirements below apply under current law as of June 2026. The OBBBA changed several thresholds and introduced a tiered holding period for stock issued after July 4, 2025 — those changes are noted where relevant.

The eight tests at a glance

Test 1: Domestic C corporation

The issuing company must be a domestic C corporation — organized under U.S. law and subject to corporate income tax. S corporations, partnerships, LLCs taxed as partnerships, and foreign corporations do not qualify as the issuing entity.²

Several structuring nuances matter in practice:

• LLC that elected C corporation status: If the LLC filed Form 8832 to be taxed as a C corporation and then issued shares, those shares can qualify — the tax classification is what matters, not the legal entity label.
• S corporation converted to C corporation: Shares issued before the conversion were issued by an S corporation and do not qualify. Shares issued after the conversion may qualify if all other tests are met, with the holding period clock starting at the post-conversion issuance date.
• C corporation that later elected S status: The active business test requires the company to be a C corporation during substantially all of the holding period. A company that converts to S status after issuance creates a question about whether the shares continue to qualify. This is an area where qualified tax counsel is essential.

Test 2: Issuance date

The stock must be originally issued after August 10, 1993 — the date Section 1202 was enacted. In practice, this requirement eliminates any pre-1993 stock but is otherwise satisfied by every startup that has been incorporated in the past three decades.

Test 3: Gross assets threshold

At the time of stock issuance and immediately after, the aggregate gross assets of the corporation must not exceed the applicable threshold.¹²

Several mechanics of this test are counterintuitive:

• Tax basis, not fair market value. Gross assets means the aggregate adjusted basis of all assets for income tax purposes — not the fair market value implied by the company's valuation. A company with a $200M post-money valuation may still have gross assets well under $75M if most of the value is in intangibles, people, and future cash flows rather than balance sheet assets.
• Includes the proceeds of the issuance itself. Cash received in the financing round that triggers the issuance is included in the gross assets calculation immediately after issuance. A round that pushes the balance sheet over the threshold means shares issued in that round may not qualify.
• The test is at issuance only. If the company's gross assets later grow above the threshold, shares already issued retain their QSBS status. The test is not ongoing — only the assets at and immediately after issuance matter for the qualifying test.
• Aggregate across subsidiaries. If the company owns subsidiaries, their assets are included in the consolidated gross asset count.

Test 4 & 5: Active business in a qualified trade or business

During "substantially all" of the taxpayer's 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.²

What counts as a qualified trade or business

Under IRC §1202(e)(3), almost any active business qualifies — except businesses explicitly excluded by the statute. Technology, software, manufacturing, retail, consumer products, clean energy, biotech, and most other operating businesses are qualified. The statute defines what is excluded, not what is included. If a business is not on the exclusion list, it is presumptively qualified.

Businesses excluded from qualified trade or business status

The following fields do not qualify under §1202(e)(3):

• Health
• Law
• Engineering
• Architecture
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services
• Brokerage services
• Banking and insurance
• Financing and leasing
• Investing
• Farming
• Oil and gas extraction
• Hotels, motels, restaurants
• Any business where the principal asset is the reputation or skill of one or more employees

The 80% test and pre-revenue startups

Pre-revenue companies typically hold cash and investments as their primary asset. The IRS has provided that cash raised to fund qualified business operations generally satisfies the 80% active business test if the company is actively deploying those funds in its qualified business — a startup that just raised a Series A and is building a software product is not disqualified simply because it is still holding most of the raise as cash. However, the active business test is evaluated throughout the holding period. If the company shifts materially into excluded activities after the shares are issued, the test can fail.

Test 6: Original issuance

QSBS must be acquired at original issuance directly from the corporation — meaning the corporation is the seller and the taxpayer is the original purchaser.² The stock must be received in exchange for:

• Cash
• Property other than stock
• Services rendered to the corporation

Stock purchased from an existing shareholder in a secondary transaction — on a platform like Forge, Carta, or in a private tender — does not satisfy this requirement. The buyer in a secondary transaction holds shares, but those shares are not QSBS in the buyer's hands. The seller may still have QSBS treatment if they acquired at original issuance, but the secondary buyer does not inherit QSBS status.

Test 7: Eligible shareholder

C corporations cannot use the Section 1202 exclusion. Individuals, trusts, estates, partnerships, and S corporations that hold QSBS can pass the exclusion benefit through to their non-corporate owners.²

The per-issuer exclusion cap applies per taxpayer. Spouses are each entitled to their own cap if they hold shares separately. This is the mechanism behind the gifting and stacking strategies — transferring shares to family members, trusts, or other eligible holders before a liquidity event effectively multiplies the available exclusion. See the gifting and stacking guide for the rules and limits on this planning.

Test 8: Holding period

The taxpayer must hold the stock for the required minimum period to claim any exclusion. The required period — and the exclusion percentage available — depends on when the stock was issued.¹

The holding period clock starts at original issuance — the date the shares were issued by the corporation — not at the date of any vesting schedule, not at the grant of an option, and not at the signing of a SAFE. A Section 83(b) election filed within 30 days of receiving unvested restricted stock starts the clock at issuance even before shares vest. Without an 83(b) election, the clock starts as each tranche vests, fragmenting the holding period. For the full analysis of when the clock starts in different scenarios, see the holding period guide.

Exclusion cap: per taxpayer, per issuer

The exclusion is not a portfolio limit — it is a per-issuer limit applied separately to each company and each taxpayer. A founder with stock in two qualifying companies has a separate $10M/$15M cap for each. A couple with QSBS in the same company held in separate name has a separate cap for each spouse.²

Common disqualifiers founders discover too late

What a specialist advisor does with this analysis

The qualification analysis for QSBS is not something that can be done in a conversation — it requires reviewing the stock purchase agreement, cap table, company articles of incorporation, funding history, and business operations. Founders often discover mid-planning that part of their position qualifies (early rounds, under the gross assets threshold) while another part does not (later rounds, issued after the company crossed $50M in tax-basis assets).

A fee-only advisor who works with startup liquidity events typically engages a qualified tax attorney to review the company-side documents and issues a preliminary QSBS memo before any transaction closes. The financial advisor's role is to model the planning — gifting, charitable, estate, and post-exit allocation — assuming the qualification analysis produces a known exclusion amount. The two professionals work together. The advisor cannot replace the attorney; the attorney cannot replace the advisor.

The optimal time to engage is before a term sheet is signed, not after the deal closes. Once the transaction structure is binding, most pre-transaction QSBS planning options are no longer available.

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Sources

1. Grant Thornton — Explaining enhanced Section 1202 benefits under the OBBBA (2025)
2. Cornell Law — 26 U.S. Code § 1202: Partial exclusion for gain from certain small business stock
3. Keystone Global Partners — QSBS Gross Assets Test ($50M → $75M): Section 1202 Qualification Guide
4. The Tax Adviser — QSBS gets a makeover: What tax pros need to know about Sec. 1202's new look (Nov. 2025)
5. Bernstein — Qualifying for the QSBS Exclusion (2026)

Section 1202 qualification requirements and OBBBA provisions verified June 2026. Tax law changes frequently; confirm with a qualified tax professional before relying on this information for planning decisions.