QSBS (Section 1202)
US federal tax exclusion on gain from qualified small business stock held five years or more. Up to $10M or 10x basis per holder per corporation.
| Corporation type | US C-corporation only (LLCs and S-corps do not qualify) |
|---|---|
| Acquisition | Original issue by the holder, in exchange for money, property (not stock), or services |
| Holding period | 5 years from acquisition |
| Asset cap | Gross assets ≤ $50M at issuance and immediately after |
| Industry | Active trade or business; certain service industries excluded |
The five eligibility requirements
To qualify for QSBS treatment, all five conditions must be met:
- The corporation is a US C-corporation. S-corps, LLCs (even those electing C-corp status), and foreign corporations do not qualify.
- The stock was acquired at original issue. The holder must have acquired the stock directly from the corporation, in exchange for money, property other than stock, or services. Secondary purchases generally do not qualify (with limited exceptions for stock acquired by gift, inheritance, or conversion).
- The corporation passes the gross-assets test. At the time of issuance and immediately after, the corporation's gross assets must not exceed $50 million.
- The corporation is engaged in a qualified active trade or business. Most operating businesses qualify; specifically excluded are professional services (law, accounting, consulting), financial services, farming, hospitality, and oil and gas production.
- The holder holds the stock for at least 5 years. The holding period clock starts on the date of original issue.
The exclusion math
If all conditions are met, the holder can exclude gain from federal tax up to the greater of $10 million per corporation or 10× the holder's basis in the QSBS sold. The exclusion applies per holder per corporation, so a founder with multiple QSBS positions in different corporations can stack the exclusion across them. The exclusion also applies to gain rolled over under section 1045 to other QSBS, which can be useful for serial founders.
For founders with low basis (typical for restricted stock acquired at near-zero FMV at incorporation), the $10 million ceiling typically binds. For investors with substantial basis (e.g. a $5 million Series A investment), the 10× basis option can be more generous, capping out at $50 million of excluded gain.
What founders should track
QSBS eligibility depends on facts at multiple points in time. To preserve the exclusion, founders and counsel should track:
- Date and form of original issue, with documentation showing the issuance was from the corporation, not a secondary purchase
- Gross asset value at issuance and going forward (the $50M test is a one-time test at issuance, but corporations that grew through that test should still document the issuance-date number)
- Industry classification, especially if the corporation pivots into a category that could disqualify (e.g. a SaaS corporation that becomes a consulting business)
- Holding period, with stock-issue and sale dates clearly recorded
The Canadian equivalent of QSBS is the Lifetime Capital Gains Exemption (LCGE) under the Income Tax Act, with different eligibility and limits.
Octelligence flags issuances of stock from US C-corporations that meet the QSBS profile and prompts the corporation to document the issuance-date facts that QSBS treatment will depend on five years later. The minute book becomes the QSBS audit trail.
See Digital Corporate RecordsIssuance facts captured at the moment they happen, ready for the eventual sale.