Guide
Qualified Small Business Stock (QSBS)
Section 1202 of the tax code lets qualifying shareholders exclude a large share of the gain on the sale of qualified small business stock. It is one of the most valuable provisions available to a business owner, and one of the most commonly missed, because the qualifying conditions have to be satisfied years before anyone thinks about selling. If you are already in a letter of intent, this page tells you whether you got lucky. If you are years out, it tells you what to set up now.
What Section 1202 does
It excludes gain on the sale of qualified small business stock from federal capital gains tax, subject to a per-issuer cap and a minimum holding period. Where it applies, the effect is not a deferral or a reduced rate. It is exclusion.
It is a shareholder-level benefit tied to specific shares, not a company-level election. Two shareholders in the same company can have entirely different outcomes depending on when and how each acquired their stock.
The tests the stock has to pass
The issuer must be a domestic C corporation, both when the stock is issued and substantially throughout your holding period. This is the test that disqualifies most small businesses before any other test is reached.
You must have acquired the stock at original issuance, directly from the company, in exchange for money, property or services. Stock bought from another shareholder generally does not qualify.
The corporation's gross assets must have been under the statutory ceiling at the time of issuance.
The corporation must run an active qualified trade or business. A long list of activities is excluded, and it hits exactly the industries small business owners are often in: health, law, accounting, consulting, financial services, brokerage, athletics, performing arts, banking, insurance, farming, hospitality, and any business whose principal asset is the reputation or skill of its employees.
You must hold the stock for the required period before selling.
Why most Main Street businesses do not qualify
The overwhelming majority of small businesses are S corporations, LLCs or sole proprietorships. None of those issue qualified small business stock. The C corporation requirement alone removes most of the market before the conversation starts.
Of the businesses that are C corporations, many are in an excluded service field. A consulting firm, a medical practice, an insurance agency and an accounting firm are all specifically outside the provision no matter how well they perform.
This is why Section 1202 shows up constantly in technology and manufacturing exits and almost never in Main Street ones. It is not that Main Street owners are missing a filing. The structure has to have been chosen years earlier, usually for other reasons.
What changed for stock issued after July 2025
Federal legislation enacted in July 2025 expanded the provision for newly issued stock: a tiered exclusion that begins before the traditional five-year mark, a higher per-issuer cap, and a higher gross asset ceiling at issuance.
Stock issued before that date continues to be governed by the prior rules, including the five-year holding period. That split matters, because it means two blocks of stock in the same company can be subject to different regimes.
**The specific thresholds are exactly the sort of figure that moves, and getting one wrong is expensive.** Treat this page as the mechanism and have your CPA confirm the current numbers against your actual issuance dates before you rely on any of it.
What to do with this if you are selling
Raise it before the letter of intent, not after. Structure decisions made at the LOI stage can preserve or destroy a Section 1202 position, and by closing it is usually too late to fix.
If your stock qualifies, the difference between a stock sale and an asset sale becomes far larger than the usual analysis suggests, because an asset sale by the corporation does not deliver the shareholder-level exclusion in the same way.
If you are years from selling and are considering a C corporation for other reasons, this is a genuine factor in that decision. If you are already an S corporation or an LLC, converting purely to chase Section 1202 is a complicated question with its own costs and holding period consequences, and it is a CPA conversation rather than a decision to make from an article.
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