Editorial · July 4, 2025
Qualified Small Business Stock: How Section 1202 Works
Qualified small business stock, often called QSBS, is stock that can let you pay no federal tax on part or all of your gain when you sell it. The rule is in section 1202 of the Internal Revenue Code. It was written to help people who back young companies, and a new law signed today, July 4, 2025, changes it for stock bought from now on.
What qualified small business stock is
Qualified small business stock is shares in a U.S. C corporation. You must get the shares when the company first issues them, in exchange for money, property, or work done for the company. Buying shares from another investor does not count.
The company must also be small. Its gross assets, meaning cash plus the tax basis of its other property, may not top $50 million before or right after it issues the stock. That cap is $75 million for stock issued after today's law.
The rule applies to stock first issued after August 10, 1993. Gain on the sale is excluded from the income of people and trusts, not from corporations. Partnerships and S corporations can pass the benefit to their owners.
Sources: Internal Revenue Code section 1202, as published by the Legal Information Institute at Cornell Law School (law.cornell.edu/uscode/text/26/1202); Public Law 119-21, section 70431, GovInfo.
The business must be an active one
At least 80 percent of the company's assets must be used in running a qualifying business for nearly all of the time you hold the stock. The company also may not hold more than 10 percent of its assets in stock of other firms or in real estate that it does not use in the business.
Some kinds of business are left out. These include health care, law, engineering, architecture, accounting, consulting, and financial services. Banking, insurance, farming, mining, hotels, and restaurants are also out. A business whose main asset is the skill or name of its staff does not qualify either.
Sources: Internal Revenue Code section 1202(c) to (e), Cornell Law School Legal Information Institute.
How the holding period and exclusion work
For stock bought on or before July 4, 2025, you must hold it for more than five years. The size of the exclusion depends on when you bought. Stock acquired from September 28, 2010 up to and including July 4, 2025 gets a 100 percent exclusion. Stock bought before that date gets 50 percent, with some special rates for stock bought in 2009 and 2010.
The exclusion is capped for each company whose stock you sell. The cap is the greater of two numbers: $10 million of gain, or ten times what you paid for the stock. Most small investors never reach it. A founder with a large gain might.
Holding the shares through a gift or at death can carry the holding period over to the next owner. Selling short against the stock can block the benefit, so check before you hedge.
Sources: Internal Revenue Code section 1202(a), (b) and (h), Cornell Law School Legal Information Institute.
What the July 4, 2025 law changed
Public Law 119-21, signed today, adds a step-up for stock acquired after the date of enactment. You no longer have to wait five years to get any benefit. The new schedule is:
- Held 3 years: 50 percent of the gain is excluded.
- Held 4 years: 75 percent of the gain is excluded.
- Held 5 years or more: 100 percent of the gain is excluded.
Two other limits move up. The per-company dollar cap rises from $10 million to $15 million for new stock. The company asset limit rises from $50 million to $75 million. The ten-times-basis option stays. Both new dollar figures are set to be adjusted for inflation in later years.
Stock bought on or before today stays under the old rules. That means the five-year wait, the $10 million cap, and the $50 million asset test still apply to it.
Sources: Public Law 119-21, section 70431, "Expansion of Qualified Small Business Stock Gain Exclusion," signed July 4, 2025 (govinfo.gov/content/pkg/PLAW-119publ21).
What to check before you rely on it
The benefit is not automatic. A few simple checks help.
- Confirm the company is a U.S. C corporation, not an LLC taxed as a partnership.
- Confirm you bought newly issued shares, and keep the purchase records.
- Ask the company in writing whether it meets the asset and active business tests at issue.
- Write down the date you acquired the shares, because the date decides which rules apply.
Rules for converting an LLC into a corporation, for stock swaps, and for state tax can be tricky. Some states do not follow the federal exclusion. This article is general information, not tax advice, so talk to a licensed tax professional about your own facts.
Sources: Internal Revenue Code section 1202(c), (d) and (h), Cornell Law School Legal Information Institute.