The short answer: The qualified small business stock tax rules now work on a sliding scale instead of a single cliff. For stock issued after July 4, 2025, Section 1202 lets a non-corporate shareholder exclude 50 percent of the gain after a three-year hold, 75 percent after four years and 100 percent after five, capped at the greater of $15 million or 10 times basis per issuing company. Stock issued on or before July 4, 2025 keeps the old rule: five full years or nothing, with a $10 million cap. The catch is that whatever is not excluded is taxed at up to 28 percent, so a 50 percent exclusion cuts a federal bill by roughly a third, not by half.
For two decades, Section 1202 behaved like a trapdoor. Hold your founder stock five years and one day, and millions of dollars of gain left your return. Sell at four years and eleven months, and you excluded nothing.
That trapdoor is gone for newly issued stock. The One Big Beautiful Bill Act, Public Law 119-21, was signed on July 4, 2025, and Section 70431 rewrote three parts of Section 1202: the holding period, the dollar cap and the size test for the issuing company. It did not disturb the old rules for older shares, so both regimes now run side by side.
Across our tax work with US founders and CPA firms, Countsure finds the hard questions are rarely about the headline percentages. They are about which share lots fall into which regime, and what the exclusion is worth once the tax on the non-excluded slice is priced in.
Key takeaways
- The qualified small business stock tax rules now split into two regimes divided by a single date, July 4, 2025, the day the OBBBA was signed into law.
- Stock acquired after that date earns a tiered exclusion of 50 percent at three years, 75 percent at four years and 100 percent at five years or more under IRC Section 1202(a)(5).
- The per-issuer cap rose to the greater of $15 million or 10 times your adjusted basis, indexed for inflation for tax years beginning after 2026.
- The issuing company’s gross asset ceiling rose from $50 million to $75 million, tested both before and immediately after the shares are issued.
- Gain that is not excluded is taxed at a maximum 28 percent rate, plus the 3.8 percent net investment income tax where it applies.
- The 7 percent alternative minimum tax preference under Section 57(a)(7) now reaches only stock acquired on or before September 27, 2010, so the new partial tiers carry no AMT add-back.
- California, Pennsylvania, Alabama and Mississippi do not follow Section 1202, so a gain that is fully excluded federally can still be fully taxed by a state.
What Is Qualified Small Business Stock, and Why Do the New Tiers Matter?
Qualified small business stock, usually shortened to QSBS, is stock in a domestic C corporation that a non-corporate shareholder acquired directly from the company at original issue and that meets a specific set of tests in Internal Revenue Code Section 1202. When those tests are met, some or all of the capital gain on sale never enters gross income.
Two terms matter. Original issue means you bought the shares from the company itself, for cash, property or services; shares bought from another shareholder never qualify. Non-corporate taxpayer means individuals, trusts and estates, so a C corporation holding another C corporation’s stock cannot claim the exclusion.
The new tiers change the shape of the decision, not just its size. Under the old cliff, an offer arriving at month 50 forced a choice between a certain deal and a speculative benefit ten months away. Under the tiers, that founder already holds a partial exclusion and is deciding how much more to earn by waiting.
The qualification tests, and the one that moved
- C corporation test. The issuer must be a domestic C corporation at issuance and during substantially all of your holding period. An LLC or S corporation cannot issue QSBS, which sits in tension with the case for staying a pass-through. We argued that other side in our piece on why a pass-through can be worth more than an identical C corporation, and for most non-venture businesses it still holds.
- Original issue test. You acquired the stock from the company, not from another holder.
- Active business test. At least 80 percent of assets by value must be used in an active qualified trade or business. Section 1202(e)(3) rules out health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage, plus banking, insurance, leasing, farming, extraction, hotels and restaurants.
- Gross asset test. This is the one that moved. Aggregate gross assets, meaning cash plus the adjusted bases of other property, must stay under the ceiling at all times before the issuance and immediately after it. That ceiling is now $75 million for stock issued after July 4, 2025, up from $50 million.
Not sure which of your share classes actually qualify as QSBS?
Countsure’s business tax team reviews cap tables lot by lot, dates each issuance against the correct regime, and documents the gross asset position at every round so the file holds up years later at diligence. You get a written QSBS position paper covering each share class, typically within two to three weeks of receiving your cap table and financials.
How Do the 50, 75 and 100 Percent Exclusion Tiers Actually Work?
The tiers sit in a short table inside the statute itself, at Section 1202(a)(5), keyed to how long you have held the stock. They apply only to stock acquired after July 4, 2025, which the statute calls the applicable date.
| Years held | Exclusion percentage |
|---|---|
| 3 years | 50 percent |
| 4 years | 75 percent |
| 5 years or more | 100 percent |
Note the drafting. The new rule reads “held for at least 3 years” and the top tier reads “5 years or more,” while the old rule required “more than 5 years.” Date-stamp the issuance rather than relying on a memory of when a round closed.
The tiers are also not a phase-in. There is no 62 percent exclusion at three and a half years. The percentage steps up on the anniversary and stays flat until the next one.
Why 50 percent excluded does not mean half the tax
Here is where most summaries quietly mislead readers. The portion of QSBS gain that is not excluded does not get the ordinary long-term rate. It is taxed as Section 1202 gain at a maximum of 28 percent, above the 20 percent top long-term rate, and the 3.8 percent net investment income tax applies on top.
A top-bracket seller of ordinary stock pays 23.8 percent. Against that baseline:
| Holding period | Excluded | Rate on included gain | Effective federal rate on the whole gain |
|---|---|---|---|
| No QSBS status | 0 percent | 23.8 percent | 23.8 percent |
| 3 years | 50 percent | 31.8 percent | 15.9 percent |
| 4 years | 75 percent | 31.8 percent | 7.95 percent |
| 5 years or more | 100 percent | Not applicable | 0 percent |
So, the three-year tier does not halve the tax bill. It cuts it from 23.8 percent to 15.9 percent, a reduction of about a third. That is not what “50 percent exclusion” sounds like.
The gaps between tiers also tell you what patience is worth. Moving from year three to year five removes 15.9 points of federal tax on every dollar inside the cap, roughly $2.4 million on a $15 million eligible gain.
What Changed on July 4, 2025, and What Did Not
Only stock acquired after the applicable date gets the new treatment. Everything issued on or before July 4, 2025 continues under the rules in force when it was issued, which for most startups means 100 percent exclusion after more than five years.
| Feature | Acquired on or before July 4, 2025 | Acquired after July 4, 2025 |
|---|---|---|
| Minimum hold for any exclusion | More than 5 years | 3 years |
| Exclusion at 3 years | Zero | 50 percent |
| Exclusion at 4 years | Zero | 75 percent |
| Exclusion at 5 years or more | 100 percent | 100 percent |
| Per-issuer dollar cap | $10 million | $15 million |
| Cap if married filing separately | $5 million | $7.5 million |
| Alternative to the dollar cap | 10 times adjusted basis | 10 times adjusted basis |
| Issuer gross asset ceiling | $50 million | $75 million |
| Inflation indexing | None | Both dollar figures, after 2026 |
| 7 percent AMT preference | Only if acquired on or before September 27, 2010 | None |
One wrinkle matters for controllers. The cap increase applies to tax years beginning after July 4, 2025, while the higher $75 million asset ceiling applies to stock issued after that date. The triggers are worded differently, but both point to the same conclusion: issuance date governs.
How Much Gain Can You Actually Exclude Under the $15 Million Cap?
Section 1202(b) caps the gain you can take into account for one issuing corporation at the greater of two figures: the applicable dollar limit, now $15 million for post-OBBBA stock, or 10 times the aggregate adjusted basis of that company’s shares you sold during the year.
Which side controls depends on what you paid. A founder with nominal basis is always on the dollar side. An investor who wrote a real check is often on the basis side: put $2 million into a Series A and 10 times basis is $20 million, comfortably above the $15 million figure.
Cap first, percentage second
The order of operations trips up experienced people. The cap limits how much eligible gain can be taken into account under Section 1202(a). The applicable percentage then applies to that capped amount, not to the total gain. Gain above the cap never enters the calculation and is taxed as ordinary long-term capital gain at up to 23.8 percent.
Reverse the steps and you will overstate the exclusion badly. A $30 million gain at the five-year tier does not produce a $30 million exclusion. It produces a $15 million exclusion and $15 million of fully taxable gain.
Married filing separately, and what the inflation index does
A married taxpayer filing separately gets half the dollar cap, so $7.5 million rather than $15 million. On a joint return, gain taken into account is split equally between spouses when the cap is applied in later years.
The $15 million figure is indexed for inflation for tax years beginning after 2026, rounded to the nearest $10,000. There is a sting in the tail: once your eligible gain from an issuer exceeds the applicable dollar limit, the limit for every later year against that issuer drops to zero, and future indexing does nothing. It is a lifetime allowance per company, not an annual refill.
A Worked Example: An $18 Million Exit at Three, Four and Five Years
Northbound Systems, a Denver-based B2B SaaS company, incorporated as a Delaware C corporation and issued 4,000,000 shares of founder common stock on September 15, 2025 for $4,000. Gross assets immediately after that issuance were $2.1 million, far below the ceiling, and the stock was issued after July 4, 2025, so it sits in the new regime.
An all-cash acquirer later buys the company. The founder’s proceeds are $18,004,000 against a $4,000 basis, producing an $18,000,000 gain. Start with the cap:
- Dollar limit: $15,000,000
- 10 times adjusted basis: 10 x $4,000 = $40,000
- Cap is the greater of the two, so $15,000,000 of gain is eligible
- Gain above the cap: $18,000,000 minus $15,000,000 = $3,000,000, taxed at 23.8 percent in every scenario, or $714,000
Now price the three exit dates, federal tax only, top bracket, net investment income tax included:
Year three, 50 percent tier. Excluded gain is $7,500,000. The remaining $7,500,000 is Section 1202 gain taxed at 31.8 percent, or $2,385,000. Add the $714,000 above the cap. Total: $3,099,000.
Year four, 75 percent tier. Excluded gain is $11,250,000. The remaining $3,750,000 at 31.8 percent is $1,192,500. Add $714,000. Total: $1,906,500.
Year five, 100 percent tier. The full $15,000,000 is excluded. Only the $714,000 remains. Total: $714,000.
The same gain with no QSBS status costs $4,284,000. So the three-year tier saves $1,185,000, about 28 percent of the bill, not 50 percent. Waiting to year five saves $3,570,000. The distance between year three and year five is $2,385,000, and that is the number worth putting in front of a board weighing an early offer. None of this touches state tax, where the larger surprise often waits.
What Founders Get Wrong About QSBS After the OBBBA
Three errors show up repeatedly, and two of them are being actively repeated in published commentary on the new law.
The AMT misconception
Several guides claim the partial 50 and 75 percent tiers revive the old alternative minimum tax preference, under which 7 percent of excluded gain was added back to alternative minimum taxable income. That is wrong, and it distorts real planning decisions.
The OBBBA amended Section 57(a)(7) so it now applies only “in the case of stock acquired on or before the date of the enactment of the Creating Small Business Jobs Act of 2010,” meaning September 27, 2010. Congress also struck the redundant cross-reference at Section 1202(a)(4)(C). No stock issued in the last fifteen years carries a QSBS alternative minimum tax preference, and neither do the new tiers.
You cannot refresh old stock into the new regime
The obvious idea, once founders grasp the two regimes, is to convert pre-July 2025 shares into post-July 2025 shares. It does not work. The acquisition date carries over through Section 1223 and the tax-free transfer rules in Section 1202(h), so a recapitalization, conversion or reorganization generally hands the new shares the old date.
An aggressive attempt can also endanger the qualification you already have. The redemption rules in Section 1202(c)(3) are unforgiving: company purchases of its own stock from you or a related person within a four-year window around your issuance can disqualify your shares, and redemptions above 5 percent of value in a two-year window can taint an entire issuance.
Your state may tax the gain anyway
Sitting on a cap table with stock issued both before and after July 4, 2025?
That is now the normal case, and it means running two sets of holding period and cap rules against the same company. A short call will tell you which lots fall where, whether your gross asset test held at each round, and what your realistic exclusion looks like three, four and five years out.
What Should Founders and CFOs Do Before the Next Financing Round?
- Date-stamp every issuance. Record the exact original issue date for each lot and flag which side of July 4, 2025 it falls on. Most cap table platforms track this; few founders have checked that it is accurate.
- Run the gross asset test at every round. Capture gross assets immediately before and after each issuance and keep the schedule. Reconstructing it three years later from bank statements is painful and rarely convincing.
- Fix the equity plan mechanics. The clock starts at exercise for options and at vesting for restricted stock, unless a Section 83(b) election was filed within 30 days of grant. If your team holds vested options rather than shares, no clock is running. Our guide to when the clock starts on your option grants covers the sequencing, and the tax difference between ISOs and NSOs at exercise bears on the same decision.
- Keep the 409A current. Exercise decisions, and therefore holding period starts, hinge on a defensible strike price. Understanding how a defensible 409A valuation gets built separates a team that can exercise early from one that cannot afford to.
- Model the three tiers before you sign an LOI, and check your state while you do it. Put the year three, four and five numbers in front of your board alongside the deal terms, rather than letting a view of how investors value an early-stage company drive exit timing alone.
Frequently Asked Questions About Qualified Small Business Stock
1. How long do you have to hold QSBS to get a tax break in 2026?
For stock acquired after July 4, 2025, three years earns a 50 percent exclusion, four years earns 75 percent, and five years or more earns 100 percent. For stock acquired on or before that date, you still need more than five years to exclude anything.
2. Is the $15 million QSBS cap per person or per company?
Both. It is a per-taxpayer, per-issuer limit, so each eligible shareholder gets their own cap for each company whose stock they hold. The cap is the greater of $15 million or 10 times the adjusted basis of the shares sold that year.
3. Can an LLC or S corporation issue qualified small business stock?
No. Only a domestic C corporation can issue QSBS. An LLC or S corporation can convert to a C corporation, and shares issued after conversion may qualify, but the holding period starts at conversion and pre-conversion appreciation is lost.
4. Does the QSBS exclusion trigger alternative minimum tax?
Not for any stock acquired after September 27, 2010. The 7 percent preference item in Section 57(a)(7) now reaches only stock acquired on or before that date, so the new 50 and 75 percent tiers carry no AMT add-back.
5. Which businesses are excluded from QSBS treatment?
Section 1202(e)(3) rules out service fields including health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage. It also excludes banking, insurance, leasing, farming, extraction industries, hotels and restaurants.
6. Does California tax QSBS gain that is exempt federally?
Yes. California does not conform to Section 1202 and taxes the entire gain at rates reaching 13.3 percent, whatever the federal result. Pennsylvania, Alabama and Mississippi also decline to conform, while New Jersey conforms for tax years beginning on or after January 1, 2026.
7. When does the QSBS holding period start for stock options and RSUs?
For stock options the clock starts on exercise, not on grant. For restricted stock units it starts at vesting, and for restricted stock it starts at vesting unless a Section 83(b) election was filed within 30 days of grant, in which case it starts at grant.
8. How is the Section 1202 exclusion reported on a tax return?
Report the sale on Form 8949, Part II, as you would any other disposition, then enter code Q in column (f) and the excluded gain as a negative number in column (g). Totals carry to Schedule D, and the non-excluded portion runs through the 28 percent Rate Gain Worksheet.
9. What happens if you sell QSBS before three years?
No exclusion is available, but Section 1045 may let you defer the gain instead. If you held the stock more than six months and reinvest the proceeds in replacement QSBS within 60 days, the gain rolls over and the original holding period carries forward.
10. Does converting an LLC to a C corporation start the QSBS clock?
Yes, from the date of conversion, provided the new corporation meets the gross asset test at that moment and every other requirement afterward. Model it carefully, because conversion trades pass-through treatment today for a possible exclusion five years out.
Planning an exit in the next three to five years?
Countsure works with US founders, CFOs and CPA firms on exactly this: dating the cap table, testing gross assets at every issuance, modeling the tiers against realistic exit windows, and building the QSBS file before a buyer’s counsel asks for it. Tell us where you are and we will tell you what is defensible
Conclusion: What the Qualified Small Business Stock Tax Rules Mean for Your Next Round
The qualified small business stock tax rules have moved from an all-or-nothing gamble to a graduated schedule, which is good news for founders whose exits arrive on someone else’s timetable. For stock issued after July 4, 2025, three years buys a 50 percent exclusion, four years buys 75 percent and five buys the whole thing, against a cap of the greater of $15 million or 10 times basis. The rules did not get simpler, though. Most cap tables now carry two regimes at once, and the value of any lot turns on a date, a dollar figure and a state that all have to be checked rather than assumed. Get those three right early and the exclusion is reliable. Leave them until diligence and it becomes an argument.
- Record the original issue date for every share lot and mark which side of July 4, 2025 it falls on.
- Document the gross asset position at each round, before and immediately after issuance, while the evidence still exists.
- Model years three, four and five in dollars before you respond to an acquisition approach.
- Confirm your state’s position rather than assuming a federal zero travels.
The founders who capture this benefit are the ones who set it up years before they need it.
Parth Shah, Managing Director
(CPA-US, FCA, RV-S&FA, DISA)
Parth Shah who is head of Accounts and Book keeping has experience of more than 10 years. A Certified Public Accountant – US, fellow Chartered Accountant, Registered Valuer and Diploma in Information System Audit.
