The short answer: The Section 1202 QSBS eligibility requirements are a set of tests that must all be satisfied at once, and most of them are measured at the moment the stock was issued rather than the moment you sell. The company must be a domestic C corporation whose aggregate gross assets never exceeded $75 million before or immediately after the issuance ($50 million for stock issued on or before July 4, 2025), you must have taken the stock at original issuance, and at least 80 percent of the company’s assets by value must be used in an active qualified trade or business for substantially all of your holding period. Businesses in the fields excluded by Section 1202(e)(3), including health, law, accounting, consulting, financial services and any business whose principal asset is the reputation or skill of its employees, fail at the door. Because the taxpayer carries the burden of proof, an exit is the wrong moment to start hunting for the evidence.
Section 1202 is the most valuable provision in the code for a founder or early investor sitting on appreciated C corporation stock. It is also the one most often assumed rather than verified. Someone says “we’re a QSBS company” in a board meeting in year two, nobody writes down why, and five years later a buyer’s tax counsel asks for proof.
The One Big Beautiful Bill Act made the payoff bigger, which raises the cost of getting eligibility wrong. In the exit work we support for US CPA firms and their clients, the Section 1202 questions that surface at diligence are almost never about the exclusion rate. They are about evidence: what the balance sheet looked like on the issuance date, and whether anyone can still produce it.
This guide walks the eligibility tests in the order a reviewer applies them, with the statutory anchors and the failure modes that actually appear in practice.
Key takeaways
- The Section 1202 QSBS eligibility requirements rest on six tests: domestic C corporation status, the gross assets ceiling, original issuance, qualified trade or business, the 80 percent active business test, and the holding period.
- The aggregate gross assets ceiling is $75 million for stock issued after July 4, 2025 and $50 million for stock issued on or before that date, tested at all times before the issuance and immediately after it.
- At least 80 percent of assets by value must sit in the active conduct of a qualified trade or business for substantially all of the holding period, not merely on the issuance date.
- Section 1202(e)(3) excludes service fields including health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage, plus banking, insurance, financing, leasing, investing, farming, extraction, and hotels and restaurants.
- More than 10 percent of asset value in non-subsidiary stock or securities, or in real property not used in the business, breaks the active business test on its own.
- For stock acquired after July 4, 2025 the exclusion runs 50 percent at three years, 75 percent at four and 100 percent at five, and the percentage-limited balance meets a 28 percent
The taxpayer bears the burden of proof. In Ju v. United States, the Court of Federal Claims rejected financial statements prepared six years after issuance as evidence that the gross assets test was met.
What Are the Section 1202 QSBS Eligibility Requirements?
Six tests have to hold at once. Miss any one and the exclusion is gone entirely, not reduced.
- The holder is not a corporation. Individuals, trusts and estates qualify. A C corporation holding the stock does not.
- The issuer is a domestic C corporation at issuance and for substantially all of the holding period, under Section 1202(c)(2)(A).
- The issuer met the gross assets ceiling at all times before the issuance and immediately after it, under Section 1202(d)(1).
- You acquired the stock at original issuance for money, property other than stock, or services, under Section 1202(c)(1)(B).
- The business is a qualified trade or business, meaning it is not on the Section 1202(e)(3) excluded list.
- At least 80 percent of assets by value are used actively in that business for substantially all of your holding period, under Section 1202(e)(1).
Notice how the tests split. Two of them are snapshots taken on the issuance date. Three of them run continuously across years you may not control. That split is why eligibility is a documentation problem long before it is a tax problem.
The One Big Beautiful Bill Act, P.L. 119-21, changed three of the numbers on July 4, 2025 and left the eligibility tests themselves untouched. Which set of numbers applies turns on the stock’s own date, not the date of sale.
| Item | Stock issued on or before July 4, 2025 | Stock issued after July 4, 2025 |
|---|---|---|
| Holding period and exclusion | 5 years for any exclusion; 100% at 5 years for stock acquired after September 27, 2010 | 50% at 3 years, 75% at 4 years, 100% at 5 years |
| Per-issuer cap | Greater of $10 million or 10 times basis | Greater of $15 million or 10 times basis, indexed after 2026 |
| Aggregate gross assets ceiling | $50 million | $75 million, indexed after 2026 |
A cap table that spans the July 2025 line therefore carries two regimes at once. Two shareholders in the same company, selling on the same day, can face different exclusion percentages and different caps purely because of when their shares were issued.
Not sure which set of Section 1202 rules governs the stock on your cap table?
Our business tax team reconstructs the issuance timeline, sorts each tranche into the pre-OBBBA or post-OBBBA regime, and tells you which shares carry which cap and which exclusion percentage. The output is a tranche-by-tranche schedule you can hand to counsel or to a buyer. Typical turnaround is five to seven business days.
Is Your Company a Qualified Trade or Business Under Section 1202(e)(3)?
This is the first gate and the one that closes hardest. Section 1202(e)(3) does not define a qualified trade or business. It defines everything that is not one, and if your company lands on that list, no amount of asset discipline saves the position.
The excluded fields, in plain English
The statute rules out any trade or business involving the performance of services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services or brokerage services. It separately rules out banking, insurance, financing, leasing, investing or similar businesses, farming, the production or extraction of products eligible for a depletion deduction, and the business of operating a hotel, motel, restaurant or similar business.
Two of those bite harder than founders expect. Engineering and architecture are excluded here even though they qualify under Section 199A, so a familiarity with the qualified business income rules can mislead you. Leasing is excluded outright, which catches equipment and fleet businesses that think of themselves as operating companies.
Why "reputation or skill" catches agencies and consultancies
The list closes with a catch-all: any trade or business where the principal asset is the reputation or skill of one or more of its employees. The IRS has described the thrust of the provision as excluding businesses that deliver value to customers primarily in the form of services, whether that is a hotel room or a partner’s individual expertise.
The practical dividing line is whether the company sells a product that exists independently of the people who built it. A firm that licenses software it wrote is generally fine. A firm that bills for the hours of a named expert generally is not, even if it calls the output a platform.
What the IRS will not tell you right now
Companies used to resolve this by requesting a private letter ruling. That route is closed for now. Under Revenue Procedure 2024-3, the IRS placed the active business question on its no-rule list while it studies regulations, and Treasury officials indicated in 2026 that a broader Section 1202 regulation package remains in development.
The existing rulings are still useful reading, but under Section 6110(k)(3) a private letter ruling may be relied on only by the taxpayer who requested it. There are no Treasury regulations interpreting the consulting or reputation-and-skill language at all. The realistic answer is a documented written analysis at issuance, refreshed as the business model shifts, rather than a guess reconstructed at closing.
How Does the 80 Percent Active Business Requirement Work?
Section 1202(e)(1) requires that at least 80 percent of the corporation’s assets, measured by value, be used in the active conduct of one or more qualified trades or businesses. It is not an issuance-date snapshot. It has to hold for substantially all of your holding period, a phrase the statute never defines.
That continuity is the part companies fail without noticing, because a balance sheet changes shape after every financing round.
Working capital counts, but only so far
Section 1202(e)(6) treats two categories as actively used: assets held as part of the reasonably required working capital needs of the business, and assets held for investment that are reasonably expected to be used within two years to fund research and experimentation or an increase in working capital.
There is a ceiling on that relief. Once the corporation has existed for at least two years, no more than 50 percent of its assets may qualify as actively used by reason of the working capital rule. A company that raised a large round and then slowed its burn can quietly cross that line while its financial statements look perfectly healthy.
Two hard 10 percent limits
Two provisions fail the active business test outright, without any weighing of facts.
Under Section 1202(e)(5)(B), the corporation fails for any period in which more than 10 percent of the value of its assets, net of liabilities, consists of stock or securities in other corporations that are not its subsidiaries. Under Section 1202(e)(7), it fails for any period in which more than 10 percent of the total value of its assets consists of real property not used in the active conduct of a qualified trade or business. The same provision states that owning, dealing in or renting real property is not active conduct.
Subsidiaries look through, and early-stage activity counts
Section 1202(e)(5)(A) disregards stock and debt in a subsidiary and treats the parent as owning its ratable share of the subsidiary’s assets and conducting its ratable share of its activities. A subsidiary here means more than 50 percent of combined voting power or more than 50 percent of value, a lower bar than the 80 percent control most tax rules use.
Pre-revenue companies get explicit protection. Under Section 1202(e)(2), assets used in start-up activities, research and experimental activities and in-house research are treated as used in the active conduct of a qualified trade or business, and the determination is made without regard to whether the company has any gross income from those activities yet.
Does Your Company Pass the QSBS Gross Assets Test?
The qsbs gross assets test is the cleanest of the six requirements to compute and the most commonly failed on evidence rather than on substance.
Tested at issuance, not at exit
Section 1202(d)(1) asks two questions about each issuance. Were the corporation’s aggregate gross assets at all times before that issuance within the ceiling, and were they within the ceiling immediately after it, counting the money raised? A company that later grows to $400 million does not lose QSBS status on shares issued when it was small. A company that was already over the ceiling cannot cure it by shrinking later.
Aggregate gross assets means cash plus the aggregate adjusted bases of other property held by the corporation, under Section 1202(d)(2)(A). Members of the same parent-subsidiary controlled group are treated as one corporation, with a more than 50 percent threshold substituted for the usual 80 percent.
Contributed property counts at fair market value
A worked example: converting an LLC in 2025
- Members contribute the business: fair market value $9,000,000, adjusted basis $1,400,000.
- The corporation also holds $600,000 of cash at conversion.
- Aggregate gross assets immediately after issuance: $9,000,000 plus $600,000, so $9,600,000.
- Ceiling for stock issued after July 4, 2025: $75,000,000. The test passes with room to spare.
- Sale in November 2030, more than five years after issuance, for $39,600,000. Gain of $36,000,000, excluded in full. Federal tax on the gain: zero.
- Same sale in November 2029, at four years. The 75 percent tier excludes $27,000,000 and the remaining $9,000,000 meets the 28 percent rate, roughly $2,520,000 of federal tax.
Did You Acquire the Stock at Original Issuance?
Section 1202(c)(1)(B) requires that the stock be acquired at its original issue, directly or through an underwriter, in exchange for money, property other than stock, or as compensation for services. Shares bought from a departing founder, from an early employee, or in a secondary sale are not QSBS in your hands, however small the company was at the time.
The redemption rules that quietly kill status
Two anti-churning rules sit inside Section 1202(c)(3), and both look backward from an issuance date that may be years in the past.
Under subparagraph (A), stock is not QSBS if, at any time in the four-year period beginning two years before the issuance, the corporation purchased any of its stock from you or from a person related to you within the meaning of Section 267(b) or 707(b). Under subparagraph (B), stock is not QSBS if, during the two-year period beginning one year before the issuance, the corporation purchased its own stock with an aggregate value exceeding 5 percent of the value of all its stock at the start of that period.
Regulation 1.1202-2 provides de minimis relief. A related-party purchase is disregarded unless the aggregate amount paid exceeds $10,000 and more than 2 percent of the stock held by you and related persons is acquired. That relief is narrow, and a routine founder buyback done as a favor can sit squarely inside the window.
Transfers that preserve status
Section 1202(h) treats three transfers as preserving QSBS status and tacking the holding period: transfers by gift, transfers at death, and distributions from a partnership to a partner where the requirements of Section 1202(g) were met. A sale to a friend is not on that list.
The Eligibility Failures That Surface in Diligence
- An S election somewhere in the middle. The issuer must be a C corporation for substantially all of the holding period. A year spent as an S corporation for a distribution planning reason can break the chain.
- Shares bought rather than issued. Buying out a co-founder feels like consolidating ownership. Those shares are not QSBS in the buyer’s hands.
- A large round parked in the market. Cash and securities beyond reasonably required working capital, past the two-year mark, can push a company below the 80 percent line while it looks well capitalized.
- Real estate held for appreciation. More than 10 percent of asset value in property not used in the business fails the test outright, and renting it out does not make it active.
- No issuance-date records. In Ju v. United States, 166 Fed. Cl. 173 (2024), the first federal decision on a litigated Section 1202 claim, the taxpayer offered financial statements prepared six years after the issuance to prove the gross assets test. The court held they could not carry his burden.
If the Stock Qualifies, What Do You Report?
Report the sale on Form 8949, Part II, exactly as you would without the exclusion. Then enter code Q in column (f) and the excluded gain as a negative number in parentheses in column (g). Totals carry to Schedule D. Omit the code and the IRS treats the whole gain as taxable, which then takes an amended return to unwind.
Three points on the tax that remains are worth getting precisely right, because they are widely muddled.
- The 28 percent rate is narrow. It applies to gain denied by the percentage limitation, meaning the unexcluded half or quarter under the three-year and four-year tiers. Gain above the per-issuer dollar cap is ordinary long-term capital gain at 20 percent, plus the 3.8 percent net investment income tax.
- The partial tiers are not an AMT preference. Section 57(a)(7) now reaches only stock acquired on or before September 27, 2010. The new 50 percent and 75 percent exclusions carry no 7 percent preference add-back.
- Excluded gain escapes the NIIT. It is excluded from gross income, so it never enters the net investment income calculation.
Your state may not follow
Frequently Asked Questions About Section 1202 QSBS Eligibility
1. What are the Section 1202 QSBS eligibility requirements in 2026?
Six tests: a non-corporate holder, a domestic C corporation issuer, gross assets within the ceiling at issuance, acquisition at original issuance, a qualified trade or business, and 80 percent active asset use across substantially all of the holding period. All six must hold at once.
2. Does an LLC qualify for the QSBS exclusion?
An LLC taxed as a partnership cannot issue QSBS. An LLC that has elected to be taxed as a C corporation can. Converting starts a fresh clock, and only stock issued after the conversion is eligible.
3. What counts as a qualified trade or business under Section 1202(e)(3)?
Anything not on the excluded list. That list rules out named service fields, banking and insurance, financing, leasing and investing, farming, extraction, hotels and restaurants, and any business whose principal asset is the reputation or skill of its employees.
4. How is the QSBS gross assets test calculated?
Add cash to the aggregate adjusted bases of all other property held by the corporation. Contributed property enters at its fair market value on the contribution date, not at carryover basis. Test the total at all times before the issuance and immediately after it.
5. Does the 80 percent active business requirement apply at all times?
It must be met for substantially all of the shareholder’s holding period, which the statute does not define. In practice this means monitoring the balance sheet after every financing round, not just on the issuance date.
6. Can a software company that also sells services qualify for QSBS?
Often yes, if the product exists independently of the people supporting it and services are ancillary. The analysis turns on facts, so document it in writing at issuance rather than reconstructing the argument during diligence.
7. Does a stock buyback disqualify QSBS?
It can. A purchase from the shareholder or a related person within four years around the issuance, or purchases exceeding 5 percent of company value in the two-year window, can strip QSBS status. Narrow de minimis relief exists in Regulation 1.1202-2.
8. Is the partial QSBS exclusion an AMT preference item?
No. Section 57(a)(7) now applies only to stock acquired on or before September 27, 2010. The 50 percent and 75 percent tiers introduced for post-July 2025 stock carry no alternative minimum tax preference.
9. How do you report the Section 1202 exclusion on a tax return?
Report the full sale on Form 8949, Part II, then enter code Q in column (f) and the excluded gain as a negative figure in column (g). Carry the totals to Schedule D of Form 1040.
10. Do all states follow the federal Section 1202 exclusion?
No. California, Pennsylvania, Alabama and Mississippi do not conform, so the gain can be fully excluded federally and still taxed by the state. Conformity follows the shareholder’s residence, not the state of incorporation.
Getting Section 1202 QSBS Eligibility Right Before the Exit
The Section 1202 QSBS eligibility requirements are decided years before anyone signs a purchase agreement. Whether the stock qualifies depends on what the corporation looked like on each issuance date and on how its balance sheet behaved in the years that followed, not on how the deal is structured at the end. Every one of the six tests is provable, and every one of them is provable only with records created at the time. The reason positions fail is almost never that the company was ineligible. It is that nobody wrote down that it was eligible while the evidence still existed. Treat this as a recordkeeping discipline you run annually, and the exclusion is there when you need it.
- Capture a balance sheet on every issuance date, showing cash plus adjusted bases, with contributed property at fair market value.
- Get a written qualified trade or business analysis at issuance, and refresh it whenever the revenue mix moves toward services.
- Test the 80 percent line annually, and again after any round that leaves a large cash or securities balance on the books.
- Clear any redemption inside the statutory windows before a buyer prices the risk into the deal, not after.
The companies that keep this exclusion are simply the ones that treated it as a live compliance obligation from the first issuance forward.
Heading into a sale with QSBS assumptions nobody has tested?
Countsure runs a full Section 1202 eligibility review under Licensed US CPA supervision: entity status through the holding period, gross assets by tranche, qualified trade or business analysis, redemption history and the 80 percent test year by year. You receive a written memorandum with the supporting workpapers, ready for counsel or a buyer’s diligence request.
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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.
