If you’ve built a business or invested in one early on, you may have heard the term “Section 1202 stock” thrown around. But unless someone has walked you through what it actually means (and what it can do for your tax bill), it’s easy to overlook a valuable provision for small business owners and investors in the tax code.
Qualified Small Business Stock, or QSBS, can allow a substantial portion of their capital gains to be excluded from federal income tax when they sell. For business owners and their investors, the potential savings can be significant and a good strategy to investigate.
At Bernath + Rosenberg, we specialize in nuanced strategies that can help small business owners save big on taxes. Here’s what you need to know about QSBS.
What Is QSBS?
QSBS refers to shares issued by a qualified small business under Section 1202 of the Internal Revenue Code. The provision was originally created in 1993 to encourage investment in small, growing companies by offering a tax incentive at the point of sale.
It has been modified several times since (most recently with notable updates in 2025), but the core idea remains: if you hold qualifying stock long enough, you may be able to exclude a large portion of your gain from federal capital gains tax.
The exclusion applies only to non-corporate taxpayers, so it’s aimed squarely at individual investors, founders, and employees who receive stock. Trusts and partnerships can also qualify under certain conditions.
How Much of the Gain Can Be Excluded?
For stock acquired and held for more than five years and after September 27, 2020, the federal exclusion is 100% of the capital gain or up to the greater of $10 million or 10 times the investor’s adjusted basis in the stock. That’s a hard ceiling, but for many founders and early-stage investors, it’s a ceiling they may never reach.
To put some numbers around it: if you invested $500,000 in a qualifying startup and sold your shares five years later for $4 million, your $3.5 million gain could be entirely excluded from federal income tax. That’s a hypothetical example, but it illustrates why QSBS gets attention in business and investment circles. The 10x basis rule means a $2 million investment could potentially yield a $20 million tax-free exclusion; a larger-scale savings benefit for larger early-stage investors in tech start-ups, as an example.
Note that the exclusion applies to federal taxes. State tax treatment varies; some states conform to the federal rule, others do not. California, for instance, does not recognize the QSBS exclusion. Businesses in Pennsylvania and New Jersey also heavily restrict or do not recognize the exclusion either. Our firm works with clients from many states, so we’re well aware of these differences in state tax law.
Does Your Stock Qualify?
Not every small business stock qualifies. The rules are specific, and missing even one criterion can disqualify an otherwise attractive investment for tax savings. Here are the key requirements:
The issuing company must be a C corporation. S corps, LLCs, and partnerships do not qualify. This is one of the first things to verify before assuming your stake is eligible.
The company’s gross assets must have been $50 million or less at the time of issuance. This includes assets held immediately after the stock is issued, so timing matters.
The stock must have been acquired at original issuance. Purchasing shares on a secondary market generally does not qualify.
The company must be in an eligible trade or business. Service businesses in fields like law, health, finance, consulting, and hospitality are generally excluded, as are retail or wholesalers. Technology, manufacturing, biotechnology, or software development businesses tend to qualify.
You must hold the stock for more than five years. Selling early eliminates the exclusion. There is a rollover provision under Section 1045 that allows you to defer gain if you sell before the five-year mark, as long as you have held the original stock for at least 6 months and reinvest the proceeds in new QSBS within 60 days of the sale.
What Changed in 2025?
The Tax Cuts and Jobs Act extensions and subsequent legislative updates brought renewed attention to Section 1202. Among the changes discussed and enacted in 2025: adjustments to how the gain exclusion interacts with the alternative minimum tax (AMT), along with technical clarifications around what counts toward the asset threshold. If you hold QSBS that was issued before the most recent changes, we recommend revisiting whether your tax plan accounts for the updated rules.
For QSBS acquired after July 4, 2025, a tiered benefit was implemented: a 50% exclusion after at least three years, a 75% exclusion after at least four years, and a 100% exclusion after at least five years.The exclusion is subject to limits on a per-taxpayer, per-issuer basis. For QSBS acquired on or before July 4, 2025, the limit is generally the greater of $10 million or 10 times the taxpayer’s basis in the stock. For QSBS acquired after July 4, 2025, the fixed-dollar limit increases to $15 million (or 10 times basis, if greater).
As an example, under long-standing PATH Act rules, for QSBS eligible for the 100% exclusion (acquired after September 27, 2010), the excluded gain is entirely exempt from AMT, a massive planning benefit. The AMT preference item (where 7% of the excluded gain was treated as an AMT preference) only applies to the older 50% and 75% exclusion brackets.
Far from obscure technicalities, these can significantly affect how much you keep after a sale. Working early with a qualified tax and wealth advisor who understands both the investment and the law might result in genuine benefits.
QSBS As Part of a Broader Tax Strategy
For founders and investors in qualifying companies, QSBS is rarely a standalone consideration. It connects to questions about entity structure, when to exercise stock options, how the sale fits into your overall income picture, and what other tax planning tools (such as opportunity zone investments, charitable vehicles, or trust strategies) might be paired with it.
For business owners who are also thinking about estate planning or succession, QSBS intersects with gifting strategies as well. Shares can in some cases be transferred to family members, though the rules around how the exclusion follows the stock are technical and require careful review.
At Bernath + Rosenberg, we work with business owners and investors who have complex tax situations and QSBS planning is exactly the kind of issue where having accounting, tax, and wealth management expertise under one roof makes a difference. You shouldn’t be navigating these questions with three different firms that don’t talk to each other.
The Bigger Picture
QSBS is one of the few places in the tax code where the rules, if followed carefully, can produce a genuinely outsized benefit. But that benefit isn’t automatic, it has to be planned for. Founders who set up the wrong entity type, investors who buy shares on the secondary market, or anyone who sells too early can forfeit a significant exclusion without realizing it.
The time to think about QSBS is before the transaction—not after. If you’re considering an investment in a private company, starting a business, or approaching a liquidity event, consider a detailed conversation about whether Section 1202 applies and how to preserve the exclusion.
To discuss whether QSBS planning makes sense for your situation, call us at (212) 221-1140 or email tstricker@brwealth.com.
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Sources
- Internal Revenue Code Section 1202, Partial Exclusion for Gain from Certain Small Business Stock.
- Internal Revenue Code Section 1045, Rollover of Gain from Qualified Small Business Stock to Another Qualified Small Business Stock.
Frequently Asked Questions about QSBS
1. What is Qualified Small Business Stock, and who qualifies for the tax exclusion?
QSBS refers to shares issued by a qualified small business under Section 1202 of the Internal Revenue Code. The tax exclusion applies only to non-corporate taxpayers, meaning it is aimed directly at individual investors, founders, and employees who receive original issuance stock. Under certain conditions, trusts and partnerships can also qualify.
2. What are the key requirements for a company’s stock to be eligible for QSBS tax benefits?
To qualify for the Section 1202 capital gains exclusion, the stock must meet strict criteria, including:
- Entity type: The issuing company must be a C corporation (S corps, LLCs, and partnerships do not qualify).
- Asset limit: The company’s gross assets must be $50 million or less at the time of issuance.
- Acquisition: Stock must be acquired at its original issuance, not on a secondary market.
- Industry type: The company must participate in an eligible trade (e.g., technology, manufacturing, software development, or biotechnology), while service fields like law, health, finance, and hospitality are generally excluded.
- Holding period: You must hold the stock for more than five years to claim the exclusion.
3. How much of the capital gains can be excluded from federal income tax under QSBS?
For qualifying stock acquired after September 27, 2010, and held for more than five years, investors can exclude 100% of their capital gains from federal income tax. This exclusion is capped at the greater of $10 million or 10 times the investor’s adjusted basis in the stock. Additionally, under long-standing PATH Act rules, this 100% exclusion is entirely exempt from the Alternative Minimum Tax (AMT). Note that state tax treatments vary; for instance, states like California, New Jersey, and Pennsylvania heavily restrict or do not recognize the federal QSBS exclusion.
About Ted
Ted Stricker, CFP®, is a partner at Bernath + Rosenberg with over 27 years of experience specializing in custom financial plans for business owners and affluent families. Since joining the firm in 2015, he has led the wealth management team in delivering practical, independent advice tailored to each client’s unique lifestyle and goals. Based out of the firm’s multi-state offices, Ted is a member of the Financial Planning Association and helps maintain Bernath + Rosenberg’s standing as a top-ranked national CPA firm in financial planning.
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