What Is Qualified Small Business Stock?

If you are planning for a liquidity event that includes selling Qualified Small Business Stock (QSBS), you may be eligible to exclude part, or even all, of your capital gains from federal income tax. That possibility sits within Section 1202 of the Internal Revenue Code, and recent federal legislation has made this tax incentive even more attractive for business owners.

But the benefits aren’t automatic. You should understand how eligibility works, what the Internal Revenue Service (IRS) requires, and what thresholds your company must meet. This article walks you through it.

Key Terms You Should Know

Before we get into the mechanics of Qualified Small Business Stock, it helps to understand a few core terms:

• Capital gains: The profit from selling an asset for more than you paid. Here, it refers to the gain you may realize when selling QSBS.
• C corporation (C corp): A business structure taxed separately from its owners. Only stock issued by a U.S. C corp can qualify as QSBS.
• Aggregate gross assets: The total value of a company’s assets, measured at original cost for tax purposes.
• Original issuance: Stock acquired directly from the company, not purchased from another shareholder.
• Alternative Minimum Tax (AMT): A parallel tax system that recalculates income using stricter rules. If you're subject to AMT, certain exclusions or deductions may still be treated as taxable income.

What You Should Know About Qualified Small Business Stock

The first thing to understand about Qualified Small Business Stock is that it is not a distinct class of stock under corporate law. It is ordinary corporate stock that may receive preferential federal tax treatment if, and only if, it meets the specific requirements of Section 1202 of the Internal Revenue Code.

What Makes Small Business Stock Qualified?

Here are the five conditions that must be met:

• Condition 1: Stock in a domestic C corporation

The stock must be issued by a corporation formed in the United States. S corporations and LLCs do not qualify. The company must be taxed as a C corporation at the time the stock is issued.

• Condition 2: Original issuance

The stock must be acquired directly from the company. That can happen through a cash investment, services rendered, payment for property, or as part of a compensation package. If you purchase the stock from another shareholder, it does not qualify.

• Condition 3: Holding period

To trigger QSBS treatment, stock acquired before July 4, 2025, must be held for at least five continuous years starting from the date you acquired it, not from the company’s formation date. For stock acquired on or after that date, the required holding period may be shorter. We'll explain how the rules changed in the next section.

• Condition 4: Qualified active business

At least 80% of the company’s assets must be used in the active conduct of a qualified trade or business. Most operating businesses meet this requirement. The main exceptions are professional services, banking, finance, insurance, farming, mining, hospitality, and real estate.

• Condition 5: No big redemptions

Section 1202 contains anti-abuse rules. If the company buys back shares from you or someone related to you within two years before or after your QSBS was issued, your stock may be disqualified. The same applies if the company redeems more than 5% of its total outstanding shares from anyone during that same two-year window.

A Quick History of QSBS Tax Benefits

While the five core requirements have held steady since Section 1202 was enacted on August 10, 1993, the tax benefits tied to QSBS have shifted over time.

Key changes in federal law have redefined how much gain you can exclude, depending on when you acquired your stock and how long you’ve held it. Let’s take a look at how those rules evolved and how the One Big Beautiful Bill Act could make QSBS even more rewarding for business owners.

Omnibus Budget Reconciliation Act of 1993

Qualified small business stock was created in 1993 through the Omnibus Budget Reconciliation Act. Section 1202 of the Internal Revenue Code allowed non-corporate investors to exclude 50% of their capital gains from federal tax on the sale of qualifying stock, so long as they held it for more than five years. To qualify, the company issuing the stock had to be a U.S. C corporation with aggregate gross assets of $50 million or less at the time of issuance.

The exclusion was capped at the greater of $10 million or ten times the investor’s basis. But there was one limitation: the excluded gain wasn’t fully ignored for tax purposes. Under the original rules, 7% of the excluded gain was added back in when calculating alternative minimum tax (AMT).

The American Recovery and Reinvestment Act

In 2009, Congress expanded the QSBS exclusion through the American Recovery and Reinvestment Act. For qualifying stock acquired after February 17 of that year, the capital gains exclusion rose from 50% to 75%. The five-year holding requirement remained in place. However, the excluded gain was still partially subject to the alternative minimum tax (AMT)

Small Business Jobs Act

The Small Business Jobs Act, passed in 2010, gave qualified small business stock its biggest boost yet. For stock acquired after September 27 of that year, the capital gains exclusion jumped to 100%. The five-year holding period still applied, but the gain was now fully exempt, not just from regular federal income tax, but also from the alternative minimum tax (AMT).

One Big Beautiful Bill Act

On July 4, 2025, President Donald Trump signed the One Big Beautiful Bill Act (OBBA) into law, marking the most significant expansion of QSBS tax benefits since Section 1202 was introduced. The Act adjusted multiple thresholds that determine who qualifies, how much can be excluded, and when that exclusion applies. Here’s what changed:

• Tiered holding period exclusions

For QSBS acquired after July 4, 2025, the holding period requirement now follows a tiered structure. If you hold the stock for at least three years, 50% of your capital gains may be excluded. At four years, the exclusion rises to 75%. If you reach the five-year mark, you qualify for a full 100% exclusion.

• Higher gross asset cap

Previously, a company’s total assets had to be $50 million or less at the time the stock was issued to qualify as a “small business” under Section 1202. The new law raises that ceiling to $75 million, measured using the same tax basis method. The cap will now adjust annually for inflation starting in 2026.

• Expanded gain exclusion cap

Under the prior version of Section 1202, the maximum amount of capital gain that could be excluded was the greater of $10 million or ten times your basis in the stock. The One Big Beautiful Bill raises the baseline cap to $15 million, again with inflation indexing beginning in 2026.

Gains excluded under Section 1202 are still exempt from the alternative minimum tax. The anti-abuse rules remain fully in effect, now operating within a broader eligibility framework shaped by the new thresholds.

Conclusion

If you hold qualified small business stock, understanding how the tax code treats it can make a real difference when you sell. With Section 1202 and the One Big Beautiful Bill Act of 2025, the path to tax savings is clearer, but only if your stock meets the rules.

Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.

At Wilkinson Law, we give business owners the clarity they need to fund, grow, protect, and sell their businesses. We are trustworthy business advisors keeping your business on TRACK: Trustworthy. Reliable. Available. Caring. Knowledgeable.®

FAQs

Does My Stock Still Qualify as QSBS if the Company Later Converts to an S Corp or LLC?

No. The company must be a U.S. C corporation at the time the stock is issued. A later change in entity type doesn’t retroactively disqualify the stock, but any new stock issued after the conversion would not qualify.

What Happens if I Sell Before Holding for Five Years?

You may still get partial exclusion under the new tiered system if your stock was acquired after July 4, 2025. At three years, you may exclude 50% of the capital gains; at four years, 75% . If your stock predates the new law, the five-year rule still applies.

What Kind of Businesses Are Excluded From QSBS Treatment?

The tax code carves out certain industries, including law, medicine, accounting, financial services, real estate, hospitality, mining, and farming. If your company is in one of these fields, its stock likely doesn’t qualify even if all other conditions are met.