Qualified Small Business Stock (QSBS): Exclude Up to $10 Million in Capital Gains
IRC §1202 allows shareholders of qualifying C-Corp stock to exclude up to $10 million — or 10× their basis — in capital gains from federal income tax entirely. For founders and early investors, this is one of the most powerful tax exclusions in the entire tax code.
The $10 Million Exclusion
IRC §1202 provides that a non-corporate taxpayer can exclude from gross income up to the greater of:
- $10 million, or
- 10× the adjusted basis of QSBS stock disposed of by the taxpayer during the year
The limit is per taxpayer, per issuing corporation. A founder who sells $10M of stock in Company A and $10M of stock in Company B can potentially exclude $20M total — $10M per issuer.
For stock acquired after September 27, 2010: the exclusion is 100% — the entire gain is excluded from federal income tax and from the Net Investment Income Tax (NIIT) as well.
Eligibility Requirements
- C-Corporation only: The issuer must be a domestic C-Corp. S-Corps, LLCs, and partnerships do not qualify — their stock is ineligible regardless of other factors.
- Gross assets under $50 million: At the time of issuance (and immediately after), the corporation's aggregate gross assets must not exceed $50 million. Once issued, the stock retains QSBS status even if the company grows beyond $50M.
- Active business requirement: At least 80% of assets must be used in an active qualified trade or business — not an investment company, REIT, or holding company.
- Original issuance: The taxpayer must acquire the stock at original issuance (from the company, not the secondary market) in exchange for money, property, or services.
- 5-year holding period: The stock must be held for more than 5 years before sale. Partial rollovers using §1045 (within 60 days) can preserve the original acquisition date.
Disqualified Businesses
IRC §1202(e)(3) excludes certain "specified service trades or businesses" from QSBS eligibility — the same exclusions that appear in the QBI deduction:
- Excluded: Law, health, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage
- Also excluded: Hospitality and food service, farming, oil/gas extraction, mining
- Eligible: Technology, software, manufacturing, retail, wholesale, scientific research, transportation, construction, and most other active businesses
Stacking QSBS Across Family Members
The $10M exclusion is per taxpayer. Each family member who owns QSBS stock independently gets their own $10M exclusion. Gifting or transferring QSBS stock to family members (trusts, children) before an exit can multiply the exclusion — subject to gift tax rules and the requirement that the transferee is a non-corporate taxpayer.
Example: Founder has $40M in QSBS gain. Gifts $10M of stock to spouse, $10M to a family trust with children as beneficiaries, retains $20M. At exit, each taxpayer excludes $10M: $40M total excluded — $0 federal capital gains on the full exit. This requires careful coordination with gift tax planning.
State Conformity Warning
Most states do NOT conform to the federal §1202 exclusion. California, for example, taxes the full QSBS gain at California rates (currently up to 13.3%). A $10M excluded federal gain that is taxable in California results in up to $1.33M in state tax.
Nevada, Texas, and Florida have no state income tax — establishing residency before an exit eliminates the state tax entirely. The QSBS exclusion makes this residency planning extraordinarily valuable for founders.
IRC §1202 (partial exclusion for gain from certain small business stock), IRC §1045 (rollover of gain from qualified small business stock), IRC §1202(e)(3) (active business requirement — excluded businesses). IRS Publication 550 (Investment Income and Expenses). Rev. Rul. 2021-13 (partnership allocations of §1202 gain).
Genie walks through every §1202 requirement against your specific facts — issuer gross assets, business type, acquisition date, holding period — and calculates the exact federal tax saved on your exit.
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