Qualified Small Business Stock: Impressive Tax Benefits for Investors – 2025 IRS Code Updates
What is Qualified Small Business Stock (QSBS)?
Qualified small business stock (QSBS), also known as Section 1202 stock, permits shareholders of certain qualified small businesses to exclude a significant portion of capital gains when selling or exchanging that stock if specific conditions are met.
- stock acquired prior to July 5, 2025, shareholders may exclude up to 100% of capital gains if the stock is held for at least five years.
- For stock acquired on or after July 5, 2025, shareholders may qualify for partial or full exclusion under a new tiered system (see below).
For example, assume you invested $2 million into a startup in 2016 and later sold your shares in 2022 for $10 million. If the stock qualifies under QSBS, you may be able to exclude the $8 million gain from federal capital gains tax.
Gain Exclusion Cap
- For stock acquired prior to July 5, 2025, the cap remains at the greater of:
- $10 million, or
- 10 times your aggregate tax basis in the stock
- For stock acquired on or after July 5, 2025, the cap is increased to:
- $15 million, or
- 10 times your aggregate tax basis, whichever is greater
- Beginning in 2027, the $15 million cap will be adjusted for inflation
Tiered Capital Gain Exclusion (Effective for Stock Acquired After July 4, 2025)
A new tiered exclusion system applies to QSBS acquired on or after July 5, 2025, allowing earlier access to partial tax benefits:
- 3 years: 50% capital gain exclusion
- 4 years: 75% capital gain exclusion
- 5 or more years: 100% capital gain exclusion
In addition, gains excluded under this tiered system are not considered tax preference items for Alternative Minimum Tax (AMT) purposes, providing further tax relief.
Which Businesses Qualify to Issue QSBS?
For the sale to be eligible, the company must:
- Be an active U.S. C-corporation (not an S-corp and not a holding company
- Have assets of $75 million or less
- Not be on the Internal Revenue Services (IRS) QSBS excluded industry list. Prohibited industries are personal services; banking, financing, insurance, investing or leasing; farming; mining; and running a hotel, motel or restaurant. Examples of industries that generally qualify include technology, wholesale or retail, and manufacturing.
What Are the Parameters for Shareholders?
- Hold the stock for at least five years, or qualify for partial exclusion under the new tiered rules (if the stock was acquired after July 4, 2025)
- If the stock is sold before the required holding period, the gain may be rolled over into new QSBS within 60 days to defer taxation
- The shareholder must hold actual stock, not options, warrants, or other derivative securities
- Purchasing QSBS benefits only eligible non-corporate shareholders, including partnerships, LLCs taxed as partnerships, and S corporations.
Who should consider a QSBS strategy?
While Section 1202 was enacted to provide a tax incentive to seed small, growing U.S. companies, there are other benefits as well. We find that a lot of clients aren’t aware of how QSBS could be used in their particular situation. We’d love to talk through your options.
