QSBS Section 1202 in 2026 (After OBBBA)

#What QSBS actually is

Section 1202 of the Internal Revenue Code is one of the most aggressive tax breaks in the entire code. If you hold qualifying small business stock long enough, you can exclude most or all of the capital gain when you sell.

The basics that have to be true for stock to qualify:

1. Issued by a domestic C-corporation. The company must be a domestic C-corporation when it issues the stock, and for nearly all the time you hold it. An LLC taxed as a partnership or an S-corp does not qualify.
2. Acquired at original issuance (you bought it directly from the company, or received it as compensation, or converted from a SAFE/convertible note. Not a secondary-market purchase.)
3. Held continuously for the required holding period (post-OBBBA: at least 3 years; pre-OBBBA: at least 5 years)
4. The company’s aggregate gross assets must have stayed under the threshold at all times before the stock was issued, and still be under it right after the issue, counting the money raised in that round ($75M for stock issued after July 4, 2025, indexed for inflation starting after 2026; $50M for stock issued on or before that date)
5. The company is in a qualifying trade or business. Most operating businesses qualify. Excluded: services in health, law, finance, accounting, consulting, performing arts, and similar fields (§1202(e)(3)). Most SaaS and product companies qualify. Tax firms do not qualify, since we are a service business.
6. The company actively ran its business during substantially all the holding period

Meet all 6 conditions, and the exclusion applies. Miss one, and it’s regular capital gains treatment.

#What OBBBA changed (effective for stock issued after July 4, 2025)

The One Big Beautiful Bill Act (signed July 4, 2025) made three substantive changes to §1202. These are the biggest reforms since the rule was enacted in 1993.

#Change 1: Tiered holding period replaces 5-year cliff

Pre-OBBBA rule (still applies to stock issued July 4, 2025 or earlier):

• Held < 5 years → 0% excluded, full capital gain taxed
• Held 5+ years → 100% excluded (up to the per-issuer cap)

Post-OBBBA rule (stock issued after July 4, 2025):

• Held < 3 years → 0% excluded
• Held 3 to <4 years → 50% excluded
• Held 4 to <5 years → 75% excluded
• Held 5+ years → 100% excluded

This is a major shift. Founders no longer have to wait the full 5 years to get any benefit. Partial exclusion kicks in at year 3.

Important rate trap: for the portion not excluded under the tiered rule (the remaining 50% or 25% of the gain), the tax rate is up to 28% (the §1(h)(4) rate for §1202 gain). That is not the standard 15-20% long-term capital gains rate. The part of the gain that is not excluded is taxed at up to 28%. At a 50% exclusion that works out to about 14% on the whole gain. At 75% it is about 7%. Both beat the usual 20% long-term rate.

• Gain × 50% × 0% = excluded
• Gain × 50% × 28% = taxed at 28%

With a 50 percent exclusion and 28 percent tax on the rest, the federal rate on the whole gain is 14 percent. At 75 percent it is 7 percent. Both beat the usual 20 percent long-term rate.

#Change 2: Per-issuer exclusion limit raised from $10M to $15M

The greater-of rule:

• $15M per issuer (post-OBBBA, was $10M), OR
• 10× your basis in the stock

For most early employees who paid pennies for their stock options, the $15M cap is what matters. For founders who put real money into the company, 10× basis can sometimes be the bigger number.

The $15M cap is adjusted for inflation each year starting with 2027. It was fixed at $10M before.

#Change 3: The gross-asset limit rises from $50M to $75M for stock issued after July 4, 2025. After 2026 the $75M amount is adjusted for inflation.

A company qualifies as a “small business” if its aggregate gross assets (cash plus the cost basis of all property, including IP) stayed under the limit at all times before the stock was issued, and stay under it right after the issue, counting the money raised in that round.

• Pre-OBBBA: $50M ceiling
• Post-OBBBA (effective for stock issued after July 4, 2025): $75M ceiling, adjusted for inflation starting with taxable years after 2026

This means more later-stage companies will qualify. A Series B or Series C company that crossed $50M in gross assets pre-OBBBA was already disqualified for new issuances. Post-OBBBA, they can keep issuing QSBS up to $75M.

#The dollar math: pre-OBBBA vs post-OBBBA

Two worked examples to show the magnitude of the change.

#Example 1: Founder selling at year 5 (pre-OBBBA stock)

Sarah, founder of a SaaS company, exits in 2030 with $15M of capital gain on stock she’s held since 2022 (pre-OBBBA issuance, so old rules apply).

• Holding period: 8 years (>5) → 100% exclusion eligible
• Per-issuer cap: $10M (pre-OBBBA)
• Excluded gain: $10M
• Taxable gain: $5M
• Federal tax on $5M @ 20% LTCG + 3.8% NIIT = ~$1.19M
• Net to Sarah: $13.81M

#Example 2: Founder selling at year 5 (post-OBBBA stock)

Same Sarah, but the stock was issued in 2026 (after OBBBA). She sells in 2031 with $15M gain.

• Holding period: 5 years → 100% exclusion eligible
• Per-issuer cap: $15M (post-OBBBA, possibly $16M+ by 2031 with inflation)
• Excluded gain: $15M
• Taxable gain: $0
• Federal tax: $0
• Net to Sarah: $15M

Improvement vs Example 1: $1.19M of additional after-tax wealth. Just from the limit going $10M → $15M.

#Example 3: Founder selling at year 3 (post-OBBBA, partial exclusion)

Mike, an early employee, exits at year 3 with $4M of capital gain from acquisition.

Pre-OBBBA approach (if his stock had been issued before July 4, 2025):

• Holding period 3 yrs (<5) → 0% QSBS exclusion
• $4M gain taxed at 20% LTCG + 3.8% NIIT = ~$952K
• Net to Mike: $3.05M

Post-OBBBA (stock issued after July 4, 2025):

• Holding period 3 yrs \u2192 50% exclusion
• Excluded gain: $2M
• Taxable gain: $2M at 28% = $560K, plus 3.8% NIIT = $76K, total $636K
• Net to Mike: about $3.36M

Improvement vs pre-OBBBA: about $316K. Mike gets to exit a year earlier than the old “wait 5 years” rule would have required, and still captures meaningful benefit.

#Operational planning: how founders + employees should think about this

The decisions QSBS changes:

#For founders deciding entity structure at incorporation

If you’re forming a new business and there’s any chance of substantial exit value (over $5M), strongly consider C-corp from day one. The QSBS exclusion only applies to C-corps. The S-corp election that saves you SE tax in the operating years can disqualify you from QSBS at exit. That disqualification is permanent for that stock.

The math: $15M exit gain × 23.8% (LTCG + NIIT) = $3.57M of federal tax saved by being a C-corp at issuance. That’s far bigger than any S-corp SE-tax savings over the operating years.

For ETS clients in the SaaS founder segment, this is a Day 0 decision we surface during initial advisory.

#For early employees deciding when to exercise options

If your company has issued stock after July 4, 2025 and you’re holding ISOs / NSOs:

• Exercising earlier starts your holding period sooner. It also costs cash, can create ordinary income or AMT, and puts that money at risk. Run the numbers before you decide.
• 3 years vs 5 years matters more now. Under the tiered rule, even a 3-year hold gets you 50% exclusion. The trade-off between “exit liquidity now vs $X more in exclusion later” is now more dynamic.

#For founders considering a sale before year 5

Pre-OBBBA: selling at year 4 meant losing 100% of QSBS benefit. Many founders held an extra year purely for the tax break.

Post-OBBBA: a year-4 sale captures 75% exclusion. The “hold for QSBS” pressure is much less acute. Liquidity events at year 3 or 4 are now legitimately on the table from a tax-planning standpoint.

#For employees joining a company that’s near the $75M threshold

Pre-OBBBA: a company that crossed $50M in gross assets stopped issuing QSBS-eligible stock. New employees got non-QSBS stock.

Post-OBBBA: more late-stage companies can still issue QSBS up to $75M gross assets. If you’re joining a $40-70M company starting 2027, ask the company whether they’re issuing QSBS-eligible stock.

#Common pitfalls (where founders lose the benefit)

#Pitfall 1: Doing an S-corp election after issuance

Once you elect S-corp status, you’re no longer a C-corp. New shares issued during the S-corp period don’t qualify for QSBS. Existing pre-election shares MAY qualify, but it’s complicated. If QSBS is on your radar, don’t elect S-corp.

#Pitfall 2: Disqualifying redemptions

Be careful with buybacks around the time new stock is issued. Buying stock from the person receiving the new shares, or from a related person, in the 4 years around the issue date can disqualify it. The same goes for buying back more than 5% of the company in the 2 years around it. Buying back stock from an employee who leaves is generally ignored. Founders need to coordinate buyback timing with cap-table events.

#Pitfall 3: Crossing the gross-asset threshold

Say your company’s gross assets exceed $75M (post-OBBBA) at any point, including right after a financing round. New stock issuances stop qualifying. Existing QSBS stays QSBS (the threshold is tested at issuance, not at exit), but new issuances after that point don’t qualify.

#Pitfall 4: Wrong type of business

The “qualified trade or business” exclusion is broad. Service businesses where “the principal asset is the reputation or skill of one or more of its employees” generally do not qualify: health, law, accounting, consulting, financial services, performing arts, athletics. SaaS and most software companies do qualify, because the principal asset is the code or product, not specific employee reputation.

#Pitfall 5: Stacking via gifting

You can multiply the per-issuer limit by gifting stock to family members. Each donee gets their own $15M cap. Done right, a founder can effectively exclude $30M, $45M, or more through careful planning with a tax-aware estate attorney. Done wrong, the IRS can challenge as a step-transaction. This needs sophisticated planning.

#Section 1045 QSBS rollover: the rarely-used escape valve

If you sell QSBS you have held for more than 6 months before the holding period is met, section 1045 lets you defer the gain by buying other QSBS within 60 days. You must reinvest the full sale price to defer all the gain, and the deferred gain lowers your basis in the new stock. The original holding period tacks onto the new stock.

This is rarely used because most founders selling early aren’t planning to immediately invest in another qualified small business. But for repeat founders + early-stage angels, it’s a real tool.

#Common questions

Does my company qualify for QSBS? Most C-corp operating businesses do, as long as gross assets are under the threshold. Exclusions are listed in §1202(e)(3): services in health, law, finance, accounting, consulting, performing arts, athletics, and a few others. SaaS, e-commerce, manufacturing, biotech and hardware generally qualify. Fintech depends on the facts, because banking, lending, leasing, investing and brokerage businesses are excluded. Also excluded are health, law, engineering, architecture, accounting, consulting, farming, mining, and hotels and restaurants.

Can I get QSBS treatment on stock I got from converting a SAFE? Yes. The conversion counts as “original issuance” for QSBS purposes. Same for convertible notes. Critical: the holding period starts at conversion, not at the SAFE or note origination.

What about RSUs? RSU shares can count as QSBS. The holding period starts when the shares are delivered to you, not when the RSU was granted. The company must still pass every other test on that day. Ask your tax adviser to check the company’s situation. However, ISOs and NSOs can qualify if exercised before the company crosses the gross-asset threshold and held for the required period.

Do all 50 states conform to §1202? No. State conformity varies widely. California does not conform to §1202. California taxes QSBS gain at full state rates. Texas has no state income tax, so federal-only matters. New York generally conforms, but check specifics. State-level analysis matters for high-income founders.

Can I use QSBS more than once? Yes. The $15M cap is per-issuer, not per-taxpayer lifetime. You can stack multiple companies’ QSBS exclusions across your career. Many serial founders end up using QSBS 2-5 times.

What if I die holding QSBS? QSBS treatment passes to your heirs at full step-up in basis. The QSBS character is generally preserved if the inheriting party meets the other requirements. This is one of the few cases where dying with appreciated stock is actually tax-favorable (basis step-up plus QSBS treatment).

What’s the “10× basis” alternative? If 10× your basis exceeds $15M, you get the bigger number. For most founders this won’t apply (basis is tiny). But for founders who put serious capital in (say $5M founder investment), 10× = $50M. That’s a much bigger exclusion than the $15M cap.

Can I gift QSBS to a trust to multiply the cap? Gifts to trusts or family can, in some cases, give each recipient a separate cap. The trust must be a separate taxpayer, you use gift exemption, and the recipient keeps your basis. Work with a tax lawyer. The savings depend on the facts and are not guaranteed. Needs careful structuring with a tax-aware estate attorney.

Does QSBS apply to ESPP shares? Generally no, ESPP shares are typically purchased at a discount to FMV, which complicates the original issuance requirement. Some narrow ESPP structures might qualify; needs specific analysis.

When should I think about QSBS planning? Three trigger moments:

1. Pre-incorporation: the C-corp-vs-S-corp decision is QSBS-determinative
2. Pre-Series-B: when gross assets are approaching the threshold ($75M post-OBBBA)
3. 18-24 months pre-exit: to evaluate trust/gifting strategies that multiply the cap

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If you’re a founder or early employee with QSBS-eligible stock and any path to a significant exit, the Discovery call is the right next step. We model QSBS strategy as part of every pre-exit Tax Analysis engagement. We also coordinate with your tax-aware estate attorney for trust-based stacking strategies that can multiply your effective exclusion.