Qualified Small Business Stock (QSBS) Tax Rules

Investors holding qualified small business stock (QSBS) should know that they can qualify for tax benefits. These perks are in place to offer encouragement for both parties, incentivizing small business investment while providing a benefit for investors. To qualify, however, there are some small business and shareholder rules that you must follow.

You might also consider speaking with a financial advisor, who can help you plan out your taxes.

What Is Qualified Small Business Stock (QSBS)?

Qualified small business stock (QSBS) is stock that is eligible for the special tax rules that Section 1202 of the Internal Revenue Code (IRC) established. Under this section of the tax code, eligible shareholders are permitted to exclude some or all the capital gains on QSBS. The percentage of gain that investors can exclude depends in part on when the stock was acquired and, for certain shares acquired after July 4, 2025, how long the investor holds it.

The IRS added this exemption to encourage investment in small businesses. In the United States, small businesses are a vital part of the economy. However, investing in these businesses can be risky. In response to that dilemma, the IRS introduced this tax exemption as part of the Revenue Reconciliation Act of 1993. In 2010, the Small Business Jobs Act expanded the exemption. Federal legislation enacted in 2025 further expanded the QSBS rules.

QSBS Tax Rules

The QSBS tax exemption allows small business owners to potentially save a significant amount on capital gains. For qualifying stock acquired after July 4, 2025, Section 1202 generally limits the eligible gain for each issuer to $15 million. ¹ Different limits can apply to stock acquired on or before that date.

The holding period also matters. Qualifying stock acquired after July 4, 2025, can receive a 50% gain exclusion after an investor has held it for at least three years. That will increased to a 75% exclusion after at least four years, and a 100% exclusion after at least five years. This means investors do not necessarily have to hold newer QSBS for five years before they receive any Section 1202 exclusion.

Older QSBS follows different rules. Stock acquired after Sept. 27, 2010, and on or before July 4, 2025, generally must satisfy a five-year holding period to receive a 100% exclusion. Stock acquired during earlier periods can qualify for smaller exclusion percentages under the rules that applied when it was acquired.

Small Business Requirements

Not all companies qualify as small businesses under IRS rules. For company shares to be eligible for the tax exemption, they must meet all the following requirements:

• Assets must fall within the applicable limit. For stock issued after July 4, 2025, the issuing corporation generally cannot have gross assets exceeding $75 million before and immediately after the stock is issued. The corresponding limit is $50 million for stock issued on or before July 4, 2025.
• Must be an active C-corp. The company must be an active C-corp that is incorporated in the United States.
• Must operate in an eligible industry. Not all industries are eligible for this exemption. Eligible industries include technology, retail, manufacturing and wholesale. Excluded industries include banking, finance, insurance, farming, mining and hospitality-related industries.

The asset test is applied when the stock is issued. A company growing beyond the applicable asset ceiling later does not, by itself, cause previously qualifying shares to lose QSBS treatment. However, the stock and issuing company must continue to satisfy the other requirements that apply under Section 1202.

Shareholder Requirements

There are also some requirements shareholders must meet to be eligible for this tax exemption, regardless of whether the small business qualifies. These requirements for investors are:

• Cannot be a corporation. While the entity in which you invest must be a corporation, the investor cannot also be a corporation. The investor should be an individual, trust or pass-through entity.
• Must hold stock in the company. This exemption only applies to stocks. Bonds, options or other types of assets are not eligible.
• Meets the applicable holding period. For stock acquired after July 4, 2025, an investor can potentially qualify for a partial exclusion after three or four years. After five years, they can qualify for the full exclusion. Earlier shares generally need to satisfy the holding-period rules that apply to their acquisition date.
• Generally acquire the shares at original issue. Section 1202 generally requires the taxpayer to receive the stock directly from the issuing corporation, including in exchange for money, qualifying property or services. Special rules can preserve QSBS treatment in certain transfers, such as gifts or inheritances.

How the QSBS Exclusion Can Work

Suppose an investor acquires qualifying shares directly from a small C corporation after July 4, 2025. Later, they sell those shares for a $4 million gain. Assuming the shares and the investor satisfy the other Section 1202 requirements, selling after three years could make 50% of that gain eligible for exclusion. If they waited to selling after four years, that could make 75% eligible. Reaching the five-year holding period could allow the full $4 million gain to qualify for exclusion because it is below the applicable per-issuer limit.

This result can vary for shares that investors acquired before the 2025 law change. Acquisition date, holding period, the issuing company’s eligibility and the amount of gain all matter when determining the amount of the exclusion. Investors considering a sale may therefore want to establish when they acquired each block of shares before calculating the potential tax treatment.

Bottom Line

Qualified small business stock (QSBS) is stock in a small business that may qualify for a tax exemption. The IRS originally introduced the exemption in 1993. Subsequent legislation has since expanded it to let investors exempt up to 100% of capital gains tax on their QSBS. Changes enacted in 2025 also created partial exclusions for certain newer QSBS held for at least three or four years, raised the gross-asset ceiling for newly issued qualifying stock to $75 million and increased the per-issuer gain limit for qualifying newer shares to $15 million.

Tips for Investing

• Deciding how to allocate your portfolio isn’t always easy. A financial advisor can help you make the right choice by helping you figure out and put together a strategy to help you reach your goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area. From there, you can interview your matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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