Qualified Small Business Stock (QSBS) is stock in a U.S. C-corporation that can qualify for a large, and sometimes total, exclusion from federal capital gains tax when you sell it, under Internal Revenue Code Section 1202.

For founders and early employees, qualified small business stock is one of the most valuable tax benefits in a startup exit. If your stock qualifies and you hold it long enough, you may pay zero federal tax on a substantial slice of your gain.

How qualified small business stock works

To qualify, several tests must be met. The issuer must be a domestic C-corporation, both when the stock is issued and, in general, throughout your holding period. You must acquire the stock at original issuance, not by buying it from another shareholder. The company’s aggregate gross assets must stay at or below the statutory ceiling at the time of issuance. And at least 80% of the company’s assets must be used in an active qualified trade or business, which excludes many service fields such as law, health, consulting, and finance. The governing statute is IRC Section 1202.

The 2025 OBBBA changes to QSBS

The size of the exclusion depends on when you acquired the stock. The 2025 One Big Beautiful Bill Act (OBBBA) changed the rules for stock acquired after July 4, 2025.

For stock acquired after July 4, 2025, a new tiered exclusion applies. You can exclude 50% of the gain after a three-year hold, 75% after four years, and 100% after five years. The per-issuer cap rises to the greater of $15 million or 10 times your basis, indexed for inflation starting in 2027. The company’s gross-asset ceiling rises to $75 million, also indexed from 2027.

For stock acquired on or before July 4, 2025, the prior rules still apply. That means a five-year hold for up to 100% exclusion on stock acquired after September 27, 2010, a per-issuer cap of the greater of $10 million or 10 times basis, and a $50 million gross-asset ceiling.

The California QSBS trap

One state trap matters here. California does not conform to Section 1202. The state does not follow the federal QSBS exclusion, so your California tax on the gain is generally unaffected even when the federal exclusion is complete.

QSBS planning for founders

QSBS planning starts on day one. Incorporating as a C-corporation, documenting original issuance, watching the gross-asset threshold, and keeping clean records all protect the benefit long before an exit is on the table. An 83(b) election and holding period planning often go hand in hand with qualified small business stock.

This is a general explanation, not tax advice. Section 1202 is fact-specific and the stakes are high, so confirm your position with tax counsel before relying on it.