What it is
TL;DRIf you hold qualifying C-corp stock for at least five years, §1202 excludes up to $10 million (or 10× your basis, whichever is greater) of gain on sale from federal income tax. Pristine planning can multiply the $10M cap across family trusts.
QSBS is the largest single exclusion available to individual taxpayers in the entire code. A founder selling for $10 million can pay zero federal capital-gains tax, saving roughly $2.4 million.
It is also unforgiving. The corporation must be a domestic C-corp at every point during the holding period, gross assets must never have exceeded $50 million (at issuance), and the company must operate in a qualifying trade or business.
Who it's for
Founders and early shareholders of C-corp operating businesses planning a sale 5+ years out.
- ✓Founders of growing C-corp operating businesses with realistic exit potential
- ✓Early-stage equity holders in tech, manufacturing, biotech, consumer products
- ✓Owners considering a C-corp conversion before a large funding round or expected exit
- ×S-corp owners who do not want C-corp double taxation on operating income (run the math carefully)
- ×Service businesses in disqualified fields, health, law, accounting, consulting, financial services
- ×Anyone selling within 5 years of issuance, no exclusion at all
How it works
1. Confirm corporate qualification
C-corporation throughout the holding period. Aggregate gross assets ≤ $50M immediately after stock issuance. Active business: 80% of assets used in a qualified trade or business. Disqualified fields excluded (services in health, law, accounting, etc., plus banking, farming, hotels, restaurants).
2. Hold for at least five years
Five years from the date of issuance to the date of sale. Stock acquired by gift, inheritance, or partnership distribution can tack the prior holder's period.
Original issuance is critical: §1202 only applies to stock acquired directly from the corporation, not stock purchased from another shareholder. Secondary purchases do not qualify.
3. Stack the exclusion through trusts and family planning
The $10M cap is per shareholder per issuer. Non-grantor trusts created for family members each have their own $10M cap. Founders with $50M+ exits routinely gift QSBS to multiple non-grantor trusts to multiply the exclusion.
Gifts must be completed (real, irrevocable transfers) and made well before sale negotiations, not on the eve of an LOI.
4. Use §1045 rollover if selling before five years
If you must sell QSBS held more than six months but less than five years, §1045 allows you to roll the gain into replacement QSBS within 60 days, preserving the eventual exclusion.
A worked example
Ben founded a Utah-based industrial automation C-corp in 2018, basis $50,000. The company is acquired in 2026 for $24,000,000 of cash. Two years before sale, Ben gifted equal portions of his stock to two non-grantor trusts for his children. Each trust holds qualifying QSBS for the required period.
| Direct sale (no trust stacking) | Three QSBS holders (Ben + 2 trusts) | |
|---|---|---|
| Gain | $23,950,000 | $23,950,000 |
| §1202 exclusion (single $10M cap) | $10,000,000 | , |
| §1202 exclusion (three $10M caps) | , | $23,950,000 |
| Federal capital-gains tax | $3,321,000 | $0 |
| Utah state tax | $1,114,000 | $1,114,000 |
| Federal tax saved | $3,321,000 |
By splitting the stock across two well-structured non-grantor trusts before the LOI, Ben converts a $3.3M federal tax bill into zero. Utah does not conform to §1202, so state tax remains. Trust setup and structure cost: roughly $35,000 of professional fees.
Limits and risks
The original-issuance rule kills more QSBS positions than any other. Founders' shares qualify; secondary buyer shares do not. Convertible-note conversions are typically fine; bought shares from another founder are not.
Trust-stacking only works if the trusts are real. Non-grantor trusts must have independent trustees, separate banking, real beneficiaries, and the founder cannot retain control. Pre-sale gifts done sloppily are pulled back into the founder under the assignment-of-income doctrine.
Several states do not conform to §1202 (California, Pennsylvania, New Jersey, and others). State residency at the time of sale controls, see the domicile-planning piece.
QSBS audits focus on three questions: was the corporation actually a C-corp during the entire holding period; were aggregate gross assets ever above $50M; and were trust gifts real and completed before sale negotiations began. Documentation is everything: corporate minutes, balance sheets at issuance, trust formation timing, and trustee actions.
IRS reference
- IRC §1202100% exclusion of gain on qualifying small business stock held 5+ years (acquired after 9/27/2010).
- IRC §1045Rollover of QSBS gain into replacement QSBS within 60 days.
- Rev. Rul. 2024-14Recent guidance on F-reorg conversions and §1202 qualification timing.