QSBS FAQs: Frequently Asked Questions About Qualified Small Business Stock

This page addresses the most frequently asked questions about Qualified Small Business Stock (QSBS) and Section 1202 exclusions. Each question is answered with references to relevant code sections and regulations, with cross-references to more detailed pages where applicable.

General QSBS Questions

What is QSBS?

Answer: Qualified Small Business Stock (QSBS) refers to stock in a C corporation that fulfills specific criteria as outlined in Section 1202 of the Internal Revenue Code. This designation allows investors to potentially exclude up to 100% of capital gains derived from such stocks from federal income taxes, depending on the acquisition date and duration of the holding period. The qualifications for a stock to be considered QSBS are stringent:

• The stock must be issued by a C corporation with total assets not exceeding $75 million at the time of and immediately following the issuance.
• It must be acquired directly at its original issue, rather than purchased through a secondary market.
• The stock must be held by the investor for a requisite period, which can be between 3 to 5 years, based on the specific acquisition date.

For a detailed breakdown of these criteria, see QSBS Basics & Overview.

How much can I exclude?

Answer: The extent of the exclusion on capital gains from QSBS depends significantly on both the date of acquisition and the duration of the holding period:

Stock acquired on or before July 4, 2025:

• A 50% exclusion is available for stocks held for more than 5 years. Special rules apply for certain periods: a 75% exclusion for stocks acquired between February 18, 2009, and September 27, 2010; and a 100% exclusion for stocks acquired post-September 27, 2010.

Stock acquired after July 4, 2025:

• The exclusion starts at 50% for stocks held for at least 3 years, increases to 75% for a holding period of at least 4 years, and reaches 100% when held for 5 years or more.

Additionally, the exclusion is subject to a per-issuer limit, which is the greater of $10 million (for stocks acquired on or before July 4, 2025) or $15 million (for stocks acquired after this date), or 10 times the adjusted basis of the QSBS.

For a complete elucidation of these rules, consult QSBS Exclusion Rules (Section 1202).

What is the per-issuer limit?

Answer: The exclusion available under Section 1202 is capped per issuer to prevent excessive tax benefits from accruing to an individual investor from a single source. The limit is set at either:

• $10 million for stocks acquired on or before July 4, 2025, or
• $15 million for stocks acquired after this date, or
• An amount equal to 10 times the investor’s adjusted basis in the QSBS.

This per-issuer cap can be applied across multiple issuers, thus enabling gains from different QSBS issuers to be excluded up to the limit specified for each.

For further details, refer to QSBS Exclusion Rules (Section 1202).

Eligibility Questions

Can S corporations qualify?

Answer: QSBS benefits are strictly reserved for stocks issued by C corporations. This specific provision excludes S corporations, partnerships, LLCs, and other such entities from qualifying as issuers of QSBS under [IRC §1202(e)(4)].

What is the asset test?

Answer: To meet the QSBS criteria, the issuing corporation must not have had aggregate gross assets exceeding $75 million at any point from August 10, 1993, through the issuance of the stock and immediately thereafter. This threshold was raised from $50 million for stocks issued after July 4, 2025, reflecting an adjustment aimed at accommodating inflation and changes in the economic environment. [IRC §1202(d)(1)]

For a thorough discussion on this topic, see QSBS Qualified Small Business Requirements.

Can I buy QSBS on the secondary market?

Answer: No, QSBS must be acquired directly from the issuing corporation at its original issue (or through an underwriter) to qualify [IRC §1202(c)(1)(B)]. Purchases made on the secondary market do not meet the requirements set forth for QSBS eligibility.

What businesses are excluded?

Answer: The statute explicitly excludes certain types of businesses from being eligible issuers of QSBS. These exclusions encompass sectors such as professional services (e.g., law, accounting, consulting), financial services (e.g., banking, insurance), and others including farming, natural resource extraction, and hospitality. The underlying rationale for these exclusions is typically based on the nature of the assets being primarily the reputation or skill of one or more employees. [IRC §1202(e)(3)]

For a comprehensive list of excluded businesses, consult the relevant statutory provision cited above.

Holding Period Questions

How long must I hold QSBS?

Answer: The required holding period for QSBS varies based on the acquisition date:

• Stock acquired on or before July 4, 2025: Must be held for more than 5 years.
• Stock acquired after July 4, 2025: The holding period must be at least 3 years, with the exclusion percentage increasing for longer holding periods.

These holding period requirements are crucial for qualifying for tax benefits under Section 1202 and are strictly enforced. For more detailed information, see QSBS Exclusion Rules (Section 1202).

Does the holding period transfer if I receive QSBS as a gift?

Answer: Yes, according to Section 1202(h), the continuity of the holding period is preserved in cases of stock transfers by gift, upon the death of the holder, or transfers from a partnership. The recipient is treated as having held the stock for the period during which the transferor held it. [IRC §1202(h)(1)]

For more details on how these transfers affect QSBS status, visit QSBS Transfers and Conversions.

Partnership Questions

Can I hold QSBS through a partnership?

Answer: Yes, Section 1202(g) facilitates the flow-through of QSBS benefits to partners, provided the partner held an interest in the partnership continuously from the time the QSBS was acquired until it was disposed of. [IRC §1202(g)]

For a detailed exploration of QSBS in the context of partnerships, see QSBS and Partnerships.

Can carried interest holders claim QSBS benefits?

Answer: The eligibility of carried interest holders for QSBS benefits under Section 1202 remains ambiguous. While the statute suggests that any partnership interest might qualify, the Regulation 1.1045-1(d) specifies that a capital interest is necessary for benefits under Section 1045, leading to uncertainty about the applicability of these rules to Section 1202 exclusions.

For a more in-depth analysis, refer to QSBS and Carried Interest.

Rollover Questions

Can I defer QSBS gains?

Answer: Under Section 1045, it is possible to defer recognition of capital gains from QSBS by reinvesting the proceeds into new QSBS within a 60-day window following the sale. [IRC §1045(a)]

For comprehensive coverage on this topic, see QSBS Rollovers (Section 1045).

What is the 60-day rule?

Answer: The 60-day rule under Section 1045 mandates that the purchase of replacement QSBS must occur within 60 days starting from the date of sale of the original QSBS. This timeline is critical as investments made even one day later, on the 61st day, fail to qualify for the rollover benefits. [IRC §1045(a)(1)]

Tax Reporting Questions

How do I report QSBS on my tax return?

Answer: Gains from QSBS and their relevant exclusions are reported on Form 8949 and Schedule D. It's essential that taxpayers maintain comprehensive documentation to substantiate the QSBS status, as this will be crucial for validating the eligibility for tax benefits.

For further guidance on reporting QSBS gains, see QSBS Reporting Requirements.

Do I need to file any special forms?

Answer: While QSBS gains are reported using standard tax forms like Form 8949 and Schedule D, meticulous records are imperative. These should detail the qualification of the stock as QSBS, adherence to holding periods, the method of acquisition, and eligibility of the corporation at the time of stock issuance, among other pertinent facts.

State Tax Questions

Does Section 1202 apply to state taxes?

Answer: Section 1202 is primarily a federal tax provision, and state conformity to these rules can vary. While some states align with federal QSBS exclusion rules, others, like California and New Jersey, do not. This discrepancy can lead to state tax liabilities even on gains excluded at the federal level.

It's advisable to review the specific QSBS tax treatments applicable in your state.

Planning Questions

Can I use both Section 1045 rollover and Section 1202 exclusion?

Answer: It is indeed feasible to employ both tax strategies, albeit they serve different purposes:

• Section 1045 allows for the deferral of gains, which effectively reduces the basis in the replacement stock.
• Section 1202 provides for a permanent exclusion of gains, provided the requisite conditions are met.

Strategically, an investor might first utilize Section 1045 to defer gains and subsequently apply Section 1202 to exclude any remaining gains upon the sale of the replacement stock, assuming all conditions, including holding periods, are fulfilled.

For strategic insights into maximizing QSBS benefits, see QSBS Planning Strategies.

Can I maximize QSBS benefits through multiple issuers?

Answer: Yes, the per-issuer limits on exclusion apply independently to each qualified issuer. Thus, if an investor holds QSBS from several different qualifying small businesses, they can exclude gains from each, subject to the separate per-issuer limits of $10 million or $15 million, depending on the acquisition dates.

Common Mistakes

What are common QSBS mistakes?

Answer: Investors often encounter pitfalls such as:

• Purchasing stock on the secondary market, which disqualifies it from being considered QSBS.
• Failing to meet the specific holding period requirements.
• Not adhering to the active business requirements during the holding period.
• Exceeding the per-issuer limits on exclusion.
• Lacking adequate documentation to substantiate QSBS status.
• Overlooking the implications of state tax laws which might not conform to federal QSBS rules.

For a comprehensive review of these and other common issues, refer to QSBS Common Issues and Pitfalls.

Recent Changes

What changed in 2025?

Answer: The amendments enacted through Pub. L. 119-21 on July 4, 2025, introduced several significant changes to the QSBS landscape:

• The threshold for gross assets was raised from $50 million to $75 million.
• The per-issuer limit on exclusion was increased from $10 million to $15 million for stocks acquired post the applicable date.
• The minimum holding period was reduced to 3 years for stocks acquired post the applicable date.
• A tiered exclusion percentage system was introduced, allowing for varying levels of exclusion based on the holding period.

For an exhaustive account of these updates, see QSBS Recent Changes and Updates.

Key Takeaways

1. QSBS requires original issue: Cannot buy on secondary market
2. Holding period matters: 3-5 years depending on acquisition date
3. Per-issuer limits apply: $10-15 million per issuer
4. Only C corporations qualify: S corps, partnerships, LLCs do not
5. State taxes may still apply: Section 1202 is federal only
6. Documentation is critical: Maintain records to substantiate QSBS status

Sources and Citations

• IRC Section 1202: Partial exclusion for gain from certain small business stock
• IRC Section 1045: Rollover of gain from qualified small business stock
• IRC Section 1202(g): Pass-through entity treatment
• IRC Section 1202(h): Transfers by gift and death
• Reg. 1.1045-1: Partnership rollover rules

Verification Date: January 2025

Note: These FAQs provide general information based on current law as of January 2025. Tax law is complex and changes frequently. This information should not be construed as legal or tax advice. Consult with a qualified tax professional regarding your specific situation. Each situation is unique, and professional advice tailored to your circumstances is essential.