QSBS After the 2025 Law Change: The $15 Million Exclusion Explained

Section 1202 is the most generous provision in the individual tax code, and most of the people who could use it have no idea it applies to them. A founder or early employee who gets stock in a C corporation while it's small, holds it five years, and sells can exclude up to $15 million of gain per company from federal income tax. Fifteen million. The One Big Beautiful Bill Act, signed July 4, 2025, made the provision bigger and, for the first time, partly available before five years. This is where things stand now.

The basic rule

Qualified small business stock is stock in a domestic C corporation, acquired at original issuance (from the company, not from another shareholder) in exchange for money, property, or services, at a time when the corporation's gross assets didn't exceed the threshold, in a corporation that uses at least 80% of its assets in an active qualified trade or business. Hold it long enough and gain on the sale is excluded from income up to the per-issuer cap.

Some businesses are shut out regardless: professional services (health, law, engineering, accounting, financial services, consulting), banking and insurance, farming, hotels and restaurants, and any business whose principal asset is the reputation or skill of its employees. Technology, manufacturing, retail, and most product companies qualify.

What changed in 2025

For stock issued after July 4, 2025:

• Tiered exclusion. 50% of gain is excluded after three years, 75% after four, and 100% after five. Before, you got nothing until five years.
• Higher cap. The per-issuer limit is the greater of $15 million (indexed for inflation in later years) or ten times your basis in the stock. It was $10 million.
• Larger companies qualify. The gross-asset test at issuance rose from $50 million to $75 million, also indexed.

Stock issued on or before July 4, 2025 keeps the old rules: a $10 million cap, a $50 million asset test, and no exclusion before five years. Because the rules attach to each share at issuance, a founder can hold both kinds at once, and every option exercise or share purchase creates a new lot with its own issuance date and its own five-year clock. Which is exactly as tedious to track as it sounds.

The 28% catch

Gain from QSBS that isn't excluded doesn't get the usual 20% long-term rate. It's "28-percent rate gain" under Section 1(h), taxed at 28% plus the 3.8% net investment income tax. So a sale after three years with a 50% exclusion pays 31.8% on half the gain, an effective 15.9% on the whole. That's roughly what an ordinary long-term sale would have cost you anyway. The four-year tier (75% excluded) brings the effective rate down to about 8%. Only the five-year tier gets you to zero. The tiers are useful when a liquidity event shows up before five years and the alternative is 23.8% on everything. They're not a reason to sell early.

The cap in practice

The $15 million cap applies per taxpayer, per issuer, over a lifetime. Two things stretch it.

Ten times basis. Someone who contributed $3 million of property or cash for stock has a $30 million cap. This matters mostly for investors and for founders who put in appreciated assets.

Gifts and trusts. QSBS that's gifted keeps its character and holding period in the recipient's hands, and each recipient gets their own $15 million cap. Founders staring at a large exit sometimes gift shares to non-grantor trusts for children, multiplying the exclusion. This is legitimate, it's aggressive, and it needs careful drafting so the trusts aren't treated as the founder's alter ego. It's a conversation to have years before the sale. Not months.

How stock loses qualification

• Buying from another shareholder. Secondary purchases aren't original issuance. Stock bought on a secondary market doesn't qualify no matter how small the company is.
• Significant redemptions. If the corporation redeems stock from the holder (or related persons) in the two years around issuance, or makes significant redemptions from anyone in the year around issuance, the stock can be disqualified.
• Exceeding the asset test at issuance. The $75 million test is measured immediately after the issuance, including the cash raised in that round. Late-stage grants often fail it.
• Converting from an S corporation or LLC. Stock received when a partnership or LLC incorporates can qualify, with the holding period and the asset test measured at incorporation and the pre-conversion appreciation left out. An S corporation is trickier: simply revoking the S election doesn't create newly issued stock, so the existing shares generally don't qualify; contributing the S corporation or its assets to a new C corporation can.
• Losing the active business test. A company that piles up cash or investments above the permitted level, or that turns into a holding company, can fail the 80% test during the holding period.
• Option and RSU timing. The holding period starts when you receive stock, not when the option or RSU is granted. An 83(b) election on early-exercised shares starts the clock at exercise. Waiting to exercise until a liquidity event means the clock never runs at all.

Section 1045 rollovers

Stock sold before the holding period is met can be rolled into new QSBS within 60 days under Section 1045, which defers the gain and tacks the holding period. It's a narrow tool, but a useful one for an investor who exits one company early and is putting money into another.

Documentation

Section 1202 qualification is proven, not assumed. You need the stock purchase or grant documents, the company's balance sheet at issuance showing gross assets, and evidence of the active business test, ideally a representation from the company. Companies that have raised institutional money often get a QSBS opinion. Employees rarely do, and at audit the burden is theirs. We ask for the documents at the start of the engagement, while the company's finance team still remembers where they are.

How we plan around it

For clients with startup equity, we track QSBS status lot by lot: issuance date, which regime applies, when each holding period ends, and how much cap is left. Exercise timing is set to start clocks early. Gifting gets evaluated once an exit looks plausible. The sale is timed against the five-year dates where the deal allows, and the liquidity event checklist puts it in sequence with everything else. For a founder, this is often the single biggest planning item of their financial life, and it's part of tax planning from the first meeting on.

Frequently asked questions

Joseph G. Valerio, CFP®, EAFounder and Lead Advisor at Valerio Wealth Management, a fee-only, fiduciary virtual family office in Miami, Florida. One advisor, credentialed in both financial planning and federal tax. About Joseph

This article is general education, not individualized advice, and it is not tax, legal, or accounting advice. Figures reflect federal law for the year stated and can change. Valerio Wealth Management does not prepare or file tax returns. Speak with a qualified professional about your own situation before acting.