The QSBS Exemption

Section 1202 of the Internal Revenue Code lets founders and investors in qualifying C corporations exclude up to $15 million or more of gain from federal income tax when they sell their stock. For a founder who builds a company and sells it, that can be the difference between paying millions in federal tax and paying nothing.

The 2025 federal tax law made the exclusion significantly more generous for stock issued after July 4, 2025. It raised the per company cap, raised the size limit for qualifying companies, and for the first time allowed a partial exclusion for stock held three or four years instead of five. It also created two sets of rules, because stock issued before that date still follows the old ones.

QSBS is also one of the easiest tax benefits to lose. The wrong entity at formation, a poorly timed redemption, too many passive assets, or a sale structured as an asset deal can eliminate it. This guide covers how the exclusion works, who qualifies, what the 2025 changes mean for 2026 planning, how Oklahoma taxes QSBS gain, and how to keep the benefit intact from formation through exit.

Table of Contents

• What Is QSBS?
• What the 2025 Tax Law Changed
• QSBS Requirements
• How Much Gain Can Be Excluded?
• What the Exclusion Is Worth: Examples
• Planning at Formation and When Converting an LLC
• Strategies to Maximize the Exclusion
• Selling a Company With QSBS
• How Oklahoma Taxes QSBS Gain
• Common Mistakes That Destroy QSBS
• Documentation and Next Steps

What Is QSBS?

Qualified small business stock (QSBS) is stock that meets the requirements of Section 1202. When a noncorporate holder, such as an individual, trust, or estate, sells QSBS after the required holding period, some or all of the gain is excluded from federal income tax. Congress created the exclusion in 1993 to encourage long term investment in small, operating C corporations, and has expanded it several times since.

The key features are simple to state:

• Only C corporation stock qualifies. LLC units, partnership interests, and S corporation stock do not.
• The stock must be acquired at original issuance, directly from the company, in exchange for money, property, or services. Stock bought from another shareholder does not qualify.
• The company must be small when the stock is issued and must use its assets in an active, qualifying business during substantially all of the holder’s holding period.
• The benefit is large. The exclusion is measured per company and per taxpayer, so a founder, each investor, and in some cases each family trust can each exclude up to the cap.

The exclusion also takes the gain out of the 3.8 percent net investment income tax. The IRS explains the reporting in Publication 550, and Carta’s QSBS overview is a helpful plain language summary.

What the 2025 Tax Law Changed

The One Big Beautiful Bill Act, signed July 4, 2025, rewrote the key numbers in Section 1202 for stock acquired after that date. The Tax Adviser’s analysis and the Tax Foundation’s summary of the law cover the changes in detail.

Nothing changed about which businesses qualify, the original issuance requirement, the active business test, or the redemption rules. The practical effect of the new law is threefold: more companies qualify at issuance, the cap covers larger exits, and holders who sell before five years get something instead of nothing.

QSBS Requirements

Every requirement must be met, some at issuance and some throughout the holding period. Missing any one of them eliminates the exclusion for the affected stock.

Requirements for the Company

• Domestic C corporation. The company must be a U.S. C corporation when the stock is issued and during substantially all of the holder’s holding period. An LLC that elects to be taxed as a C corporation counts; an S corporation does not.
• Gross assets test. The corporation’s aggregate gross assets (cash plus the tax basis of other property, with contributed property counted at its value when contributed) must not exceed $75 million at any time before the issuance and immediately after it, for stock issued after July 4, 2025. Once a company passes the threshold, later issuances do not qualify, but stock already issued keeps its status.
• Active business test. At least 80 percent of the company’s assets, by value, must be used in the active conduct of one or more qualified trades or businesses during substantially all of the holder’s holding period. Excess cash, investment portfolios, and real estate not used in the business can cause a company to fail. Working capital held for reasonably expected business needs and research spending get some leeway.

Excluded Businesses

Section 1202 excludes several categories of business entirely:

• Services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services
• Any business whose principal asset is the reputation or skill of one or more employees
• Banking, insurance, financing, leasing, investing, and similar businesses
• Farming
• Businesses producing or extracting products eligible for percentage depletion, which includes most oil and gas production
• Hotels, motels, restaurants, and similar businesses

Software, technology, manufacturing, distribution, most retail and ecommerce, biotechnology, and many business services generally qualify. Some lines are fuzzy: a company that sells a product and provides related services, or a health technology company, needs careful analysis of what its business actually is.

Requirements for the Holder

• Noncorporate taxpayer. Individuals, trusts, and estates can claim the exclusion. Pass through entities such as LLC funds can hold QSBS and pass the benefit through to their individual members, subject to additional rules.
• Original issuance. The holder must acquire the stock directly from the corporation for money, property other than stock, or services. Stock received by gift or at death keeps the transferor’s QSBS status and holding period.
• Holding period. At least three years for a partial exclusion on stock issued after July 4, 2025, and more than five years for a full exclusion (and for any exclusion on older stock).

The Redemption Traps

Two anti abuse rules disqualify stock when the company buys back shares around the time it issues new ones:

• Redemptions from the holder. If the company redeems more than a de minimis amount of stock from the holder or a related person within the two years before or after the issuance, the newly issued stock does not qualify.
• Significant redemptions. If the company redeems more than 5 percent of the value of all its stock within the one year before or after an issuance, stock issued in that window does not qualify for anyone.

These rules catch ordinary transactions, such as buying out a departing cofounder shortly before a financing round. Any redemption, including repurchases of unvested founder or employee shares, should be reviewed for QSBS impact before it happens.

How Much Gain Can Be Excluded?

The Per Company Cap

For each company, a taxpayer can exclude gain up to the greater of:

• $15 million (for stock issued after July 4, 2025; $10 million for older stock), reduced by gain already excluded on that company’s stock in prior years, or
• 10 times the taxpayer’s aggregate adjusted basis in the QSBS of that company sold during the year

For a founder who received shares for a nominal amount, the $15 million figure usually controls. For an investor who put in significant cash, or a founder who contributed valuable property, the 10 times basis figure can be much larger. An investor who paid $3 million for QSBS can exclude up to $30 million of gain from that company.

The Holding Period Tiers

For stock issued after July 4, 2025, the percentage of eligible gain excluded depends on how long the stock was held:

*For a taxpayer in the top bracket, assuming the taxable portion is taxed at the 28 percent maximum rate plus the 3.8 percent net investment income tax, and that the gain is within the per company cap. Alternative minimum tax and individual circumstances can change the result.

The partial tiers make QSBS relevant to companies that sell earlier than expected, which happens often. But the difference between a sale at four years and eleven months and a sale at five years can still be millions of dollars. Sale timelines, earnouts, and installment payments should be planned with the holding period dates in mind.

Gain Above the Cap

Gain beyond the per company cap is taxed as ordinary long term capital gain at up to 20 percent plus the net investment income tax. Several of the strategies below are designed to increase the cap available to a family or to move more of the gain within it.

What the Exclusion Is Worth: Examples

Founder Exit After Five Years

A founder forms a C corporation in 2026, buys her founder shares for $1,000, and sells the company in 2031 for proceeds of $12 million on her shares. Her entire $11,999,000 gain is under the $15 million cap and held more than five years. Her federal tax on the gain is zero, compared with roughly $2.86 million without QSBS.

The Same Exit at Three Years

If the same founder sold in 2029, three years after issuance, half of the gain would be excluded and the other half taxed at up to 28 percent plus the net investment income tax. Her federal tax would be roughly $1.9 million. That is a meaningful savings compared with no QSBS, and a strong reason to understand the holding period clock before agreeing to a sale date.

Investor Using the 10 Times Basis Rule

An investor pays $3 million for preferred stock in a qualifying Oklahoma software company and sells five years later for $40 million. His gain is $37 million. His cap is the greater of $15 million or ten times his $3 million basis, so $30 million is excluded, and only $7 million is taxed.

An LLC Converted to a C Corporation

An operating LLC worth $8 million converts to a C corporation. For QSBS purposes, the owners’ stock takes a basis equal to the $8 million value at conversion, the holding period starts at conversion, and the $8 million of pre conversion appreciation is not eligible for the exclusion. Five years later, the company sells for $50 million. The $42 million of post conversion gain is eligible, and the cap is the greater of $15 million or ten times the $8 million basis, which is $80 million, so the entire $42 million can be excluded. Conversions can be powerful, but the timing and valuation need to be documented carefully.

Planning at Formation and When Converting an LLC

Choosing the Entity

QSBS is one of the main reasons companies planning to raise outside capital and sell organize as C corporations from the start. The tradeoff is double taxation on corporate earnings and on any asset sale, and the loss of pass through losses in the early years. For a business that expects to distribute most of its profits every year, an LLC or S corporation is often better. For a company that expects to reinvest and sell, a C corporation with QSBS often wins. Our comparison of LLCs, S corporations, and C corporations walks through the analysis.

Founder Stock and 83(b) Elections

Founders who receive stock subject to vesting should generally file an 83(b) election within 30 days of the grant. The election starts the holding period and fixes the founder’s taxable value at grant, which is usually nominal. Without it, the holding period for each vesting tranche may not begin until that tranche vests.

Employee Equity

Stock options are not stock. The QSBS holding period for option shares begins when the option is exercised, not when it is granted, and the stock must still qualify at exercise. Companies that want employees to benefit should consider early exercise provisions or restricted stock, and should track the gross assets test at each exercise.

SAFEs and Convertible Notes

When SAFEs or convertible notes convert into stock, whether the holding period starts at the original investment or at conversion depends on the instrument and is not fully settled. Investors who care about QSBS often prefer priced equity or instruments drafted with QSBS in mind. Our guide to startup venture financing compares the instruments, and our guide to unregistered securities offerings covers the securities rules for issuing them.

Converting an Existing LLC or S Corporation

An LLC can convert to, or elect to be taxed as, a C corporation, and stock issued at that point can qualify. The holding period starts at conversion, and the appreciation before conversion is not eligible, as the example above shows. The gross assets test is measured using the value of the contributed business, so a company worth more than $75 million at conversion cannot issue QSBS. S corporation stock never becomes QSBS, even if the company later revokes its S election, so S corporations generally need a restructuring to create new qualifying stock. Anyone considering a conversion should model the tax cost of giving up pass through treatment against the expected exclusion.

Strategies to Maximize the Exclusion

Contributing Property to Build Basis

When a founder contributes appreciated property, such as an existing business, intellectual property, or equipment, to a new C corporation in exchange for stock, the stock’s basis for QSBS purposes is the property’s value at contribution. That raises the 10 times basis cap. The pre contribution gain is not excluded, but everything after it can be, up to a cap that may far exceed $15 million.

Gifts and Trusts

Because the cap applies per taxpayer, gifting QSBS to family members or to separate non grantor trusts before a sale can multiply the total exclusion available to a family. Recipients take over the donor’s holding period and QSBS status. This technique, often called stacking, must be done well before a sale is agreed, each trust must have genuine independent substance, and the IRS has tools to aggregate trusts formed mainly to multiply tax benefits. It should be coordinated with the family’s broader estate plan; our guides to irrevocable trusts and grantor trusts explain the trust types involved. With the federal estate tax exemption at $15 million per person for 2026, some families can make these gifts without using exemption they need elsewhere.

The Section 1045 Rollover

A holder who has owned QSBS for more than six months but cannot yet meet the holding period can defer the gain by reinvesting the proceeds in other QSBS within 60 days under Section 1045. The holding period of the old stock carries over to the new stock. Carta’s Section 1045 guide explains the mechanics. Rollovers are useful when an early acquisition offer would otherwise cut the holding period short.

Reorganizations and Stock for Stock Deals

When a QSBS company is acquired in a tax free reorganization for buyer stock, the buyer stock can keep QSBS status to the extent of the gain built into the original shares at the time of the exchange, even if the buyer itself is too large to issue new QSBS. Our guide to merger structures explains how these reorganizations work.

Managing the Tiers

With partial exclusions at three and four years, the calendar matters. Owners should know the exact anniversary dates for each block of stock, negotiate closing dates with those dates in mind, and understand how earnouts and installment payments are taxed when they arrive after the sale.

Selling a Company With QSBS

The exclusion applies only when shareholders sell stock. If the company sells its assets and distributes the proceeds, the corporation pays tax on the asset sale, and the shareholders’ exclusion applies only to the liquidating distribution. Buyers often prefer asset purchases for the stepped up basis and liability protection they provide, so a QSBS company’s owners should expect to negotiate for a stock sale or a merger treated as a stock sale. Our guide to asset vs. stock purchases covers that negotiation.

Other sale issues that affect QSBS:

• Rollover equity. Sellers asked to roll part of their equity into the buyer can often structure the rollover as a tax free exchange that preserves QSBS status for the rolled portion.
• Buyer diligence. Sophisticated buyers and their advisors increasingly ask for the company’s QSBS support, particularly gross asset calculations and redemption history. Sellers who cannot produce it may face price pressure or a request for a tax indemnity.
• Escrows and earnouts. Contingent payments received later are generally part of the gain on the stock sold, but their timing and treatment should be modeled against the cap and the holding period.

For the broader sale process, see our guide to selling a business in Oklahoma.

How Oklahoma Taxes QSBS Gain

Oklahoma Follows the Federal Exclusion

Oklahoma computes individual income tax starting from federal adjusted gross income, and gain excluded under Section 1202 never enters federal adjusted gross income. Oklahoma does not require an addback for that gain, so excluded QSBS gain is generally excluded for Oklahoma purposes too. Not every state agrees: California, Pennsylvania, Alabama, and Mississippi tax QSBS gain in full, and EisnerAmper’s state survey tracks others that have limited or are limiting the exclusion. Founders who move out of Oklahoma before a sale should check the rules in their new state.

The Oklahoma Capital Gain Deduction

Any QSBS gain that remains taxable, such as the non excluded half at three years or gain above the cap, may qualify for Oklahoma’s own capital gain deduction. Under that deduction, gain on the sale of stock or an ownership interest in an Oklahoma company is deductible for Oklahoma purposes if the company’s primary headquarters has been in Oklahoma for at least three uninterrupted years and the seller held the interest for at least two uninterrupted years, claimed on Oklahoma Form 561. For an Oklahoma headquartered company, the combination can mean no Oklahoma tax on the sale at all. Otherwise, the taxable portion is subject to Oklahoma’s top individual rate, which fell to 4.5 percent for 2026.

Oklahoma Businesses and the Excluded Industries

Oklahoma’s economy leans on several industries that Section 1202 excludes, most notably oil and gas production, farming, and financial services. An exploration and production company generally cannot issue QSBS. Oilfield service, energy technology, midstream technology, and agricultural technology companies may qualify, depending on what they actually do. Companies in these sectors should get an early opinion on whether their business is a qualified trade or business before counting on the exclusion.

Oklahoma Capital and Incentives

Oklahoma’s 2026 legislation extended the state’s deduction for qualified equity investments in eligible Oklahoma venture capital companies through tax year 2031, which supports the fund formation that feeds QSBS eligible startups. Our summary of Oklahoma’s 2026 tax legislation covers that change and others.

Common Mistakes That Destroy QSBS

• Forming as an S corporation or keeping an LLC too long. S corporation stock never qualifies, and LLC appreciation before conversion is not eligible.
• Buying shares from another shareholder. Secondary purchases are not original issuance.
• Redeeming a cofounder at the wrong time. A buyback near a financing round can disqualify stock issued in that round.
• Letting cash or investments pile up. Large idle cash balances or investment portfolios can cause the company to fail the 80 percent active business test.
• Drifting into an excluded business. A technology company that becomes primarily a consulting firm, or a product company that shifts into financial services, can lose qualification.
• Skipping the 83(b) election. Without it, the holding period for restricted stock may not start until vesting.
• Selling assets instead of stock. An asset sale by the corporation does not produce excludable stock gain in the same way.
• Keeping no records. The taxpayer bears the burden of proving qualification, sometimes a decade after the stock was issued.

Documentation and Next Steps

The single most valuable QSBS habit is keeping a file that proves qualification. It should include:

• Formation documents and evidence of C corporation status at each issuance
• A gross assets calculation as of each stock issuance, including the value of any contributed property
• Periodic support for the 80 percent active business test, including cash and investment balances
• A log of all stock issuances, redemptions, and repurchases, with dates and amounts
• Copies of 83(b) elections, option exercises, and conversion documents
• A description of the business supporting that it is a qualified trade or business

Many companies now provide shareholders with an annual QSBS statement summarizing this support. When a holder sells, the exclusion is reported on Form 8949 and Schedule D; the Form 8949 instructions explain the adjustment code. The text of the 2025 law is available from Congress for advisors who want the statutory language.

For new companies: decide on C corporation status before issuing stock, file 83(b) elections, and start the QSBS file on day one. For existing LLCs and S corporations: model a conversion or restructuring before the next financing round or before value grows further. For companies considering a sale: assemble the QSBS file before the letter of intent, so the structure and closing date can be negotiated with the exclusion in view.

Frequently Asked Questions

• What is the QSBS exemption?

  It is the federal exclusion under Section 1202 for gain on the sale of qualified small business stock. For stock issued after July 4, 2025, holders can exclude 50, 75, or 100 percent of their gain after three, four, or five years, up to the greater of $15 million or ten times their basis per company.

• What are the QSBS requirements?

  The stock must be in a domestic C corporation, acquired at original issuance for money, property, or services, when the company had no more than $75 million in gross assets ($50 million for older stock). The company must use at least 80 percent of its assets in a qualifying active business, and the holder must meet the holding period.

• Can an LLC or S corporation issue QSBS?

  No. Only C corporation stock qualifies. An LLC that converts to or elects C corporation status can issue QSBS going forward, with the holding period starting at conversion. S corporation stock never qualifies, even after the S election ends.

• How long do I have to hold QSBS?

  For stock issued after July 4, 2025, three years for a 50 percent exclusion, four years for 75 percent, and five years for 100 percent. For stock issued before July 5, 2025, more than five years is required for any exclusion.

• What businesses do not qualify for QSBS?

  Professional services such as health, law, engineering, architecture, accounting, and consulting; financial services, banking, insurance, and investing; farming; oil, gas, and mining production; hotels and restaurants; and any business whose principal asset is the skill or reputation of its employees.

• Does Oklahoma tax QSBS gain?

  Generally not. Oklahoma starts from federal adjusted gross income and does not add back excluded Section 1202 gain. Any remaining taxable gain may qualify for Oklahoma’s capital gain deduction if the company has been headquartered in Oklahoma for three years and the stock was held for two years.

• What happens to QSBS if my company is acquired?

  In a stock sale or a merger treated as a stock sale, you claim the exclusion on your gain. In a tax free reorganization for buyer stock, the new stock can keep QSBS status for the gain built in at the time of the exchange. In an asset sale, the corporation pays tax first, which usually reduces the benefit.

• Can employees get QSBS through stock options?

  Yes, but the holding period begins when the option is exercised, and the stock must qualify at that time, including the gross assets test. Early exercise or restricted stock with an 83(b) election starts the clock sooner.

• Can I gift QSBS to family members?

  Yes. Gifted QSBS keeps its status and the donor’s holding period, and each recipient has a separate per company cap. Gifts must be made well before a sale, and trusts used for this purpose need independent substance to be respected.

• Can I defer QSBS gain if I sell before the holding period?

  Yes, if you held the stock for more than six months. Section 1045 lets you defer the gain by reinvesting the proceeds in other QSBS within 60 days, and your holding period carries over to the new stock.

Disclaimer: This article provides general information about the federal qualified small business stock exclusion and related Oklahoma tax rules, and should not be considered specific legal, tax, or financial advice. QSBS qualification depends on detailed facts about the company, its assets, its stock issuances, and each holder, and tax outcomes depend on individual circumstances including the alternative minimum tax. Tax laws change. Consult qualified legal and tax advisors before relying on the exclusion.

About Cantrell Law Firm: We are Oklahoma business attorneys who help entrepreneurs and business owners form, finance, grow, and sell companies. As former business owners ourselves, we plan equity and exits with a practical view of what founders actually keep. Contact Cantrell Law Firm to discuss your QSBS planning.