Read from 26 USC 1202 at law.cornell.edu, 4 September 2026

QSBS Exclusion: Section 1202 Requirements, Qualified Small Business Stock Rules and the $15 Million Cap

QSBS is the reason two founders can sell nearly identical software companies for nearly identical money and pay wildly different tax. Section 1202 lets a non-corporate taxpayer exclude gain from the sale of qualified small business stock, and after the July 2025 amendments the exclusion can reach 100 percent of the gain up to the greater of $15,000,000 or ten times basis. That is not a deduction or a deferral. It is gain that never enters gross income.

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Almost everything written about it is written for the person receiving the stock: the founder incorporating, the employee exercising options, the angel writing a check. Very little is written for the moment the stock is actually sold, which is the moment the rules bite. This page is written from that end, because a marketplace sees the same three failures over and over. A seller discovers in diligence that the company was an LLC for its first four years. A buyer assumes the exclusion travels with the shares it is buying. And a deal that everyone agreed to structure as an asset purchase quietly deletes a seven-figure tax benefit that nobody priced.

Every figure and every quotation below was read directly from the text of 26 USC 1202 and 26 USC 1045 at law.cornell.edu on 4 September 2026, not from a summary. Where the codified text differs from the way commentary describes it, we say so and show the words. Buyouts is a marketplace for AI SaaS businesses where MRR, ARR, growth and churn are verified before a listing goes live; browsing is free and buyer membership is planned rather than currently on sale, and listings shown in the product are illustrative UI. Nothing on this page is tax or legal advice, section 1202 is one of the most fact-specific provisions in the code, and the difference between qualifying and not qualifying is usually a document rather than an opinion.

Section 1202 excludes gain on the sale or exchange of qualified small business stock. Every word in that sentence is load bearing, and three of them are where deals go wrong: stock, sale, and qualified.

The six tests, in the order they fail

QSBS requirements: what has to be true, and where a software company usually breaks

Section 1202 is a series of independent tests, and failing any one of them turns the whole exclusion off. They are listed here in the order they tend to fail in a real software exit rather than in statutory order, with the subsection each one comes from so you can read it yourself.

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Requirement	What the statute says	Where software companies break
Domestic C corporation	Section 1202(c)(1) defines qualified small business stock as stock in a C corporation, and 1202(d)(1) defines a qualified small business as a domestic corporation which is a C corporation	The company spent its first years as an LLC or an S corporation. Converting later works, but the clock and the basis both start at conversion, so early growth is outside the exclusion
Acquired at original issue	Section 1202(c)(1)(B) requires that the stock be acquired by the taxpayer at its original issue, directly or through an underwriter, in exchange for money or other property (not including stock), or as compensation for services	This is the rule buyers get wrong. Shares bought from an existing holder are not acquired at original issue, so QSBS does not transfer with the certificate. It is a shareholder benefit, not a company attribute
Gross assets under the ceiling	Section 1202(d)(1)(A) and (B) require that aggregate gross assets did not exceed $75,000,000 at all times before the issuance and do not exceed $75,000,000 immediately after it	Rarely the binding test for a bootstrapped software company. It matters most for capital-intensive businesses and for companies that raised a very large round early
The 80 percent active business test	Section 1202(e)(1)(A) requires that at least 80 percent by value of the assets are used in the active conduct of one or more qualified trades or businesses	A company sitting on a very large cash balance relative to its operating assets can fail this without anyone noticing, which is a live issue after a big raise or a partial secondary
A qualified trade or business	Section 1202(e)(3)(A) excludes consulting, and any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees	Software normally qualifies. A founder-dependent product with heavy services revenue is where the argument starts, and it is the same fact pattern a buyer already prices as key person risk
Held long enough, and sold as stock	Section 1202(a)(5) sets the applicable percentage at 50 percent for 3 years, 75 percent for 4 years and 100 percent for 5 years or more; subsection (a) applies to gain from the sale or exchange of qualified small business stock	The deal closes as an asset purchase. There is no sale or exchange of stock by the shareholder, so there is nothing for section 1202 to exclude

All statutory language above was read from 26 USC 1202 at law.cornell.edu on 4 September 2026. One reporting note worth making, because commentary is split on it: the codified text of 1202(d)(1)(A) and (d)(1)(B) reads $75,000,000 in both places, with no $50,000,000 alternative inside the section itself. The $50,000,000 figure that most articles still quote is the pre-amendment text, and the rule about which stock gets which ceiling lives in the effective-date provision of the amending act rather than in section 1202. Section 1202(d)(4) then provides that for taxable years beginning after 2026 the $75,000,000 amounts in paragraphs (1)(A) and (1)(B) are indexed, using calendar year 2025 as the base. If you are testing stock issued years ago, the ceiling that applied on the issuance date is the one that matters, and that is a question for your own adviser rather than a number to read off a table.

The numbers, as the statute sets them

How much QSBS gain is actually excluded, and the two caps that decide it

Two separate limits run at the same time. The holding period sets the percentage of gain that is excluded, and the per-issuer limitation sets the ceiling on how much gain can be run through the exclusion at all. Both changed for stock acquired after the applicable date, which section 1202(a)(6)(A) defines as the date of enactment of that paragraph, being 4 July 2025.

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Provision	Stock acquired after 4 July 2025	Stock acquired on or before it	Source
Holding period for any exclusion	At least 3 years	More than 5 years	1202(a)(1)(B) and 1202(a)(1)(A)
Exclusion at 3 years	50 percent of gain	None	1202(a)(5) table
Exclusion at 4 years	75 percent of gain	None	1202(a)(5) table
Exclusion at 5 years or more	100 percent of gain	100 percent for stock acquired after 27 September 2010	1202(a)(5) table and 1202(a)(4)
Per-issuer dollar cap	$15,000,000	$10,000,000	1202(b)(4)(B) and 1202(b)(4)(A)
Alternative to the dollar cap	10 times aggregate adjusted bases, if greater	10 times aggregate adjusted bases, if greater	1202(b)(1)(B)
Married filing separately	Half the dollar amount otherwise in effect	$5,000,000 substituted for $10,000,000	1202(b)(3)(A)
Aggregate gross assets ceiling	$75,000,000, indexed for tax years after 2026	The ceiling in force on the issuance date	1202(d)(1) and 1202(d)(4)

The per-issuer limitation in 1202(b)(1) applies the greater of the dollar cap or ten times the aggregate adjusted bases of the qualified small business stock disposed of during the year, so a founder whose stock has almost no basis is capped by the dollar figure, while an investor who paid real money for the shares may be capped by the multiple instead. That asymmetry is why the same exit can be fully excluded for one holder on the cap table and only partly excluded for another. The dollar cap is also per issuer and per taxpayer, which is the mechanical reason non-grantor trust planning exists in this area. Read from law.cornell.edu on 4 September 2026 and offered as description, not as a plan.

Side by side

Selling stock into a marketplace deal, with the exclusion tested or assumed

A fair look at what each does well. Both are useful. Here is where they differ.

Feature	Buyouts	Finding out after the term sheet
When QSBS is checked	Before the listing goes live, when the structure can still be changed	In diligence, after price and structure are already agreed
Deal structure	Stock sale priced as a stock sale, because 1202 excludes gain on the sale or exchange of stock	Asset purchase agreed because the buyer preferred it, with the tax cost discovered later
Entity history	Incorporation date, any LLC or S corporation period and the conversion date documented up front	A cap table that starts at the Series A and a founder who is sure it was always a C corp
Who gets the benefit	Understood as a per-shareholder test, so each holder knows their own answer	Treated as a company-level fact quoted to everyone in the data room
Buyer expectation	The buyer knows it is starting a fresh clock and gets no exclusion on shares it purchases	The buyer assumes the exclusion transfers with the shares
The 80 percent test	Checked against the balance sheet, including any large idle cash balance	Assumed because the company writes software
Evidence	Issuance documents, gross asset figures at issuance and 80 percent support kept from the start	Reconstructed under time pressure from email archives

Comparison reflects general, publicly understood positioning. Capabilities change, so check each marketplace for the latest. Trademarks belong to their owners.

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QSBS does not transfer when you buy the shares

This is the single most expensive misunderstanding on a marketplace, and it comes from a nine word phrase in 1202(c)(1)(B): the stock has to be acquired by the taxpayer at its original issue. Not acquired from the founder, not acquired at a fair price, not acquired in a properly documented transfer. Originally issued, by the company, to that taxpayer, in exchange for money or other property that is not stock, or as compensation for services. So when a buyer purchases a founder's shares in a secondary or in a full stock acquisition, the buyer holds ordinary stock with an ordinary basis and no section 1202 status at all. The seller may exclude their gain. The buyer starts from zero. Whether the exclusion applies is a fact about a person, not about a company, and there is no version of the purchase agreement that changes it. What a buyer can do is have the company issue new stock to it directly, which starts that buyer's own clock, subject to every other test in the section including the gross assets ceiling measured at that issuance.

An asset sale switches the exclusion off entirely

Section 1202(a) excludes gain from the sale or exchange of qualified small business stock. In an asset purchase the shareholder does not sell stock. The corporation sells its assets, recognizes gain at the corporate level, and the shareholder then receives what is left through a distribution or a liquidation. There is no sale or exchange of qualified small business stock to exclude, so the section has nothing to operate on. The reason this keeps happening is that buyers have a genuine and well-founded preference for asset purchases. They get a stepped-up basis in the acquired intangibles, amortizable over fifteen years under section 197, and they leave unknown liabilities behind. That is a real benefit and a buyer is right to want it. What makes the outcome bad is not that the buyer asked, it is that the seller agreed before anyone quantified the give-up. If the exclusion is worth seven figures to the seller and the step-up is worth less than that to the buyer, the efficient deal is a stock sale at a price that shares the difference. You cannot negotiate that trade if you find out about it in week six of diligence, which is why the structure question belongs in the same conversation as the purchase price allocation rather than after it.

The reputation or skill exclusion is key person risk wearing a tax hat

Section 1202(e)(3)(A) denies qualified trade or business status to consulting, and to any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees. Written in 1993, aimed at professional practices, and now sitting directly on top of a very modern fact pattern: the solo-founder software business where the founder is the support team, the sales team, the roadmap and the reason customers renew. A licensed product with self-serve signups and a support queue is plainly a qualified trade or business. A product wrapped around bespoke implementation work billed by the founder is a harder conversation, and the more of the revenue that is services rather than subscription, the harder it gets. The useful part is that a buyer is already measuring exactly this. Founder dependence is the first thing diligence tests, because it determines whether the business survives the handover. That the same fact can also cost the seller the exclusion is a reason to fix it early: document the processes, move the relationships onto the company, get real recurring revenue away from the founder's calendar. Both problems have the same cure.

Keep reading on the parts of a deal this page touches: purchase price allocation and Form 8594, what an asset purchase agreement actually costs, asset purchase versus stock purchase for a SaaS deal, key person risk in a SaaS acquisition, the letter of intent stage where structure is set.

Good questions

QSBS exclusion, answered

The QSBS exclusion is section 1202 of the Internal Revenue Code, which lets a taxpayer other than a corporation leave gain from the sale or exchange of qualified small business stock out of gross income entirely. For stock acquired after 4 July 2025 the excluded share is 50 percent at three years, 75 percent at four and 100 percent at five or more, capped per issuer at the greater of $15,000,000 or ten times the aggregate adjusted bases of the stock sold.

Six conditions have to hold together. The issuer is a domestic C corporation, its aggregate gross assets are within the ceiling both before and immediately after the issuance, you acquired the stock at its original issue rather than from another holder, at least 80 percent of the corporation's assets by value are used in the active conduct of a qualified trade or business, that business is not one of the excluded types, and you have held the stock for the required period. Missing any one of them switches the exclusion off.

Usually yes, as long as it is a C corporation. Section 1202(e)(3) excludes health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, banking, insurance, financing, leasing, investing, farming, extraction and hotel, motel or restaurant businesses. Software is not on that list. The clause that catches software is the one denying qualification where the principal asset of the business is the reputation or skill of one or more of its employees.

Not while it is an LLC, because section 1202 requires stock in a domestic C corporation and an LLC has no stock. Converting to a C corporation is common and it works going forward, but the stock is treated as issued at conversion. The holding period starts then, and the property contributed on conversion is taken into the corporation at its fair market value for the gross assets test under 1202(d)(2)(B), which means the appreciation earned as an LLC sits outside the exclusion.

The per-issuer limitation in section 1202(b)(1) caps it at the greater of the applicable dollar limit or ten times the aggregate adjusted bases of the qualified small business stock you disposed of that year. The dollar limit is $15,000,000 for stock acquired after 4 July 2025 and $10,000,000 for stock acquired on or before it, halved on a married filing separately return. Founders with almost no basis are capped by the dollar figure; investors who paid real money may be capped by the multiple.

No. Section 1202 excludes gain from the sale or exchange of qualified small business stock, and in an asset sale the shareholder sells nothing. The corporation sells its assets and recognizes gain, then the proceeds reach the shareholder through a distribution or liquidation. Because there is no sale or exchange of stock, there is no gain for the section to exclude. This is why deal structure has to be discussed before the letter of intent, not during diligence.

No. Section 1202(c)(1)(B) requires the stock to be acquired at its original issue, directly or through an underwriter, in exchange for money or other property that is not stock, or as compensation for services. Shares bought from an existing shareholder fail that test however the purchase is documented. QSBS status attaches to a holder, not to a certificate, so it does not travel with the shares in a secondary or in a stock acquisition.

It depends on when the stock was acquired. Stock acquired after 4 July 2025 needs at least 3 years for any exclusion and reaches 100 percent at 5 years, on the sliding table in section 1202(a)(5). Stock acquired on or before that date follows the older rule in 1202(a)(1)(A) and must be held for more than 5 years, with nothing available before that point. Section 1045 offers a rollover route for stock held more than 6 months.

Section 1202(d)(1) requires that the corporation's aggregate gross assets did not exceed the ceiling at any time before the stock was issued and do not exceed it immediately after the issuance, counting amounts received in that issuance. Aggregate gross assets means cash plus the aggregate adjusted bases of other property, so it is a basis measure rather than a valuation. Property contributed to the corporation is counted at its fair market value at the time of contribution.

Not automatically. Section 1202 is a federal provision and state conformity varies, so a gain that is fully excluded on a federal return can still be taxable at the state level. Several states decouple from it entirely. This is a state-by-state question with real money attached and it is one to put to a tax adviser in your own state before you assume the headline number is what you keep.

No. The exclusion belongs to whoever originally received the stock from the company. A buyer purchasing shares gets no section 1202 status on them and starts with an ordinary basis. If the buyer wants its own QSBS position it has to receive newly issued stock from the corporation, which starts a fresh holding period and has to satisfy every other test, including the gross assets ceiling measured at the time of that new issuance.

Section 1045 lets a taxpayer other than a corporation sell qualified small business stock held for more than 6 months and roll the gain into replacement qualified small business stock purchased during the 60-day period beginning on the date of sale. Gain is recognized only to the extent the amount realized exceeds the cost of the replacement stock. Section 1045(b)(1) uses the same definition of qualified small business stock as section 1202(c).

Sometimes, and the way to find out is arithmetic rather than instinct. Compare what the seller loses by selling assets instead of stock against what the buyer gains from a stepped-up basis amortized over fifteen years under section 197. If the seller's loss is larger, a stock sale at an adjusted price makes both sides better off. If it is smaller, the asset deal is correct and the seller should stop arguing. Run the comparison before the letter of intent.

Keep the incorporation and conversion documents, the stock purchase or issuance paperwork showing acquisition at original issue, a balance sheet at the issuance date supporting the gross assets test, and periodic support for the 80 percent active business test across the holding period. Section 1202(d)(1)(C) also requires the corporation to agree to submit reports the Secretary may require. Assembling this years later, under a closing deadline, is where otherwise valid claims fall apart.

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