QSBS exclusion: 50% at 3 years, 100% at 5 under 2025 law

For qualified small business stock (QSBS) acquired after July 4, 2025, IRC §1202 excludes 50% of the gain from federal income tax after 3 years, 75% after 4 years and 100% after 5 years. The excluded gain is capped per company at the greater of $15,000,000 or 10 times your basis in the stock, with the $15,000,000 indexed for inflation from 2027.

The change came from section 70431 of Public Law 119-21, approved July 4, 2025. Stock acquired before then keeps the old rules: 100% after more than 5 years, a $10,000,000 cap and a $50,000,000 asset test. This guide covers which stock qualifies, a worked example with three holding periods, the cap, the gross assets test your balance sheet decides, what can disqualify stock later, and how a sale is reported.

How much gain the QSBS exclusion covers

For stock acquired after July 4, 2025, the share of the gain you exclude depends on how long you held it: 50% at 3 years, 75% at 4 years and 100% at 5 years or more. Below 3 years nothing is excluded. Stock acquired earlier needs more than 5 years and then excludes 100%, if it was acquired after September 27, 2010. For founder shares that vest, the holding period starts when the shares are transferred only if you filed an 83(b) election within 30 days of receiving them; without one, each block's clock starts when it vests.

The new rules are in Public Law 119-21, section 70431, which rewrote §1202(a)(1) and added the 50%, 75% and 100% table as §1202(a)(5). The 100% rate for stock acquired after September 27, 2010 is in §1202(a)(4), and the Instructions for Schedule D (2025) list the same dates.

The exclusion is for taxpayers other than corporations: founders, employees and individual angels, and funds that pass the gain through to their partners under §1202(g).

Which stock counts as qualified small business stock

QSBS is stock in a domestic C corporation that you acquired at original issue, for money, property other than stock, or as pay for services. On the day it was issued, the company's gross assets were at most $75,000,000 ($50,000,000 for stock issued on or before July 4, 2025), and for substantially all of your holding period the company ran a qualified business.

The tests come from §1202(c), (d) and (e):

• A C corporation, start to finish. The stock must be in a C corporation when issued, and the company must stay one during substantially all of your holding period. S corporation stock never qualifies. The usual YC structure, a Delaware C corporation, does, and it comes with an annual Delaware franchise tax filing due March 1.
• Original issue. You must get the stock from the company, not buy it from another shareholder. Gifts and inheritances carry the original holder's status under §1202(h).
• An active, qualified business. At least 80% of the company's assets, by value, must be used in a qualified trade or business. Software is one. Services in fields such as health, law, engineering, accounting, consulting, financial services and brokerage are not, nor is banking, insurance or investing.

Research counts as active business even before there is revenue. §1202(e)(2) treats assets used in start-up activities and in research as used in the business. Since 2025 that rule points at research expenditures under §174 and §174A, the same costs that became deductible again in the year paid.

A worked example: $12,000,000 of gain held 3, 4 or 5 years

A founder receives common stock in a Delaware C corporation on September 1, 2025, paying $1,000. The company's gross assets that day are well under $75,000,000. Years later the company is acquired and the founder's shares sell for $12,001,000, a gain of $12,000,000. What is taxed depends on the sale date:

A sale at 2 years is an ordinary long-term capital gain. At 3 and 4 years, the part that is not excluded is "section 1202 gain", which §1(h)(4) and (7) put in the 28-percent rate group rather than the lower long-term rates. The 5-year sale pays no federal income tax on the gain.

The gap between 4 and 5 years is $3,000,000 of taxable gain on one founder's shares. When a sale comes up close to an anniversary, the closing date is worth a conversation with your tax adviser before the term sheet is signed.

How the $15,000,000 cap and the 10 times basis rule work

The cap is per taxpayer and per company. For stock acquired after July 4, 2025, the gain that counts toward the exclusion from one company is limited to the greater of $15,000,000, less the gain from that company you already counted in earlier years, or 10 times your adjusted basis in the shares sold that year.

The $15,000,000 limit is §1202(b)(4)(B), added by Public Law 119-21. It is increased for inflation for taxable years beginning after 2026, rounded to the nearest $10,000. The 10 times basis alternative is in §1202(b)(1)(B).

For a founder who paid $1,000, ten times basis is $10,000, so the dollar limit decides. If the same founder had a $20,000,000 gain held 5 years, $15,000,000 of it would be excluded at the base amount and $5,000,000 taxed as a normal long-term gain. The basis alternative matters for an investor: an angel who paid $2,000,000 for preferred stock can count up to $20,000,000 of gain from that company.

Married people filing separately get half the dollar limit each. On a joint return, the excluded gain is split equally between the spouses for later years.

How the $75,000,000 gross assets test reads your balance sheet

Gross assets are the company's cash plus the adjusted tax basis of everything else it owns, measured before an issuance and immediately after it, including the money just raised. If that total exceeds $75,000,000 at any time, stock issued from then on cannot be QSBS. Stock issued earlier keeps qualifying.

§1202(d) sets the test: aggregate gross assets "at all times" before the issuance, and immediately after it, may not exceed the limit. Public Law 119-21 raised it from $50,000,000 to $75,000,000 for stock issued after July 4, 2025, indexed from 2027. Two details make it a books question rather than a valuation question:

• It uses tax basis, not fair value. A company valued at $500,000,000 can pass if its cash and the basis of its other assets are under the limit.
• Contributed property counts at fair market value. When founders contribute code or an LLC's assets for stock, that property enters the test at its value on the contribution date, under §1202(d)(2)(B).

Take a company with $30,000,000 of cash and $2,000,000 of other assets at tax basis that raises a $50,000,000 Series B. Immediately after the round its gross assets are $82,000,000, so the Series B preferred is not QSBS. The founders' common stock and the seed investors' preferred, issued when gross assets were lower, still qualify.

What can disqualify QSBS after it is issued

Stock that qualified at issue can lose its status later. The company has to meet the active business test during substantially all of your holding period and stay a C corporation, and certain buybacks taint stock issued around them. These are the events that catch startups that are holding a large raise.

From §1202(c)(3) and (e):

• Too much idle cash. Cash held as reasonably required working capital, or expected to be spent on research within 2 years, counts as used in the business. Once the company is at least 2 years old, no more than 50% of its assets can qualify that way.
• Portfolio investments. More than 10% of net assets in stock or securities of companies that are not subsidiaries fails the test. Treasury bills and money market funds deserve a look with your adviser.
• Real estate. More than 10% of total assets in real property not used in the business fails it.
• Buybacks. Stock is tainted if the company bought back stock from you or a related person in the 4 years starting 2 years before your shares were issued. It is also tainted if, in the 2 years starting 1 year before issuance, the company bought back more than 5% of the value of its stock.
• Converting. An S election or a change of entity ends C corporation status.

How a QSBS sale is reported on your return

You report the whole gain on Form 8949, Part II, and the exclusion as a negative adjustment beside it: code "Q" in column (f) and the excluded amount in column (g). A 100% exclusion needs nothing further. A 50% or 75% exclusion also feeds the 28% Rate Gain Worksheet in the Schedule D instructions.

The steps are in the Instructions for Schedule D (2025), which also say that a sale not paid in full in the year of sale is generally an installment sale on Form 6252, with the exclusion taken in proportion to the gain recognized each year. State treatment varies, and not every state follows §1202, so check your state's rules with a CPA before you count on the exclusion.

What the IRS will ask, if it asks, is whether the company met the tests on each issuance date. That evidence is the company's: share issuances, their dates and prices, the tax-basis balance sheet at each round, and any buybacks. LedgerIt keeps the ledger and the balance sheet for every month end, so the figures for a round's closing date come from books that were already closed.

What to do this month

• Confirm you are a C corporation, and never make an S election.
• List every stock issuance with its date, price, holder and whether it was for cash, property or services.
• Record gross assets at tax basis before and after each round, and flag any round that would take the total over $75,000,000.
• Check idle cash against working capital needs once the company is 2 years old.
• Clear any buyback with your CPA before it happens, because of the 5% and 2-year windows.
• Note each holder's 3, 4 and 5 year dates, so a sale can be timed around them.