QSBS (qualified small business stock) is stock in a US C corporation that, if every test in Section 1202 of the tax code is met, lets an individual exclude some or all of the gain from federal income tax when they sell it. For stock acquired after July 4, 2025, the exclusion is 50% after 3 years, 75% after 4 years and 100% after 5 years, capped per company at the greater of $15 million or 10 times your basis. Stock acquired on or before July 4, 2025 keeps the old rules: more than 5 years of holding, and a $10 million or 10x cap.
For a SaaS founder who incorporated as a Delaware C corporation and bought common stock for a few thousand dollars, QSBS can be the difference between paying about $4.8 million of federal tax on a $20 million exit and paying about $1.2 million. This guide covers the requirements, what Public Law 119-21 (the "One Big Beautiful Bill Act") changed, the tax math at each holding tier, how the exit waterfall feeds into it, and the common ways founders lose it.
This is not tax advice. The rules below come from the statute as of October 2026. Whether your stock qualifies depends on facts only your advisor can check, and several points (SAFEs, state treatment) are unsettled or changing. Confirm every decision with a tax attorney or CPA.
Quick answer: the QSBS requirements checklist
Section 1202 has tests the company must pass and tests you, the holder, must pass. All of them have to hold.
Company-level tests
- Domestic C corporation. The company must be a C corporation when the stock is issued and "during substantially all of the taxpayer's holding period" (26 U.S.C. 1202(c)(2)(A)). LLCs and S corporations do not issue QSBS.
- Gross assets of $75 million or less ($50 million for stock issued on or before July 4, 2025) before the issuance and "immediately after the issuance" (1202(d)(1)). Gross assets means cash plus the tax basis of other property, not valuation. The test is applied per issuance, so later growth does not disqualify stock already issued.
- Active business. During substantially all of your holding period, "at least 80 percent (by value) of the assets of such corporation are used by such corporation in the active conduct of 1 or more qualified trades or businesses" (1202(e)(1)(A)). Working capital counts, but after the company's first 2 years no more than 50% of assets can qualify that way (1202(e)(6)). Software development counts as active (1202(e)(2)).
- Not an excluded business. Section 1202(e)(3) excludes "any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or 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," plus banking, insurance, financing, investing, farming, extraction and hospitality.
- No disqualifying redemptions around the issuance date (see "What breaks QSBS" below).
Holder-level tests
- Not a corporation. The exclusion applies to "a taxpayer other than a corporation" (1202(a)(1)): individuals, trusts, estates, and partners through pass-through rules.
- Original issuance. You must acquire the stock from the company "at its original issue," in exchange for "money or other property (not including stock), or as compensation for services" (1202(c)(1)(B)). Shares bought on a secondary are not QSBS; gifted or inherited shares keep the giver's status (1202(h)).
- Holding period. At least 3 years for stock acquired after July 4, 2025 (partial exclusion until year 5); more than 5 years for older stock.
Does a SaaS company qualify?
Software is not on the excluded list, and SaaS companies are commonly treated as qualified businesses. The risk sits in the catch-all clause about a business whose principal asset is "the reputation or skill" of its employees. In private letter ruling 202319013 (2023), the IRS concluded that an enterprise cloud application software company was a qualified trade or business because its principal asset was its own intellectual property, not the skill of its staff (RSM summary; also covered by Taft).
Two cautions. A private letter ruling binds only the taxpayer that asked for it, so it shows how the IRS reasoned, not a rule you can rely on. And it is a facts-and-circumstances question: a "SaaS" company that earns most of its revenue from implementation, custom development or advisory work starts to look like the consulting and engineering services the statute excludes.
Old vs new rules: what changed on July 4, 2025
Section 70431 of Public Law 119-21 changed Section 1202 with two slightly different triggers: the holding tiers and the cap apply to stock "acquired after the applicable date," defined as the date of enactment, July 4, 2025 (1202(a)(1)(B) and (a)(6)); the $75 million asset test applies to "stock issued after the date of the enactment of this Act" (section 70431(c)(3)). For stock you receive at original issue, those are normally the same day. Note the word "after": stock acquired on July 4, 2025 itself is old-rule stock.
| Acquired on or before July 4, 2025 | Acquired (issued) after July 4, 2025 | |
|---|---|---|
| Holding period | More than 5 years | At least 3 years |
| Exclusion | 100% (stock acquired after Sept 27, 2010); 50% or 75% for older stock | 50% at 3 years, 75% at 4 years, 100% at 5 years or more |
| Per-company cap | Greater of $10 million or 10x basis | Greater of $15 million (indexed from 2027) or 10x basis |
| Gross-assets test | $50 million | $75 million (indexed from 2027) |
| Tax on the non-excluded part of capped gain | None at 100% (28% applies only to the 50% and 75% pre-2010 stock) | 28% maximum rate, plus 3.8% NIIT, at 3 and 4 years |
| AMT on excluded gain | None for stock acquired after Sept 27, 2010 | None |
The tiers are set out in a table in 1202(a)(5). The cap in 1202(b)(4)(B) is "$15,000,000, reduced by" gain you already excluded on that company's stock. For tax years beginning after 2026, the $15 million and $75 million amounts rise with inflation (1202(b)(5) and the second 1202(b)(4)); once you exceed your cap on a company's new-rule stock, its cap "shall be zero" in later years (1202(b)(5)(B)).
The change is not retroactive. Shares a founder got in 2023 still need more than 5 years and keep the $10 million cap; new shares from the same company after July 4, 2025 get the new rules, and gain on the old shares counts against the $15 million. A tax-free exchange of old stock for new does not reset the date, because the acquisition date is determined "after the application of section 1223" (1202(a)(6)(B)).
How the tax works at each tier
Three rates matter for a founder in the top bracket:
- 20% on ordinary long-term capital gain, including any gain above the QSBS cap.
- 28% on the part of capped QSBS gain that the percentage does not exclude, which Section 1(h)(7) calls "section 1202 gain" and puts in the 28% rate group (26 U.S.C. 1(h)(4)). In the IRS's words: "The eligible gain minus your section 1202 exclusion is a 28% rate gain" (IRS Pub. 550).
- 3.8% net investment income tax on the taxable portion only. Excluded gain is not in gross income, and NIIT applies to net gain "to the extent taken into account in computing taxable income" (26 U.S.C. 1411(c)(1)(A)(iii)).
So, for gain that fits inside the cap, the effective federal rate is:
| Holding period (new-rule stock) | Excluded | Effective federal rate on capped gain |
|---|---|---|
| Under 3 years | 0% | 23.8% (20% + 3.8%) |
| 3 years | 50% | 15.9% (half taxed at 28% + 3.8%) |
| 4 years | 75% | 7.95% (a quarter taxed at 31.8%) |
| 5 years or more | 100% | 0% |
The 3-year rate of 15.9% is better than 23.8%, but less than many headlines suggest, because the taxable half pays 28% instead of 20%. The AMT is no longer a factor: Section 57(a)(7) now treats excluded gain as a preference item only for stock "acquired on or before" September 27, 2010 (26 U.S.C. 57(a)(7)).
Worked example: a SaaS exit at year 3, 4 and 5
All numbers were recalculated in a script. Assumptions: federal tax only, top brackets, the unindexed $15 million cap, no state tax. The cap table: two founders with 50% and 25% after the seed round, and a seed investor who paid $2 million for 25% as non-participating 1x preferred stock, all issued after July 4, 2025.
Step 1: the waterfall sets what QSBS applies to
QSBS applies to what you actually receive, which the liquidation preferences decide, not your ownership percentage. If the company sells for $40 million, the seed investor converts (25% of $40 million is $10 million, more than its $2 million preference), and the 50% founder receives $20 million. Our liquidation preference calculator runs this for any preference stack; the cap table and dilution calculators show how rounds change your share.
The waterfall also tells you whether the cap matters. Suppose instead the company raised $8 million of 1x non-participating preferred for 25%, and it sells for $12 million. Converting would give investors $3 million, so they take their $8 million preference, and the $4 million left goes to common. The 50% founder holds two-thirds of the common and receives about $2.67 million. That is well inside the $15 million cap, so for this founder only the holding period matters: at year 4 the federal tax is $211,841; at year 5 it is $0.
Step 2: the founder, $20 million of proceeds, $2,000 basis
The founder's gain is $19,998,000. The cap is the greater of $15 million or 10 x $2,000, so $15 million. Gain above the cap ($4,998,000) is taxed as ordinary long-term gain at 23.8% whatever the holding period.
| Sold | Excluded | Taxed at 28% + 3.8% | Taxed at 20% + 3.8% | Federal tax | After-tax proceeds |
|---|---|---|---|---|---|
| Before year 3 (or QSBS fails) | $0 | $0 | $19,998,000 | $4,759,524 | $15,240,476 |
| Year 3 (50%) | $7,500,000 | $7,500,000 | $4,998,000 | $3,574,524 | $16,425,476 |
| Year 4 (75%) | $11,250,000 | $3,750,000 | $4,998,000 | $2,382,024 | $17,617,976 |
| Year 5 or later (100%) | $15,000,000 | $0 | $4,998,000 | $1,189,524 | $18,810,476 |
Waiting from year 4 to year 5 is worth $1,192,500 to this founder; waiting from year 3 to year 5 is worth $2,385,000. If an acquirer offers to close a few months before your 4- or 5-year date, that number belongs in the negotiation next to the headline price (the SaaS valuation guide covers how buyers set it).
Compare a founder of an older company whose shares were acquired before July 4, 2025. At year 4 those shares get no exclusion at all, so the tax is $4,759,524. After more than 5 years they get 100% but only up to $10 million, for a tax of $2,379,524, almost exactly what the new-rule founder pays at year 4.
Step 3: the seed investor and the 10x-basis cap
Now the investor from Step 1, with a $2 million basis, in a larger exit where its stake is worth $30 million. The cap is the greater of $15 million or 10 x $2,000,000 = $20,000,000, so the basis test gives the investor a larger cap than the founder.
- No QSBS: $28 million gain x 23.8% = $6,664,000 of tax.
- Year 4: $15 million excluded (75% of $20 million), $5 million at 31.8%, $8 million at 23.8%: $3,494,000.
- Year 5: $20 million excluded, $8 million at 23.8%: $1,904,000, an effective 6.8% on the whole gain.
That is one reason investors ask for QSBS representations in financing documents (see the SaaS fundraising guide).
When does the clock start? SAFEs, notes, options and unvested stock
- Founder stock with an 83(b) election. Restricted stock's holding period begins when the shares are "transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier" (26 U.S.C. 83(f)). Without an 83(b) election, each vesting tranche starts its own clock as it vests. A timely 83(b) election starts the clock at grant.
- Stock options. An option is not stock. Shares you get on exercise are acquired when you exercise, and both the holding period and the company's gross-assets test are measured then.
- Convertible notes. A note is debt, so the general view is that the clock starts when it converts into shares, and the asset test is applied at conversion. Convert after the company passes $75 million of assets and the shares may not qualify.
- SAFEs: unsettled. "The IRS has yet to provide any guidance on whether a SAFE will be considered 'stock'" for Section 1202 (PKF O'Connor Davies). If a SAFE is stock, the holding period "would commence when the SAFE is issued"; if not, it "would not commence until the SAFE converts into preferred stock" (FBT Gibbons, which concludes the factors suggest a SAFE "should be treated as stock"). Plan on the conservative date (conversion) unless your advisor is comfortable with the earlier one.
- Preferred converting to common. Converting QSBS preferred into common of the same company keeps QSBS status and the original holding period (1202(f)).
Things founders do that break QSBS
- Buying back stock at the wrong time. Your shares are disqualified if the company bought stock from you or a related person at any time "during the 4-year period beginning on the date 2 years before the issuance" (1202(c)(3)(A)). And all stock in an issuance is disqualified if, in the 2-year window starting 1 year before it, the company repurchased more than 5% of the value of all its stock (1202(c)(3)(B)). The regulations allow small de minimis amounts. Buybacks from departing employees and founder secondaries structured as company repurchases are where this bites.
- Starting as an LLC and converting late. When you convert an LLC to a C corporation, the stock is treated as acquired on the date of the exchange, with a basis of "in no event ... less than the fair market value of the property exchanged" (1202(i)). The clock starts at conversion, and value built up inside the LLC is not excludable. Converting while the company is worth little keeps that loss small. (A Delaware C corporation also takes on yearly filings; see the Delaware annual report guide.)
- Electing S corporation status. The company must be a C corporation during substantially all of your holding period. Stock issued while the company was an S corporation is not QSBS, and converting later does not fix shares already issued.
- Parking a big raise in investments for years. After the first 2 years, working capital can be at most 50% of the assets counted toward the 80% test.
Selling early: the Section 1045 rollover
If you sell QSBS held "for more than 6 months" and reinvest in other QSBS within "the 60-day period beginning on the date of such sale," you can elect to defer the gain (26 U.S.C. 1045). The replacement stock's basis is reduced by the deferred gain, and its holding period includes the time you held the old stock (IRS Pub. 550), so the clock toward 3, 4 or 5 years keeps running.
State taxes may not follow
States choose whether to follow Section 1202. As of September 2026, EisnerAmper lists Alabama, California, Mississippi and Pennsylvania as giving no Section 1202 exclusion, Illinois and Oregon as requiring a full addback starting with 2026, Hawaii as capping the exclusion at 50%, and Maine as decoupling for stock acquired after July 4, 2025, while New Jersey conforms for tax years beginning on or after January 1, 2026 (EisnerAmper; on Illinois, Plante Moran). A California founder pays California tax on the full gain even when the federal tax is zero. The list changed more than once in 2026, so check the rule in the state where you will live when you sell.
FAQ
How long do you have to hold QSBS?
For stock acquired after July 4, 2025: at least 3 years for a 50% exclusion, 4 years for 75%, and 5 years for 100%. For stock acquired on or before July 4, 2025: more than 5 years, with nothing excluded before that.
What is the QSBS limit?
Per taxpayer, per company: the greater of $15 million (new-rule stock, indexed from 2027) or 10 times your basis in the shares sold that year. For older stock, $10 million or 10 times basis.
Do SaaS companies qualify for QSBS?
Generally yes, since software is not an excluded field, and an IRS private letter ruling treated a cloud software company as qualified. It remains a facts-and-circumstances test, and companies whose revenue is mostly services or consulting carry more risk.
Can an LLC or S corporation issue QSBS?
No. Only stock issued by a C corporation can qualify. An LLC that converts to a C corporation can issue QSBS from the conversion date, but only gain after that date can be excluded.
Does a SAFE start the QSBS holding period?
It is unsettled. If the IRS treats the SAFE as stock, the clock starts when you sign it; if not, it starts when the SAFE converts into shares. There is no IRS guidance either way.
Does California recognize QSBS?
No. California taxes the full gain at its normal rates, and so do several other states, including Pennsylvania, and from 2026 Illinois and Oregon.