Section 1202 QSBS: the $15M federal exclusion early employees need to understand

What QSBS is (and why it matters at these valuations)

IRC § 1202 — commonly called the QSBS exclusion — lets non-corporate taxpayers exclude a portion (up to 100%) of capital gain from selling Qualified Small Business Stock from federal income tax. At a $1M–$10M+ gain, that exclusion is meaningful in a way that ordinary capital-gains planning simply is not.

The exclusion is per issuer, per taxpayer: each employee can exclude up to the greater of $15M or 10 times their adjusted basis in stock from a single qualifying company.¹ Employees who early-exercised at a low strike price can have basis of $50K–$500K, making the 10x-basis cap far larger than the flat $15M for most private-company scenarios.

The five-part eligibility test

All five requirements must be satisfied. One failure means no exclusion:

1. Original issue from a domestic C-corp. You must have acquired the shares directly from the issuing company — not on a secondary market. Shares purchased from another employee or via a platform like Forge or EquityZen are not original issue and do not qualify. Exercising options you received as compensation is original issue; buying shares from a departing colleague is not.
2. Gross assets at or below the threshold at issuance. The company's aggregate gross assets must have been at or below the applicable limit at the time your shares were issued (and immediately after). For stock issued after July 4, 2025, that threshold is $75 million. For stock issued on or before July 4, 2025, the threshold is $50 million.¹ Many late-stage unicorns exceed these limits before employees get around to exercising recent grants — the gross asset test applies to the issuance date of your specific shares, not to the company's current balance sheet.
3. Active business in a qualifying industry. The company must conduct an active trade or business. Several industries are explicitly excluded from QSBS regardless of size: professional services (law, consulting, finance, accounting, health, performing arts), banking and insurance, investing, farming, and hospitality. Most tech, software, and hardware companies qualify. Financial-services-adjacent businesses require a closer look at whether the company's primary revenue is technology versus regulated financial activity.
4. Non-corporate holder. The exclusion is available to individuals and certain pass-through entities. Shares held in a C-corporation receive no Section 1202 benefit.
5. Holding period met. This determines your exclusion percentage — and it changed significantly with OBBBA. See the next section.

What OBBBA changed: two regimes, one critical date

The One Big Beautiful Bill Act (signed July 2025) restructured Section 1202 for newly issued stock. The rules that apply depend entirely on when you acquired your shares:

Employees who exercised options before July 4, 2025 play by the old rules: it's binary — five years for full exclusion, zero before that. The tiered structure and higher caps only apply to shares acquired after the OBBBA effective date.

The 28% rate trap on partial exclusions

The tiered exclusion looks appealing at three years — but there's a catch. The non-excluded portion of QSBS gain is taxed at 28%, not at the ordinary 15%/20% long-term capital gains rates.² This rate has always applied to partially excluded QSBS; OBBBA's tiered structure makes it relevant again for anyone selling before the five-year mark.

A worked example for a high-income filer selling $2M in post-OBBBA QSBS gain at the three-year mark:

• 50% excluded ($1M): $0 federal income tax
• 50% taxed at 28% ($1M): $280,000
• NIIT at 3.8% on the non-excluded $1M: +$38,000
• Total federal tax: $318,000 on a $2M gain

Compare holding two more years for full exclusion: $0 federal tax on the same $2M gain. Or selling non-QSBS stock at 20% long-term rates + NIIT: $478,000. The point isn't that the three-year option is bad — it's that the math is less obvious than "50% off." The optimal hold point depends on your basis, the expected exit price, state taxes, and whether the IPO timeline puts a ceiling on the wait.

How your instrument type affects QSBS

• ISO early exercise: Exercising ISOs and holding shares starts the QSBS clock from the exercise date. For early-exercised unvested shares, filing an 83(b) election within 30 days is necessary to start both the QSBS and capital-gains clocks from that date — without it, the clock starts as each tranche vests, potentially years later. See the early exercise and 83(b) guide.
• NQSOs: Shares acquired by exercising non-qualified stock options qualify for QSBS from the acquisition (exercise) date. The ordinary income recognized at exercise becomes your basis — so the QSBS exclusion applies only to appreciation after exercise, not to the spread already taxed as ordinary income at exercise.
• Tender offers and liquidity windows: Selling shares in a tender offer before you hit the required holding threshold resets the clock on those specific lots and forfeits any pending exclusion. If you're approaching three or five years on a QSBS lot and a tender window opens, lot selection — which shares to sell — becomes a direct tax decision worth modeling before you participate.
• Shares purchased on secondary marketplaces: Not original issue — full stop. Shares acquired via Forge, EquityZen, Hiive, or directly from another employee do not qualify for QSBS, regardless of how long you hold them afterward.

California and the states that don't conform

California explicitly decouples from IRC § 1202 under California Revenue and Taxation Code § 18152.³ A gain that is 100% excluded federally is still taxed in full by California at the applicable state capital-gains rate — up to 13.3%. California treats QSBS gain as ordinary income for state purposes.

Other states that do not conform as of 2026: Alabama, Mississippi, and Pennsylvania. New Jersey enacted conformity in 2026 with certain timing limitations. All other states generally follow the federal treatment — but confirm your state, since conformity rules change.

For California residents, federal QSBS planning still has significant value — zeroing out federal tax on a $5M gain saves roughly $1M at the 20% + NIIT level — but the California bill doesn't go away. Some employees plan a change of domicile before a liquidity event. That move must be genuine and completed before the gain is recognized; California aggressively audits departures timed around large liquidity events, and a failed domicile claim is worse than not trying.

What to verify before counting on the exclusion

The gross asset test is the one that most often surprises late-stage employees. The threshold applies to the issuance date of your specific shares — not to the company's current balance sheet. A company raising $200M Series D rounds today may have had well under $50M in gross assets when earlier grants were issued, and well over $75M by the time of recent grants. The threshold is not the company's equity valuation (which is usually much larger) — it's gross assets on the balance sheet.

Practically, you'll need a representation from the company (or its historical financial statements) to confirm the gross asset test at your grant date. Equity specialists and CPAs handle this routinely. It determines whether QSBS analysis is even in scope for your specific grant before any planning can proceed.

Run a rough sanity check before engaging: early grants at companies still small enough to meet the $50M threshold are the most likely QSBS candidates. Late grants at mature unicorns are far less likely to qualify — the company was already well past $75M in gross assets by the time you exercised.

Does your equity qualify? Verify before you count on the exclusion.

QSBS eligibility turns on your company's historical gross assets, your grant date, and which lots you sell. Get matched with a fee-only equity specialist who can pull the analysis together — free, no obligation.