QSBS: the section 1202 tests, and why the figures depend on a date

What section 1202 does

Section 1202 lets a non-corporate taxpayer exclude from gross income a portion of the gain on the sale or exchange of qualified small business stock held for the required period. The exclusion is per taxpayer and per issuing corporation, so a person holding QSBS in three different companies is tested three separate times.

It is worth being blunt about how the provision reads. Section 1202 is one of the most heavily conditioned sections in the Code: it tests the issuer, the stock, the acquisition, the holder, the holding period, and the corporation’s activities across time. Almost every popular summary of it — including this one — flattens conditions that decide real cases.

The section has been amended, and the figures split by date

The exclusion percentage has moved repeatedly since 1993, rising through 50 percent and 75 percent tiers tied to when the stock was acquired before reaching 100 percent for stock acquired after 27 September 2010. In 2025 the section was amended again, and the current text of section 1202 now distinguishes stock acquired on or before an "applicable date" of 4 July 2025 from stock acquired after it.

The eligibility tests, in the order they usually fail

The redemption rules deserve their own mention because they surprise people. Section 1202(c)(3) can taint stock when the corporation buys back its own shares within specified periods around the issuance, and it does not require any intent to abuse the provision. A perfectly ordinary founder departure and share repurchase can sit inside that window.

How the cap actually works

Section 1202(b)(1) limits the eligible gain from any one issuer, in any taxable year, to the greater of two amounts: the applicable dollar limit for the year, reduced by eligible gain already taken into account for that issuer in prior years, or ten times the aggregate adjusted bases of qualified small business stock of that issuer disposed of during the year.

The ten-times-basis branch is the one people forget. It matters for holders who paid real money for their stock rather than founders who paid a nominal price, because basis is the multiplicand. A founder with near-zero basis is effectively capped by the dollar limit; an investor who put in eight figures at original issue may be capped by the basis branch instead, and that branch can be much larger.

Two further mechanics are worth knowing exist rather than memorising. Section 1202(b)(3) halves the dollar limit for a married taxpayer filing separately. Section 1045 provides a separate rollover route for QSBS held for a shorter period, allowing gain to be rolled into replacement QSBS within a statutory window instead of excluded. Both are technical and both are commonly handled by a CPA at the point of sale.

What this means for a cap table

QSBS analysis runs on facts that live in the share record, not in a spreadsheet of percentages. For each block of shares you need the acquisition date, whether the shares were issued by the company or bought from someone else, what was paid, the holder’s adjusted basis, and the company’s aggregate gross assets around the issuance date. A cap table that only records "holder, class, share count" cannot answer any of those questions later.

This is why QSBS questions so often arrive years late and unanswerable. The financing documents exist, the ledger exists, but nobody recorded aggregate gross assets at issuance, or which secondary sales moved shares out of original-issue status. Those are records problems with a tax consequence, and they are cheap to fix at the time and expensive to reconstruct at exit.

Employee equity interacts with all of this. Stock acquired on exercise of an option is acquired at original issue from the corporation, so exercising can start a QSBS holding period where holding an unexercised option cannot. That is a genuine consideration in exercise timing — and it sits alongside the alternative minimum tax question covered in the guide to AMT and incentive stock options, which frequently points the other way.

State tax is a separate question

Section 1202 is federal. States are not obliged to follow it, and several do not conform or conform only partly. A holder can have a fully excluded federal gain and a fully taxable state gain on the same sale. Because conformity rules change and depend on residence at the relevant times, this is one of the clearest cases for asking a CPA licensed where the holder actually files.