IRC §1202
Qualified Small Business Stock (QSBS)
Section 1202 excludes up to $10 million (or 10× your cost basis, whichever is larger) of gain on C-Corporation stock held for 5+ years from federal capital gains tax. At the top rate, that’s up to $2,380,000 in federal tax saved.
The major state-level trap: California does not recognize the exclusion. CA residents owe 13.3% state capital gains tax on the full gain regardless of federal treatment — a $10,000,000 excluded gain still triggers $1,330,000 in CA tax. Founders in CA approaching a liquidity event should explore domicile planning well before the sale.
Who this may apply to
- Own stock in a C-Corporation with <$50,000,000 in assets
- Stock acquired at original issuance
- Held for 5+ years
- Corporation is an active business (not investment company)
Strategy connections
Works well with
- C-Corporation Conversion / Management Corporation: Section 1202 generally applies to eligible stock issued by a qualifying C corporation.
- Estate & Wealth Transfer Planning: Transfer planning must preserve holding-period, basis, and eligibility records.
What could block this
- Issuer or business fails Section 1202 requirements
- Stock was not acquired in a qualifying original issuance
- The required holding period is not met
Important considerations
- California does not recognize the §1202 exclusion at all — CA residents owe California capital gains tax (up to 13.3%) on the full excluded gain. On a $10,000,000 exclusion, that’s potentially $1,300,000 in CA tax that remains due even though the same gain is $0 federally. For founders in CA, domicile planning (establishing residency in a no-tax state before a liquidity event) is worth a serious conversation with a tax attorney — but it must be genuine and completed well before the sale.
- Other non-conforming states include NJ and PA — verify your state’s treatment before planning around QSBS as a total tax elimination strategy.
- Certain businesses are excluded: professional service firms, finance, banking, farming, hotels, restaurants
- If the corporation ever exceeded $50,000,000 in gross assets, even briefly, the stock may not qualify — document this carefully at issuance
- Stacking QSBS across family members (spouses, children, trusts) can multiply the exclusion — but each must independently own qualifying shares. Get a tax attorney involved early.
Professional support
Tax Attorney + CPA
Will evaluate QSBS qualification, document the exclusion, and plan the timing of any stock sale.
Timing
The 5-year holding period clock starts at acquisition. QSBS qualification must be established at the time of issuance — you cannot retroactively qualify existing stock.
Official sources
Reviewed 2026-07-24