QSBS after the 2025 changes: the founder's guide to Section 1202

Section 1202 lets holders of qualified small business stock exclude some or all of the gain when they sell. For many founders, it is the most valuable tax provision they will ever use.

The new rules for stock issued after July 4, 2025

For older stock, the 100% rate applies only to shares acquired after September 27, 2010. Shares acquired earlier get 50% or 75%.

Under the partial exclusions, the non-excluded gain is taxed at up to 28%, plus the 3.8% net investment income tax where it applies, so a 3-year sale is less generous than it looks and a five-year hold remains the goal. The excluded gain on stock acquired after July 4, 2025 is not an AMT preference at any tier. Only stock acquired before September 28, 2010 still carries one.

Requirements

1. The stock must be C corporation stock, acquired at original issuance in exchange for money, property, or services.
2. Gross assets must be $75M or less at all times before and immediately after issuance.
3. Under the active business test, during substantially all of your holding period, the company must be a domestic C corporation using at least 80% of its assets in a qualified trade. Excluded are services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage. Banking, insurance, financing, leasing, and investing are also excluded, as are farming, mining and oil and gas extraction, hotels and restaurants, and businesses whose principal asset is the reputation or skill of employees. Health care product companies, such as biotech and medtech, can generally still qualify.
4. You must meet the holding period requirements shown above.

Key numbers: cap $15M or 10x basis · $75M gross assets · 50% / 75% / 100% at 3 / 4 / 5 years · non-excluded gain taxed at up to 28%, plus 3.8% NIIT.

Pitfalls

• LLC to C corp conversions start the holding period at conversion, and the basis for the 10x test is the value contributed.
• Redemptions by the company around the time of issuance can disqualify stock.
• SAFEs and convertible notes generally don't start the holding period until conversion into stock.
• Too much cash or investment assets can fail the active business test, especially after a large raise.
• California doesn't follow the federal QSBS exclusion, and several other states limit or deny it, so state tax may still apply. Connecticut does follow it. Its income tax starts from federal AGI and has no add-back for excluded §1202 gain, so gain excluded federally is also excluded for Connecticut, as our Connecticut guide explains.

Stacking the exclusion

The cap applies per taxpayer, per issuer. Gifts of QSBS to children, or to non-grantor trusts, give each recipient its own cap while preserving the holding period. This planning must occur well before a sale, and the IRS can challenge arrangements that lack substance. Trusts with substantially the same grantor and the same primary beneficiaries can be treated as one trust under §643(f), so each trust needs a different beneficiary.

Connecticut residents should also plan for the state's own gift tax. A Connecticut gift tax return (Form CT-706/709) is required for Connecticut taxable gifts, which typically include gifts of shares to a trust, even when no tax is due under the $15 million 2026 exemption. The return is due April 15 of the year after the gift.

A worked example

A founder receives 4M shares in February 2026 at $0.001 per share and files an 83(b). In 2027 she gifts 1M shares to each of two non-grantor trusts, one for each of her children. The company is acquired in March 2031 at $10 per share, more than five years after the shares were issued, so the 4M shares are worth $40M.

• Her remaining 2M shares produce $20M of gain, of which she excludes $15M, or a little more once the cap is indexed for inflation.
• Each trust has $10M of gain and its own cap, so each excludes $10M.

About $35M of the $40M is excluded from federal tax, compared with $15M without planning. A sale closing before the five-year mark in February 2031 would cut each exclusion to 75% or less.

How Summer Associates helps

Summer Associates' startup team tests QSBS eligibility at each financing round, documents gross assets and active business status, and models gifting strategies with your estate attorney.

This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.