What benefits are available to holders of QSBS?

Gain Exclusion

Gain from the sale of QSBS held for more than five years is eligible for 100 percent exclusion from U.S. federal capital gains tax (or a lower percentage as described below), as well as a corresponding 100 percent exclusion from the alternative minimum tax (AMT) and 100 percent exclusion from the 3.8 percent net investment income tax (NIIT). 

Section 1202 of the Internal Revenue Code (IRC) provides for a lower percentage of exclusion (generally 50 percent or 75 percent) for QSBS issued prior to September 28, 2010, and held for more than five years, or for QSBS issued after July 4, 2025, and held for at least three years but less than five years. The amount of gain that is not excluded is generally taxed at a 28 percent rate and is also subject to the NIIT. The excluded portion of any gain is treated as a preference item for AMT purposes.

Table 1 summarizes the applicable effective federal tax rates on gain from the sale of eligible QSBS, depending on the date on which the QSBS was originally issued and for how long such QSBS was held before a sale or disposition.

 

Issue Date[1]	Holding Period	Applicable Cap on Eligible Gain Exclusion[2]	Exclusion Percentage	Effective Maximum Tax Rate	Effective Maximum Federal AMT Rate	Gain Subject to 3.8% NIIT
8/11/93 – 2/17/09	>5 years	$10 million	50%	14%	14.98%	50%
2/18/09 – 9/27/10	>5 years	$10 million	75%	7%	8.47%	25%
9/28/10 – 7/4/25	>5 years	$10 million	100%	0%	0%	0%
7/5/25 – present	At least 3 and less than 4 years	$15 million (indexed for inflation)	50%	14%	14.98%	50%
7/5/25 – present	At least 4 and less than 5 years	$15 million (indexed for inflation)	75%	7%	8.47%	25%
7/5/25 – present	5 years or more	$15 million (indexed for inflation)	100%	0%	0%	0%

 

The amount of gain excludable from the sale of a single corporation’s QSBS is generally limited, regardless of the exclusion percentage, to the greater of $10 million ($15 million for stock issued after July 4, 2025, indexed for inflation) or 10 times the taxpayer’s adjusted basis in the QSBS.^[3] 

Rollover 

Under Section 1045 of the IRC, if an electing stockholder holds QSBS for more than six months, sells the original QSBS in an otherwise taxable transaction, and purchases new QSBS within 60 days of the sale, such stockholder generally will recognize gain on the sale of the original QSBS only to the extent that the proceeds from the sale exceed the amount invested in the replacement QSBS (QSBS gain rollover). As a result, under these rules, if a stockholder must sell before the five-year holding period has elapsed, such stockholder could still qualify for Section 1202 gain exclusion by purchasing new QSBS. 

The provisions under Sections 1045 and 1202 of the IRC can provide an excellent tax planning tool for non-corporate founders or investors forming or investing in small businesses. Assuming the rules described above are satisfied, the potential 100 percent capital gains exclusion along with the exclusions for NIIT and the AMT provide a significant tax incentive. Moreover, the rollover rules under Section 1045 provide flexibility in the event an investor must exit earlier than the five-year holding period.

 

^[1] For this purpose, stock is treated as issued on the date the holding period begins (as determined under Section 1223), even if the stock has not yet been issued.

^[2] For taxpayers that file married filing separately, the applicable cap is $5 million and $10 million (indexed for inflation), respectively, rather than $10 million and $15 million (indexed for inflation), respectively.

^[3]For this purpose, the adjusted basis of property (other than money or stock) transferred to a corporation may equal its fair market value at the time of transfer, providing an opportunity for founders and investors who incorporate an existing business.

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