Section 1202 QSBS: What to Review Before a Business Sale

Before you sell a business, it is worth understanding how much of the gain may be available for your family’s next chapter. For eligible shareholders, Section 1202 can exclude some or all of the gain on qualified small business stock, known as QSBS, from federal income tax.

Whether your shares qualify depends on the business, how and when you acquired them, how long you have held them and the sale itself. Confirm those details with your CPA and attorney, then connect the after-tax proceeds to your personal investment and retirement plan.

What makes stock eligible for Section 1202?

The general rules include:

• Original issuance: The shareholder generally acquires stock originally issued by a qualifying domestic C corporation in exchange for money, eligible property or services. A secondary-market purchase does not ordinarily meet that requirement; certain gifts and other transfers have special rules.
• Company size: For stock issued after July 4, 2025, the company's aggregate gross assets generally must not exceed $75 million before and immediately after the issuance, taking applicable predecessor and aggregation rules into account. That new threshold is indexed after 2026. The earlier threshold is $50 million.
• Active business: During substantially all of the relevant holding period, the company must satisfy the C-corporation and active-business requirements. At least 80% of asset value generally must be used in a qualified trade or business, and specified service and other businesses are excluded.
• Ownership history: Acquisition dates, original issuance and applicable carryover holding periods need to be documented rather than inferred from when the business was founded.

Start with your stock issuance or purchase records and any documents covering gifts, transfers or changes in the business. Your CPA and attorney can use those records to review the full Section 1202 requirements.

How long must the shares be held?

For qualifying stock acquired after July 4, 2025, the general exclusion percentage increases with the holding period. Earlier acquisitions follow different rules:

These are the general date categories, not a substitute for checking special rules. Gifts and certain other transactions can preserve a prior owner's holding period, so a recent transfer does not necessarily begin a new clock. See Section 1202(a) and (h).

The gain limit generally uses the greater of an applicable per-issuer dollar limit or 10 times the adjusted basis of the stock sold. For the applicable post-July-4-2025 acquisitions, the dollar amount is $15 million before inflation adjustments after 2026; the earlier amount is $10 million. Prior eligible gains and filing status can reduce the available limit.

The percentage exclusion is then important too: a 50% tier does not turn $15 million of eligible gain into a $15 million exclusion. The portion left taxable because of the percentage limit can fall into the maximum 28% federal-rate category, with net investment income tax potentially applying as well. See Section 1202 and Section 1(h).

What could the exclusion mean in dollars?

This hypothetical comparison uses the same $15 million stock-sale gain in each column. It assumes the full gain in the qualifying-stock column is eligible for the 100% exclusion, the applicable gain limit is sufficient and all other Section 1202 requirements are met.

The taxable column assumes a 20% long-term capital-gains rate plus 3.8% net investment income tax. This is not a comparison of every S corporation with every C corporation, and it excludes state taxes, transaction costs and any corporate-level tax. A stock sale and a corporation's asset sale can produce very different results.

The point is to verify the available treatment early, not to assume that choosing a C corporation automatically makes a business sale tax-free.

What if your shares do not qualify or you need to sell sooner?

Changing an S corporation's tax status alone does not automatically make its existing shares QSBS. A contribution of an LLC business or other restructuring also has its own qualification, valuation, basis and holding-period consequences. Your CPA and attorney should compare the whole transaction, including the ongoing tax consequences of the structure.

If qualifying stock is sold before the relevant Section 1202 holding period is met, Section 1045 may allow an eligible noncorporate taxpayer to elect deferral. Among its requirements, the sold QSBS must have been held for more than six months and qualifying replacement stock must be purchased within the 60-day period beginning on the sale date. Reinvestment amounts and the replacement shares' basis matter; this is not an automatic permanent exclusion.

If an offer or letter of intent is already on the table, have your CPA and attorney review the shares, deal terms and remaining options promptly. Any trust transfers or proposed ownership changes should be evaluated as part of that review.

Connect the proceeds to your personal plan

Once you have a clearer estimate of the after-tax proceeds, the next question is what that money needs to do for you. Todd can help you plan for near-term cash needs, reduce investment concentration and build a diversified portfolio around your retirement and other personal goals.

Your CPA and attorney can address the business-sale tax and legal details. For the personal side of the transition, read Planning for a Liquidity Event or schedule an introductory meeting with Todd to discuss investing the proceeds.