The IRS quietly made an important clarification on January 20, 2026: the updated instructions for Form 1041 (U.S. Income Tax Return for Estates and Trusts) now explicitly address how Section 1202 Qualified Small Business Stock (QSBS) exclusions are reported by estates and trusts.
This matters because, until now, practitioners have largely been inferring how QSBS exclusions should flow through fiduciary returns. The new instructions confirm that the IRS expects QSBS exclusions to be reflected directly on the fiduciary return—and properly allocated to beneficiaries through Schedule K-1.
What changed?
The updated instructions provide line-level guidance showing where QSBS exclusions reduce capital gain on Form 1041 and how those adjustments flow through Schedules A, B, and K-1. The instructions also clarify how those exclusions interact with Net Investment Income Tax (NIIT) and AMT calculations at the fiduciary level.
Why this matters
For estates and trusts holding QSBS, this is no longer a gray area or a purely “worksheet-level” adjustment. The exclusion is now clearly visible on the return. That increases the importance of:
- Accurate QSBS qualification analysis
- Clean allocation of excluded gain between fiduciaries and beneficiaries
- Consistent reporting across Form 1041, Schedule K-1, and beneficiary returns
Practical takeaway
If QSBS is held in trust or passes through an estate, fiduciaries and advisors should review their Form 1041 reporting mechanics carefully. The IRS has now signaled exactly where it expects to see the Section 1202 exclusion—and inconsistencies are more likely to stand out on examination.
This update doesn’t change the law, but it does change expectations. And expectations drive audits.
