QSBS Requirements: The Section 1202 Eligibility Checklist

Before you count on a tax-free exit, verify both stock qualification and the amount of gain eligible for exclusion. Section 1202 applies acquisition-date rules, holding periods, and per-issuer limits. The $10 million and $15 million figures are starting dollar limits on eligible gain, not automatic tax-free amounts; the 10× basis alternative can be larger. A qualification failure and a taxable remainder are different issues.

Preserve the original issuance evidence and review the substantiation file as the business and holding period develop. An annual review and updates after material events are useful practices; Section 1202 does not require an annual attestation letter. A later update supplements historical evidence rather than replacing it.

This checklist flags the main qualification and calculation issues to review before a sale. It cannot resolve every exception or establish eligibility by itself. The QSBS eligibility checker is also an initial screening tool.

For detailed analysis, see the Complete Guide to QSBS & Section 1202. Review each requirement and its exceptions, then calculate the holding-period percentage and eligible-gain limit separately.

Washington context: Only gain actually excluded under Section 1202 generally stays outside Washington’s capital gains tax and the enacted 2028 income tax. A partial exclusion or gain above the limit can leave taxable gain. State conformity varies; qualifying stock does not make every dollar of a sale tax-free.

Quick eligibility summary (all required)

• Domestic C corporation for federal tax purposes, including an eligible LLC that elects C-corporation classification
• Original issuance (you acquired stock from the corporation)
• Gross assets ≤ $75M (post-OBBBA; $50M for stock issued on or before July 4, 2025) before and immediately after issuance
• 80% active business test (service-business risk)
• Holding period and acquisition date: older stock generally requires more than five years; qualifying post-July 4, 2025 acquisitions use the 3/4/5-year tiers, with applicable tacking
• No problematic redemptions

Download: Free QSBS Issue-Spotting Checklist

1. Entity Requirement: Is It a C Corporation?

☐ The issuer is a domestic C corporation for federal tax purposes. An LLC taxed as a partnership, an S corporation, or a foreign corporation does not meet this requirement.

It is worth emphasizing one threshold requirement: only C corporations can issue QSBS.

☐ The company was a C corporation at the time the stock was issued

☐ The corporation was a C corporation and met the active-business requirements during substantially all of your holding period. Review any S election or other change in tax status.

Why this matters: Federal tax classification matters. An LLC taxed as a partnership cannot issue QSBS, but an LLC classified as a domestic C corporation can potentially qualify. A conversion from partnership tax status can start a new QSBS holding period for qualifying equity received in the conversion; prior ownership does not count merely because the business later becomes a C corporation.

Public benefit corporations. Delaware public-benefit status is a state-law corporate designation; it does not by itself determine federal C- or S-corporation tax status. An otherwise eligible corporation may have an S election in effect, in which case it cannot issue QSBS. A charter-only change of an existing C corporation into a Delaware PBC does not by itself restart the stock holding period or change federal tax classification; the other QSBS requirements still apply. See DGCL §362, IRC §1361, and the Delaware PBC conversion guide.

2. Gross Asset Test: Was the Company Small Enough?

☐ The corporation and any predecessor never exceeded the applicable aggregate-gross-assets limit during the statutory pre-issuance period, and the corporation was within the limit immediately after issuance, including the proceeds received. The limit is $50 million for stock issued on or before July 4, 2025 and $75 million for later issuances, with indexing after 2026.

☐ Measure aggregate gross assets as cash plus adjusted tax bases of other property, applying the fair-market-value rule for contributed property and the parent-subsidiary controlled-group aggregation rules in Section 1202(d). This is not simply book assets or company valuation.

☐ Keep records supporting the pre-issuance asset history and the immediately-after-issuance calculation, including predecessors, contributed property, and applicable controlled-group members.

Why this matters: A snapshot taken only on the issuance date is insufficient. A prior breach can matter even if assets later decline. Growth after a qualifying issuance does not itself disqualify those earlier shares, although continuing active-business requirements and redemption rules still matter.

3. Original Issuance: Did You Get the Stock Directly from the Company?

☐ You acquired stock at original issuance, directly or through an underwriter, or can document an applicable statutory transfer or conversion exception. An ordinary purchase from another shareholder does not qualify.

☐ At original issuance, the consideration was money, property other than stock, or services to the corporation (other than underwriting services), subject to the statutory conversion and exchange exceptions.

☐ If acquired for services, you were an employee, director, or contractor of the company

Why this matters: Stock bought on the secondary market does not qualify, no matter how long you hold it.

Gift or inheritance: Stock received by gift or inheritance can keep its QSBS status by carrying over the original holder’s holding period. Ordinary secondary-market purchases cannot.

4. Active Business Requirement

☐ During substantially all of your holding period, at least 80% by value of the corporation’s assets were used in one or more qualified active businesses, applying the startup, research, subsidiary look-through, and working-capital rules.

☐ The company is not in an excluded industry (see list below)

☐ Check the two separate 10% restrictions. Section 1202(e)(5)(B) addresses stock or securities in nonsubsidiary corporations measured against asset value in excess of liabilities, with an exception for qualifying working-capital assets. Section 1202(e)(7) separately limits nonbusiness real property to 10% of total asset value. These are not one blanket cap on all passive investments.

Excluded Industries (QSBS Does NOT Qualify)

✘ Professional services: law, medicine, accounting, consulting, engineering, financial services, architecture

✘ Banking, insurance, or lending

✘ Farming or mining

✘ Hotels, motels, or restaurants

✘ Any business where the principal asset is the reputation or skill of employees

Technology, SaaS, manufacturing, e-commerce, and retail businesses must satisfy the same statutory requirements as other issuers. For a mixed software-and-services business, examine the actual activities, contracts, work product, and asset use. Bundling services with software or changing invoice labels does not establish qualification.

5. Holding Period

☐ For stock acquired after July 4, 2025: at least five years permits a 100% exclusion of eligible gain within the available limit.

☐ For stock acquired after July 4, 2025: at least four but less than five years permits a 75% exclusion of eligible gain within the available limit.

☐ For stock acquired after July 4, 2025: at least three but less than four years permits a 50% exclusion of eligible gain within the available limit.

☐ For stock acquired after September 27, 2010 through July 4, 2025: more than five years is required for the 100% exclusion. Earlier acquisition dates generally fall under historical 50% or 75% regimes, with special rules; they do not all receive 100%.

☐ Document the acquisition date after applicable Section 1223 holding-period tacking. Gifts, inheritances, conversions, and rollovers can carry an earlier date; newly issued replacement shares do not automatically receive the newer exclusion regime.

On the unexcluded portion: At the new 50% and 75% tiers, the nonexcluded portion of eligible gain can be subject to the maximum 28% Section 1202 gain rate and, where applicable, 3.8% NIIT. These are not flat rates for every taxpayer. Gain exceeding the eligible-gain limit is a separate calculation. Excluded gain is outside NIIT.

If you need to sell before reaching 5 years, see Section 1045 Rollovers: How to Defer QSBS Gains.

6. Gain Cap

☐ Calculate the eligible-gain limit before applying the exclusion percentage. It is generally the greater of the remaining per-issuer dollar limit or 10 times qualifying basis in that issuer’s QSBS disposed of during the taxable year. Disregard basis additions after original issuance and apply the special contributed-property basis rules.

☐ The starting dollar limit is $10 million for acquisitions on or before July 4, 2025, or $15 million for later acquisitions, indexed after 2026. Reduce it for prior eligible gain and coordinate old and new stock from the same issuer, including same-year sales. These are not additive $10 million and $15 million allowances.

☐ Apply the appropriate exclusion percentage to gain within the available limit and separately calculate the taxable remainder. Exceeding the limit does not disqualify the stock or eliminate the exclusion on gain within the limit.

For strategies to multiply the exclusion beyond $15 million, see QSBS Stacking: How to Multiply the Exclusion with Trusts and Family Gifts.

7. Redemption Test

☐ Review corporate purchases from you or a related person during the four-year period beginning two years before each issuance. Under Treas. Reg. §1.1202-2(a), apply the de minimis test to purchases in aggregate: the total amount paid must exceed $10,000 and the sum of the purchase percentages must exceed 2%. For each purchase, divide the purchased stock’s purchase-date value by the purchase-date value of all stock held directly or indirectly by you and related persons immediately before that purchase. Add those percentages across purchases. Do not disregard each small buyback separately; also test the paragraph (d) exceptions.

☐ For significant redemptions, review the two-year period beginning one year before each issuance. Under Treas. Reg. §1.1202-2(b), both the separate de minimis condition and the 5% condition must be exceeded. The de minimis condition requires aggregate amounts paid above $10,000 and a sum of purchase percentages above 2%, using all outstanding stock immediately before each purchase as the purchase-date value denominator. The separate 5% condition compares the aggregate purchase-date value of the repurchased stock with the value of all corporate stock at the beginning of that issuance’s two-year period. Apply the exceptions before concluding that an issuance is disqualified.

Why this matters: The related-person test and significant-redemption test have different windows, denominators and affected holders. Purchase size matters to both de minimis tests. A non-de-minimis related-person purchase may disqualify the affected holder’s shares unless an exception applies; it does not automatically disqualify every shareholder’s stock. The significant-redemption test can reach stock issued to other holders, but each issuance must be tested against its own window.

Measure each issuance separately. The 5% test uses value, not share count. Its denominator is the company’s aggregate stock value at the start of the relevant two-year period, while purchases enter the numerator at their respective purchase-date values. If that starting date precedes formation, do not simply assume a zero or small denominator: the cited regulation does not expressly resolve that pre-formation valuation question. Identify the issue and obtain transaction-specific analysis rather than treating a later buyback as automatically fatal.

Check each exception’s conditions. Under Treas. Reg. §1.1202-2(d)(1), the employee/director exception requires stock the seller acquired in connection with performing those services and a repurchase incident to retirement or another bona fide termination of those services. It does not cover every share owned by a departing employee; the independent-contractor termination provision is reserved. The death exception requires the specified pre-death ownership, a purchase from a seller listed in paragraph (d)(2), and purchase within three years and nine months after death. Separate exceptions address purchases incident to disability or mental incompetency and qualifying divorce. Paragraph (c) excludes specified shareholder transfers to employees, independent contractors or their beneficiaries in connection with services from treatment as corporate purchases. Document the applicable exception rather than relying only on the transaction’s label.

8. Documentation Checklist

Keep these records throughout your holding period:

☐ Stock purchase agreement or grant documentation showing original issuance

☐ Board resolutions approving the stock issuance

☐ Financial and tax records supporting the full gross-assets test, including pre-issuance history and proceeds received at issuance

☐ Records showing the company met the active business requirement throughout your holding period

☐ Records supporting both 10% asset restrictions, the 80% active-business test, and any working-capital or subsidiary look-through treatment relied upon

☐ 83(b) election filing confirmation (if restricted stock)

☐ 409A valuation at time of issuance (if applicable)

☐ Records of any stock redemptions by the company

The IRS can challenge QSBS claims years after a sale. Contemporaneous documentation is your best defense.

Examples

LLC → C corp conversion QSBS eligibility is generally tied to the C corp shares you acquire after conversion, not a prior LLC interest.

Secondary purchase You buy shares from another shareholder. That is not QSBS.

Redemptions in the cap table. A founder buyback can affect QSBS, but not automatically everyone’s stock. Apply the related-person and significant-redemption tests to each relevant issuance, including their separate windows, aggregated de minimis conditions and exceptions.

FAQ

Is QSBS still available in 2026?

Yes. Section 1202 remains available. For qualifying stock acquired after July 4, 2025, the OBBBA introduced 50%, 75%, and 100% exclusion tiers after at least three, four, and five years and raised the starting per-issuer dollar limit on eligible gain to $15 million. The separate $75 million gross-assets limit applies to stock issued after July 4, 2025. Both dollar amounts are indexed after 2026. Acquisition dates reflect applicable holding-period tacking.

What disqualifies stock from being QSBS?

Qualification can fail because of the issuer’s federal tax classification, a breach of the historical or immediately-after-issuance gross-assets test, an ordinary secondary purchase, failure of the active-business requirements, or a disqualifying redemption. Statutory and regulatory exceptions matter. A qualifying share can still be too young for an exclusion; exceeding the eligible-gain limit instead leaves a taxable remainder without automatically disqualifying the stock.

Can LLC stock qualify as QSBS?

An LLC taxed as a partnership or S corporation cannot issue QSBS. An LLC classified as a domestic C corporation for federal tax purposes can potentially qualify; the state-law LLC label alone does not decide the issue. Qualifying equity received when a partnership-taxed LLC converts to C-corporation tax status can begin a QSBS holding period, but the prior partnership holding period does not count merely because of that conversion.

What happens if I sell QSBS before the five-year holding period?

For stock acquired on or before July 4, 2025, the exclusion generally requires more than five years; older acquisition dates have different exclusion percentages. For qualifying post-July 4, 2025 acquisitions, the new tiers allow 50% after at least three years, 75% after at least four years, and 100% after at least five years, within the eligible-gain limit. Determine acquisition dates after applicable tacking. A Section 1045 rollover may defer gain on QSBS held for more than six months if its election, 60-day reinvestment, and other requirements are met. The taxable portion of eligible gain at a partial-exclusion tier can face a maximum 28% rate and applicable NIIT; gain above the limit is calculated separately.

How much can I exclude?

First calculate the eligible-gain limit: generally the larger of the remaining $10 million or $15 million per-issuer dollar limit, as applicable, and 10 times qualifying basis in that issuer’s QSBS disposed of that year. Prior use, inflation adjustments for the newer dollar limit, and coordination between old and new stock can affect the result. Then apply the applicable exclusion percentage. For example, $15 million of eligible gain at the 50% tier produces a $7.5 million exclusion, not $15 million.

Does a SAFE or note conversion count as original issuance?

It can, depending on the structure and documentation. See convertible notes vs. SAFEs.

Does consulting revenue disqualify QSBS?

Consulting is an excluded field under Section 1202(e)(3). For a company with both software and services, identify the character of each business and separately test whether at least 80% of assets by value are used in qualified active businesses. Revenue percentages and billing format do not settle either question. Fact-specific private letter rulings may illustrate the analysis, but they are not precedent for other taxpayers under Section 6110(k)(3).

What about state tax?

Federal QSBS is only one layer. Washington generally follows the federal exclusion; Oregon no longer conforms, so Oregon residents should assume their QSBS gain is fully taxable at the state level.

Can later financing break QSBS for early shares?

Growth above the gross-assets limit after a qualifying issuance does not by itself disqualify earlier shares. The new shares must separately satisfy the asset test. Redemptions in the relevant issuance windows and continuing active-business compliance can still affect eligibility.

Washington State Bonus

If your stock qualifies as QSBS under Section 1202, the excluded gain is also exempt from Washington's capital gains tax and the new 9.9% income tax (ESSB 6346, effective 2028). The Washington legislature considered decoupling from the federal exclusion (SB 6229/HB 2292) but those bills did not pass.

For comprehensive WA tax planning strategies, see the Washington State Income Tax Planning Guide.

This post is for educational purposes only and is not legal or tax advice. Consult a qualified attorney about your specific situation.