July 1, 2025
Section 1202 of the U.S. Internal Revenue Code, which governs Qualified Small Business Stock (QSBS), represents one of the most potent tax incentives within the American innovation economy. Enacted to spur high-risk, long-term investment in emerging companies, this provision offers the extraordinary potential for non-corporate taxpayers—including founders, employees, and investors—to exclude 100% of their capital gains from federal taxation upon the sale of eligible stock. The excludable amount is substantial, capped at the greater of $10 million or ten times the investor's basis in the stock, per issuer. For stock acquired after September 27, 2010, this exclusion extends to the Alternative Minimum Tax (AMT) and the 3.8% Net Investment Income Tax (NIIT), resulting in a potential federal tax rate of 0% on transformative liquidity events.
However, realizing this remarkable benefit is contingent upon navigating a labyrinth of stringent and complex rules. Eligibility is a multi-layered challenge that must be satisfied at the corporate, shareholder, and stock levels. The issuing company must be a domestic C-corporation that meets a critical $50 million gross asset test at the time of stock issuance and is engaged in a "qualified trade or business." Shareholders, in turn, must acquire the stock at its original issuance, hold it for more than five years, and be a non-corporate taxpayer.
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