Section 1202 (QSBS): The HNW Founder's Best Tax Break

How qualifying founders can exclude up to $15 million --- or more --- of federal gain, and why the planning must begin years before a sale.

July 26, 2026

A founder can spend a decade building a company and then discover, shortly before the sale, that the tax result was largely determined when the first shares were issued. That is the unusual power of Section 1202. When the company, the stock, the shareholder, and the holding period all qualify, the rule can remove a substantial portion of the gain on a stock sale from federal gross income rather than merely defer it or reduce the rate.¹

For a high-net-worth founder, this can be a seven-figure planning issue. Under current law, stock acquired after July 4, 2025 can support a cumulative per-issuer exclusion limit of $15 million, subject to coordination with earlier sales, or a larger limit equal to ten times the basis of the qualifying shares sold. The same 2025 law also raised the issuer's gross-asset ceiling from $50 million to $75 million for stock issued after July 4, 2025 and created partial exclusions after three and four years.^1,2

The headline is generous. The qualification work is not. Section 1202 is best viewed as a chain: every link has to hold from formation through exit. A founder who waits until a letter of intent is signed to examine that chain may be years too late.

Congress created Section 1202 in 1993 to encourage investment in smaller domestic C corporations. The original benefit generally excluded 50% of eligible gain after the required holding period. Congress increased the exclusion to 75% for a limited 2009--2010 acquisition window and then to 100% for qualifying stock acquired after September 27, 2010.^1,3

Public Law 119-21 expanded the rule again on July 4, 2025. Stock acquired after that date can qualify for a 50% exclusion after three years, a 75% exclusion after four years, and a 100% exclusion after five years. Stock acquired on or before July 4, 2025 did not receive the new three- and four-year off-ramps; qualifying post-September 27, 2010 stock from that older vintage still generally needs the full five-year period for a 100% exclusion.^1,2 Figure 1 shows the new holding-period staircase.

This is the financial-planning version of letting bread rise. An earlier exit may now produce something valuable, but the fifth year is where the full federal exclusion becomes available. The distinction matters in a sale process because a few months of timing can change both the percentage excluded and the category in which the remaining gain is taxed.

Figure 1: Exclusion percentages for qualifying stock acquired after July 4, 2025.

The first gate is the shareholder and the security. Section 1202 is available to a taxpayer other than a corporation, and the asset must be stock of a domestic C corporation. The shareholder generally must acquire the shares at original issue from the company in exchange for money, qualifying property, or services. A secondary-market buyer usually fails this gate, while qualifying transfers by gift or at death can preserve the transferor's acquisition method and holding period.^1,4 An LLC interest, S corporation share, option, warrant, convertible note, or other contract is not automatically qualifying stock simply because it may later lead to shares.¹

The second gate is company size at issuance. For stock issued after July 4, 2025, aggregate gross assets cannot exceed $75 million at any time after August 9, 1993 and before the issuance, or immediately after the issuance after counting the cash and property received. Stock issued on or before July 4, 2025 remains subject to the former $50 million ceiling.^1,2,4 Gross assets for this test generally mean cash plus the adjusted tax basis of other property, with special fair-value rules for contributed property; this is not simply the company's headline valuation. Controlled subsidiaries are aggregated.¹

The third gate is the business itself. During substantially all of the shareholder's holding period, the corporation must remain a C corporation and generally use at least 80% of its assets, by value, in one or more qualified active businesses. Startup and research activity can count, and the statute contains working-capital rules, but excess portfolio securities or nonbusiness real estate can create problems.^1,3 Service businesses in fields such as health, law, accounting, consulting, financial services, and brokerage are excluded, as are banking, insurance, financing, leasing, investing, farming, extractive activities, hotels, motels, and restaurants.^1,3

The fourth gate is the exit. The taxpayer needs gain from the sale or exchange of qualifying stock and must satisfy the applicable holding period. A buyer's preference for an asset purchase can therefore change the result materially: a corporate asset sale is not the shareholder's sale of QSBS. Certain issuer redemptions around the original issuance date can also taint the shares, which is why repurchases and founder-liquidity programs deserve review before they are executed.^1,3

Figure 2 compares the two 2025 threshold changes. The higher $75 million issuer ceiling admits more growing companies, while the $15 million dollar limit increases the baseline exclusion for new-vintage shares. Both new amounts are scheduled to begin inflation adjustments for taxable years after 2026.^1,2

Figure 2: Prior and new-vintage limits; the dollar cap uses acquisition date, while the issuer asset ceiling uses issuance date.

The maximum eligible gain is not always $15 million. For qualifying stock acquired after July 4, 2025, Section 1202 generally looks to the greater of the applicable $15 million cumulative dollar limit or ten times the aggregate adjusted basis of the qualifying shares sold during the year. The dollar limit is coordinated across dispositions of stock from the same issuer and is reduced by eligible gain used in prior years. Earlier-vintage shares generally retain a $10 million dollar limit, and prior dispositions can reduce the room available under the newer limit.^1,2

That distinction separates founders from many early investors. A founder with $100,000 of basis has a ten-times-basis amount of $1 million, so the $15 million limit is more valuable. An original-issue investor with $2 million of basis has a ten-times-basis amount of $20 million and may have a larger ceiling. The rule is per taxpayer and per issuer, not one lifetime limit across every qualifying company.¹

Consider a founder with $100,000 of basis and a $20 million gain on qualifying shares acquired after July 4, 2025. Using the current $15 million amount before future inflation adjustments, the founder's eligible gain is capped at $15 million because that is greater than ten times the $100,000 basis. A sale after three years would exclude $7.5 million, a sale after four years would exclude $11.25 million, and a sale after five years would exclude the full $15 million. Figure 3 shows the excluded and taxable portions of the $20 million gain at each milestone.^1,2

At the five-year mark, a $15 million exclusion can represent roughly $3.57 million of federal tax avoided for a taxpayer otherwise facing the 20% long-term capital-gain rate and the 3.8% net investment income tax. That illustration ignores state tax, loss netting, deductions, transaction structure, and future inflation adjustments.^3,6 The three- and four-year cases require more care: the unexcluded portion of eligible Section 1202 gain generally enters the 28% capital-gain category, so a 50% exclusion does not necessarily equal a 50% reduction in the tax that otherwise would have applied.⁸

Figure 3: Perissos illustration of a $20 million gain with $100,000 basis and the current $15 million limit.

The strongest candidate is the founder of a scalable product, technology, software, manufacturing, or other qualifying operating company who receives original-issue C corporation stock while the company remains under the asset ceiling and expects both substantial appreciation and a multi-year holding period. The lower the founder's basis and the larger the expected stock-sale gain, the more valuable the fixed dollar limit becomes. Early employees can also benefit when they acquire actual original-issue stock for services, but an unexercised option does not itself satisfy a rule written for stock.¹

Early outside investors can be even better positioned under the ten-times-basis alternative. A meaningful original investment can support an exclusion above $15 million if the gain is large enough. Investors through a partnership or S corporation may also qualify, but the owner generally must hold the pass-through interest when the entity acquires the QSBS and continuously until the entity sells it; buying into the fund or partnership later does not retroactively create the benefit.^1,5

High-net-worth families may have an additional estate-planning angle. Section 1202 allows qualifying stock transferred by gift or at death to retain the transferor's acquisition method and holding period, while the dollar limit is applied at the taxpayer level.¹ That combination is why advisers discuss QSBS "stacking" through completed gifts to family members or properly structured separate taxpayers. It is not a mechanical multiplier. Control, grantor-trust status, state tax, gift-tax reporting, valuation, economic substance, and the timing of any expected sale all require coordinated legal and tax advice.

The poor fit is equally important. A founder of an excluded service business, an owner selling assets rather than stock, a shareholder who purchased shares from another investor, a company that was too large when the shares were issued, or an owner who cannot substantiate the qualification history should not model the exclusion as though it were certain. Section 1202 is a tax benefit attached to a specific block of stock, not a general reward for owning a small business.

The first planning task is to create a contemporaneous QSBS file. I would want the incorporation and board records, stock-purchase or service agreements, capitalization table, proof of the original issuance and payment, the shareholder's basis records, and any restricted-stock election. On the company side, I would preserve tax-basis balance sheets immediately before and after each material issuance, supporting bank and property records, annual evidence of the 80% active-business test, C corporation returns, and a history of stock redemptions. The goal is to document the path while the people who know the facts are still available.

The second task is to treat every new financing as a separate qualification date. Crossing the asset ceiling later does not necessarily destroy shares that qualified when issued, but stock issued after the ceiling has been exceeded can fail even when earlier founder shares remain eligible.¹ Options exercised in different rounds, conversions of financing instruments, recapitalizations, gifts, and secondary sales can therefore create blocks with different acquisition dates, bases, and tax treatment.¹

The third task is to model the buyer's deal structure well before exclusivity. Founders often focus on enterprise value while buyers focus on basis step-up, indemnification, and post-closing deductions. Those priorities can push a negotiation toward an asset transaction or a deemed-asset election that produces a very different seller result. QSBS should be part of the stock-versus-asset analysis before price and structure harden.

If qualifying shares must be sold too early, Section 1045 may offer a bridge. A noncorporate taxpayer who has held QSBS for more than six months can elect to defer eligible gain to the extent sale proceeds are reinvested in replacement QSBS during the 60-day period beginning on the sale date. The deferred gain reduces the basis of the replacement shares, and the prior holding period generally carries over for the later Section 1202 analysis.³ This is deferral, not forgiveness, and a 60-day reinvestment window is too short for casual diligence.

Most QSBS failures are structural, not mathematical. The company was organized as an LLC or S corporation and converted too late. The founder held an option but did not acquire stock until years later. The issuance occurred after the company crossed the gross-asset ceiling. Too much value migrated into investments or real estate. A redemption contaminated an issuance. The buyer purchased assets. Or the documentation was reconstructed after the sale announcement.

State law can also take back part of the headline benefit. State conformity is not uniform, and a federal exclusion does not guarantee a state exclusion. California, for example, states that it does not conform to the federal Section 1202 exclusion or the 2025 expansion.⁷ Residency planning, trust situs, transaction sourcing, and state audit exposure need to be evaluated on their own facts; changing an address shortly before closing is not a substitute for a defensible domicile and tax analysis.

Old-vintage stock deserves a separate calculation. Shares acquired before September 28, 2010 can fall under 50% or 75% exclusion rules, and the excluded amount can create an alternative-minimum-tax adjustment. The taxable eligible gain remaining after a partial exclusion is generally subject to the special 28% capital-gain framework.^5,8 A founder should not apply the modern 100% headline to a block issued under an older rule.

I believe Section 1202 deserves a place on the founder's agenda when the company is formed, when equity is issued, at every financing, before any redemption, when estate-planning gifts are considered, and well before a sale process begins. The best time to establish the evidence is not the year of the exit. It is the year of the issuance.

For an existing company, the practical next step is a share-by-share inventory. We would identify the issuer, issue date, acquisition method, basis, holding period, company asset level at issuance, business activity during the holding period, transfers, redemptions, and the likely exit form. From there, the financial plan can compare the federal exclusion, state tax, charitable and estate-planning alternatives, transaction timing, and post-sale liquidity needs without assuming that tax savings automatically outweigh business risk.

This is also where "tax-aware, not tax-driven" matters. Holding a concentrated private company solely to reach an anniversary can expose the family to operating, financing, buyer, and market risk. Gifting stock solely to multiply exclusions can surrender control and beneficial access. Converting the business solely for QSBS can create corporate-level costs elsewhere. The right answer is the best after-tax family outcome, not the largest theoretical exclusion.

The takeaway is straightforward: Section 1202 can be the HNW founder's best tax break because it rewards exactly the gain that can dominate a founder's balance sheet. Under the post-July 4, 2025 rules, the combination of a $15 million baseline cap, a ten-times-basis alternative, a higher issuer asset ceiling, and partial relief beginning after three years makes the provision more useful than it has ever been.^1,2

But this is a qualification exercise before it is a tax calculation. Our role is to connect the ownership record, the company history, the exit structure, and the family plan, then coordinate the conclusions with the client's business attorney, estate attorney, and CPA. Our team will continue monitoring Treasury and IRS guidance as the expanded rules move into real transactions and tax filings.

All my best,

Brandon VanLandingham, CFA, CMT, CFP

Founder / CIO

Net Investment Income Tax (NIIT): What Triggers It and How to Plan

Reducing Capital Gains on a Highly Appreciated Portfolio

Lifetime Gifting Strategies for Families With $10M+

Charitable Bequests vs. Lifetime Giving: Tax Implications

Section 199A QBI Deduction for Business Owners: 2026 Update

[1] U.S. House of Representatives, Office of the Law Revision Counsel, 26 U.S.C. Section 1202 --- Partial Exclusion for Gain From Certain Small Business Stock (text containing laws in effect June 20, 2026), https://uscode.house.gov/view.xhtml?edition=prelim&num=0&req=granuleid%3AUSC-prelim-title26-section1202.

[2] Public Law 119-21, Section 70431, Expansion of Qualified Small Business Stock Gain Exclusion, enacted July 4, 2025, 139 Stat. 240--243, https://www.govinfo.gov/link/plaw/119/public/21.

[3] Internal Revenue Service, Publication 550 (2025), Investment Income and Expenses, "Gains on Qualified Small Business Stock" and "Capital Gain Tax Rates," https://www.irs.gov/publications/p550.

[4] Internal Revenue Service, Instructions for Schedule D (Form 1120-S) (2025), qualified small business stock tests, https://www.irs.gov/instructions/i1120ssd.

[5] Internal Revenue Service, Instructions for Schedule D (Form 1040) (2025), Section 1202 reporting, 28% rate gain, alternative minimum tax, and Section 1045 rollover instructions, https://www.irs.gov/instructions/i1040sd.

[6] Internal Revenue Service, Topic No. 559, Net Investment Income Tax (3.8% rate and treatment of taxable stock gains), https://www.irs.gov/taxtopics/tc559; Internal Revenue Service, Publication 550 (2025) (20% maximum rate for other long-term capital gain), https://www.irs.gov/publications/p550.

[7] California Franchise Tax Board, Summary of Federal Income Tax Changes --- Public Law 119-21, Section 70431 (California nonconformity to the federal QSBS exclusion and 2025 expansion), https://www.ftb.ca.gov/about-ftb/data-reports-plans/Summary-of-Federal-Income-Tax-Changes/index.html.

[8] U.S. House of Representatives, Office of the Law Revision Counsel, 26 U.S.C. Section 1(h)(4) and (7) --- 28-Percent Rate Gain and Section 1202 Gain (text containing laws in effect July 15, 2026), https://uscode.house.gov/view.xhtml?req=%28title%3A26+section%3A1+edition%3Aprelim%29.

This piece is educational. It is not legal, tax, or accounting advice and is not a recommendation to take or refrain from any specific action. Tax law is fact-specific and changes regularly. Please coordinate any decisions discussed here with your attorney, your CPA, and Perissos before acting.

Perissos Private Wealth Management is a Registered Investment Adviser ("RIA"). Registration as an investment adviser does not imply a certain level of skill or training, and the content of this communication has not been approved or verified by the United States Securities and Exchange Commission or by any state securities authority. Perissos Private Wealth Management renders individualized investment advice to persons in a particular state only after complying with the state's regulatory requirements, or pursuant to an applicable state exemption or exclusion. All investments carry risk, and no investment strategy can guarantee a profit or protect from loss of capital. Past performance is not indicative of future results.

The information contained in this newsletter is intended to provide general information about market themes. It is not intended to offer investment advice. Investment advice will only be given after a client engages our services by executing the appropriate investment services agreement. Information regarding investment products and services is given solely to provide education regarding our investment philosophy and our strategies. You should not rely on any information provided in making investment decisions.

Market data, articles and other content in this material are based on generally available information and are believed to be reliable. Perissos Private Wealth Management does not guarantee the accuracy of the information contained in this material.

Perissos Private Wealth Management will provide all prospective clients with a copy of our current Form ADV, Part 2A (Disclosure Brochure), Part 2B (Supplemental Brochures), and Part 3 (Client Relationship Summary) prior to commencing an advisory relationship. You can also view these documents at any time at adviserinfo.sec.gov or by contacting us requesting a copy.