Qualified Small Business Stock

Derek Notman |

What Founders Need To Know About IRC Section 1202 - Qualified Small Business Stock.

While starting a business is an exciting venture, it can be challenging for a new startup to keep abreast of all the latest changes to the tax code.  In our latest blog, I’ll be sharing information about Founder Stock and how your business can leverage the benefits of Qualified Small Business Stock, a provision of Internal Revenue Code (IRC) section 1202.

Let’s start at the beginning by defining what Founder Stock is.

Defining Founders Stock

As per the Internal Revenue Code, Founder Stock is outlined in IRC Section 1202 and provides a tax exclusion on gains to taxpayers in certain small business stock sales.   When qualified stock is sold, an individual can exclude gains of up to $10 million or  10 times the adjusted basis of stock.


What is qualified small business stock?

With limited exceptions and subject to compliance with certain reporting requirements imposed by the Internal Revenue Service, Qualified Small Business Stock (QSBS) means any stock acquired on original issuance by the taxpayer from a domestic C corporation after August 10, 1993 that meets the following requirements:

  • The aggregate gross assets of the corporation must not have exceeded $50 million at the time of and immediately after the issuance of the stock;
  • At least 80% of the assets, by value, of the corporation must have been used in an active conduct of one or more qualified trade or businesses.

How to qualify for this tax exclusion

A business first must show proof that they qualify as a Qualified Small Business Company in order to take advantage of the potential tax exclusion.  General guidelines to qualify as a QSBC are outlined in Section 1202:

  • The stock must be in a domestic C Corporation;
  • The corporation must have less than $50 million dollars in revenue or assets on date the stock is acquired;
  • The majority (80%) of the value of the corporation’s assets must be actively used in the handling of the qualified businesses (not an investment vehicle or inactive business);
  • It is probable that most early-stage C corporation companies could meet these requirements.


Tax benefits of Qualified Small Business Stock

If your business is deemed a Qualified Small Business Corporation (QSBC), then the stock must be assessed to determine whether the stock can be considered Qualified Small Business Stock (QSBS).  QSBS offer investors two valuable tax advantages:


  1. Up to a 100% exclusion of gain

  • Usually, taxpayers selling QSB stock are permitted to exclude a portion of their gain if they have held the stock for more than five years.
  • The amount of the exclusion depends on the acquisition date.
  • The exclusion is 100% for stock acquired on or after September 28, 2010.
  • So, if you purchase QSB stock in 2018, you can enjoy a 100% exclusion if you hold it until sometime in 2023. (The specific date, of course, depends on the date you purchase the stock.)


  1. Tax-free gain rollovers

  • If you do not want to hold the QSB stock for five years, you still have an opportunity to enjoy the tax benefit.
  • Within 60 days of selling the stock, you can purchase other QSB stock with the proceeds and defer the tax on your gain until you dispose of the new stock.
  • The rolled-over gain reduces your basis in the new stock.

What is IRC Section 1202?

IRC Section 1202 was passed in 1993 as an incentive for taxpayers to start and invest in certain small businesses.  Section 1202 is a section of the Internal Revenue Code which provides an exclusion for gain in certain small business stock sales by taxpayers other than corporations. 

Section 1202 allows a taxpayer to exclude 100% of the eligible gain realized from the sale or exchange of QSBS issued after September 27, 2010 and held for more than five years.  QSBS must be issued by a qualified small business and generally be acquired by the taxpayer at original issuance, either in exchange for cash or other property, which does not include stock, or as compensation for services rendered to the corporation.

As always it is important that you work with experts in tax and legal to make sure you handling your QSBS correctly.

I hope you found this article helpful, thank you for reading!


Derek Notman

*This is for informational purposes only.  New York Life Insurance Company, and its affiliates and representatives do not provide legal, tax, or accounting advice.  Clients should consult their own legal and tax advisors.