Qualified Small Business Stock (QSBS)
Also: QSBS, qualified small business stock, section 1202 stock
C-corporation stock held more than five years that qualifies for up to 100% federal capital gains exclusion under IRC Section 1202, capped at the greater of $10 million or 10 times basis per issuer.
QSBS is stock in a domestic C corporation that, at issuance, had gross assets of $50 million or less and was engaged in a qualified trade or business. The shareholder must acquire the stock at original issuance, hold for more than five years, and meet the active business requirements. Gain on sale is excluded from federal income tax, up to the greater of $10 million or 10 times the shareholder’s adjusted basis in the stock.
Example: an early employee exercises options for $100,000 in 2021 at a company under the $50 million asset test, triggering the QSBS clock. A 2027 sale at $12 million delivers a $11.9 million gain, all excluded from federal tax. California does not conform and taxes the gain at up to 13.3%.
Common mistake: assuming RSUs qualify. RSUs are not acquired at original issuance, so vested RSU shares are not QSBS. Exercised ISOs and NSOs, and purchased restricted stock, do qualify when the other tests are met.
QSBS matters at formation (choice of entity), at exercise (tracking the five-year clock), and at exit (coordinating state rules and the per-issuer exclusion cap).