You meet with a new tech startup: three founders, a Delaware C-corp filed six weeks ago, and a seed round closing next month. They’ve done everything right so far, except nobody mentioned that the entity they formed, and the stock they issued, will determine whether they can each shield up to $15 million in gains from federal taxation when they eventually sell. The clock has been running since day one, and they didn’t know.

That’s the QSBS conversation. Attorneys who raise it early are often the ones delivering durable value to their clients.

IRC §1202, the Qualified Small Business Stock exclusion, allows eligible noncorporate taxpayers, including trusts, estates, and partnerships, to exclude up to 100% of federal capital gains on the sale of QSBS.

The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, expanded those benefits materially: the per-eligible taxpayer exclusion cap changes from $10 million to the greater of $15 million (inflation-indexed) or 10x basis; the gross assets threshold rises from $50 million to $75 million; and a new tiered holding period allows partial exclusions at three and four years. These changes apply to stock issued after July 4, 2025; clients with stock straddling that date may be operating under two parallel regimes simultaneously.

To qualify, the issuing corporation must be engaged in a qualified trade or business throughout substantially all of the holding period, with at least 80% of assets by value deployed in the active conduct of that business. Several industries are expressly excluded (among them law, health, accounting, financial services, and consulting), and the exclusion applies based on the nature of services performed, not formal classification.

Below are five §1202 topics worth putting on the checklist for every formation, financing, and conversion engagement.

Entity Type

QSBS is only available for stock issued by a domestic C corporation. LLCs, S corporations, and partnerships generally do not qualify. The implications can surprise clients who organized for operational flexibility without modeling the tax consequences at exit.

Converting from an LLC to a C corporation is a restart. The QSBS clock begins at conversion, not at original formation. There’s also a less-discussed wrinkle when intellectual property is contributed to the corporation in exchange for stock at conversion: that fair market value establishes both the tax basis and the gross assets measurement for that property. By contrast, internally developed IP that was expensed as incurred typically carries near-zero tax basis and minimal gross assets impact. Founders converting from an LLC and contributing IP should model the timing carefully since, if conversion is delayed and the IP has appreciated significantly, its fair market value at contribution may push aggregate gross assets over the applicable threshold, disqualifying shares issued at that financing from QSBS treatment.

Practical Takeaway

Before your client defaults to an LLC, run through the QSBS math. The benefits of locking in eligibility from day one and starting the holding period clock early often outweigh the flexibility of waiting.

The Gross Assets Test

The gross assets test is measured at issuance and immediately after. Under post-OBBBA rules, aggregate gross assets must be $75 million or less at both points; pre-OBBBA stock retains the $50 million threshold. In a venture-backed company, the threshold can be crossed faster than expected, often not between rounds but mid-series, once new cash hits the balance sheet.

A concurrent 409A valuation, obtained for equity compensation purposes, supports this analysis and creates a contemporaneous record far more defensible than anything assembled at exit.

Practical Takeaway

Add a gross assets analysis to your financing checklist. Run it before the round closes and again immediately after. Flag it if the company is within 10–15% of the threshold.

Holding Period

Under prior law, the five-year hold was binary. The OBBBA’s tiered structure changes that: for stock issued after July 4, 2025, a three-year hold yields a 50% exclusion; four years yields 75%; five or more yields 100%. Partial shelter is meaningful shelter, as a 75% exclusion on $15 million still leaves $11.25 million excluded.

For option holders, the clock starts at exercise, not at grant. An employee who was granted options three years ago and exercised last month holds QSBS that is one month old, which is a point that matters now that even a three-year hold carries value.

Practical Takeaway

Know when the stock was issued, and for option holders, when options were exercised. Model the tiered exclusion before assuming clients need to wait for the full five-year mark.

Direct Issuance

QSBS must be acquired directly from the issuing corporation. Secondary market purchases generally do not receive §1202 treatment, regardless of whether the original holder qualified. The exclusion cap applies per taxpayer and per issuer, so investors in multiple qualifying companies can apply separate caps to each.

Practical Takeaway

Secondary investors should not assume they inherit QSBS treatment.

Contemporaneous Documentation

The value of a QSBS position is only as good as the documentation supporting it, and that documentation is most reliable when it is created at issuance, not at exit. At each key milestone, the questions are: What were gross assets at issuance and immediately after? What was the fair market value of any non-cash property contributed? Is there a contemporaneous valuation supporting common stock basis?

With a potential $15 million exclusion at stake, and the 10x alternative yielding a higher ceiling in some cases, a contemporaneous 409A and/or IP valuation is a far more defensible foundation than a reconstruction prepared years later.

Practical Takeaway

Build valuation into the QSBS compliance cadence from the start. A qualified business appraiser at formation and at each subsequent financing creates the documented foundation for an exclusion that could be worth tens of millions of dollars.

A Note on State Conformity

The federal exclusion does not translate uniformly at the state level. California does not conform to §1202, meaning qualifying gains generally remain taxable for California income tax purposes. Oregon enacted SB 1507, decoupling from the federal exclusion for tax years beginning on or after January 1, 2026. Washington currently excludes qualifying QSBS gains from its separate capital gains excise tax regime, although recent legislative proposals have sought to eliminate that treatment, underscoring the need to monitor future developments. Clients with multistate exposure should confirm current state-level treatment with tax counsel as part of any exit planning analysis.

Conclusion

The OBBBA’s changes make §1202 a powerful planning tool. They also make the earliest decisions more consequential than ever. Attorneys who build the above five items into their standard checklists will likely be the ones their clients remember when the exit arrives.