Selling stock in a growing business should be a milestone—not a trigger for a massive tax bill. If you own shares in a qualified small business, Section 1202 of the Internal Revenue Code offers a powerful tax break: the chance to exclude up to 100% of your capital gains when you sell.
This exemption, commonly referred to as the Qualified Small Business Stock (QSBS) exclusion—was created to encourage investment in small, innovative companies. But it only applies under very specific conditions, and it’s easy to miss out if you don’t plan ahead.
This article provides a high-level overview to help you understand how the exemption works, who qualifies, and when this strategy makes sense. It’s a complex area of the tax code, so be sure to consult a CPA before making any moves.
For founders, early employees, or investors in high-growth businesses, the Section 1202 exemption can offer one of the most generous tax advantages available—excluding up to $15 million or 10 times your investment in capital gains. If you’re aiming for a strategic exit and already meet the structural criteria, it’s worth exploring.
This strategy tends to be most effective when:
It’s not a fit for every business. Here are a few limitations to keep in mind:
To claim the Section 1202 exemption, your stock—and the company behind it—need to meet a few key requirements.
...but you'll need to have held the stock for at least five years to get the full benefit.
The One Big Beautiful Bill Act introduced a tiered system. Before, you needed to hold stock for five years before you could qualify at all—but now, you can start excluding part of your gain in as early as three years:
The clock starts when the stock is originally issued to you—not when you join the company or exercise options. Sell too soon, and you lose the exemption entirely.
You need to acquire the stock at original issuance, either by investing, working for the company, or participating in an early fundraising round. Buying shares from someone else on a secondary market doesn’t count.
This is a hard cutoff. If the company crossed $75 million in total assets before your shares were issued, they’re not eligible. Growth after issuance is fine—as long as you got in early.
Not every type of business qualifies. The IRS excludes certain service-heavy industries, including:
This exemption is aimed at product-driven businesses—especially those focused on tech, research, and innovation. If you’re unsure whether your company qualifies, it’s worth talking with a tax advisor before moving forward.
For a full breakdown of eligibility requirements and legal definitions, you can access Section 1202 of the Internal Revenue Code.
Technically, yes—but it’s not as simple as flipping a switch, and we don’t recommend using it as a one-off strategy.
An LLC can convert to a C corporation and issue qualified small business stock, but the five-year holding period only starts after the conversion. Any growth or gains from before the switch won’t qualify for the exemption.
More importantly, restructuring just to chase a tax benefit can create long-term issues—especially if you don’t actually plan to operate as a C corporation going forward. You could run into complications with ownership, tax filings, or your future exit strategy.
If Section 1202 is part of your broader growth plan, consider:
This structure may help you qualify—but only if done correctly. Work closely with a tax advisor and attorney to make sure everything is set up properly from the start.
This exemption works best for businesses with high growth potential—especially those planning for a future sale or public offering. If you're structured as a C corporation and meet the industry and asset requirements, Section 1202 can offer significant long-term tax savings.
You’re more likely to benefit from this strategy if:
If your business doesn’t check these boxes—or you're not planning to exit—it may not be the right fit. But if you're raising outside capital or building with growth in mind, it’s worth exploring early to see if this strategy aligns with your long-term goals.
Not every business—or shareholder—will meet the strict criteria for Section 1202. But that doesn’t mean you’re out of tax planning options. Depending on your timeline and structure, there may be other ways to reduce or defer capital gains.
If you sell QSBS before meeting the five-year holding period, Section 1045 may allow you to defer taxes—if you reinvest the proceeds into new QSBS within 60 days. This only applies to stock that originally qualified under Section 1202, so it’s a limited but valuable tool for eligible sellers.
Your business might benefit more from an S corporation or LLC, depending on how you generate income and what your long-term goals look like. While those structures don’t qualify for QSBS, they may offer other tax advantages—especially for businesses not planning to raise outside capital or go public.
A good CPA can help you explore other options that fit your business, including deductions, credits, or exclusions that don’t require changing your legal structure. The key is making these decisions early—before a major sale or funding event puts you on the clock.
Section 1202 isn’t something to figure out right before a sale. If you want to take full advantage of the small business stock exemption, it has to be part of your long-term strategy from the start.
Here’s what that looks like:
QSBS can be one of the most powerful tax planning tools available to founders, early investors, and fast-growing businesses—but it only works if you meet the requirements and document everything clearly.
If you're thinking about using this strategy or want help mapping out how it fits into your goals, we’re here to help. Schedule a consultation with our team at DiMercurio Advisors—and let’s make sure you’re set up to take full advantage of what the tax code allows.