New QSBS Rules: A Year-4 Sale Costs $1,192,500 More Than Waiting

The common reading of the 2025 rewrite is that founders can now sell after three years and keep the exclusion. They keep part of it. The new qualified small business stock rules pay the full exclusion only at five years, and each year short of that costs real money.

On a $20,000,000 gain, stock acquired after July 4, 2025 and held five years pays $1,190,000 of federal tax. Sell the same stock after four years and the bill is $2,382,500, which is $2,500 more than a founder with older stock paid on a full exclusion.

The figures below are federal, at the rates in effect for tax year 2026, under section 1202 as amended by P.L. 119-21 on July 4, 2025.

1. What changed for stock acquired after July 4, 2025

Congress amended section 1202 in three ways, and each one applies only to stock acquired or issued after the date of enactment.

• A shorter clock with tiers. Held at least 3 years, 50% of the gain is excluded. At 4 years, 75%. At 5 years or more, 100%.
• A bigger cap. The per-issuer limit is $15,000,000, up from $10,000,000, or 10 times your basis in the shares if that is greater. The $15,000,000 is indexed for inflation for tax years beginning after 2026, rounded to the nearest $10,000.
• A bigger company can issue it. The aggregate gross assets ceiling rose from $50,000,000 to $75,000,000 for stock issued after July 4, 2025, also indexed after 2026.

The statute dates your shares by the first day you held them, counting any holding period carried over under section 1223. That date, not the date of a later sale, decides which set of rules you are under.

2. Older stock keeps the old rules

Shares acquired on or before July 4, 2025 still need more than five years, still use the $10,000,000 cap, and get the percentage set by the window they were acquired in.

A founder can hold both kinds in the same company: common stock from 2023 and a 2026 option exercise, for example. Those blocks share one cap. For the newer shares, the $15,000,000 is reduced by gain on any of that company's stock already counted against the cap in earlier years, plus gain on the older shares counted in the same year.

3. The worked example, to the dollar

A married founder filing jointly sells shares for a $20,000,000 gain. Basis is $10,000, so 10 times basis is only $100,000 and the dollar cap is the limit that binds. She is in the top bracket, so taxable long-term gain pays 20%, the part of the capped gain that is not excluded pays the 28% maximum rate, and everything included in income also pays the 3.8% net investment income tax. Federal only. To keep the comparison clean we hold the new cap at $15,000,000, before any inflation adjustment. New shares cannot reach three years before July 2028, and the cap is indexed for tax years after 2026, so the real cap at sale will be somewhat higher and the tax on new stock a little lower.

Waiting from year 4 to year 5 saves $1,192,500. Waiting from year 3 to year 5 saves $2,385,000.

4. Why the early tiers give back so much

Two rules do the damage. Under section 1(h), the slice of capped gain you could have excluded at 100% but did not is "section 1202 gain", which is 28-percent rate gain, taxed at up to 28% instead of 20%. And under section 1411 every dollar that lands in income adds 3.8% to the extent modified AGI is above $250,000 joint or $200,000 single. So a 50% exclusion saves less than half of the tax.

An early sale also spends the whole cap. The $15,000,000 for later years is reduced by the eligible gain counted against it, not just the excluded part, so a year-3 sale uses the full limit while excluding half of it. In our example the $20,000,000 of eligible gain is more than the $15,000,000 limit, and section 1202(b)(5)(B) then sets that company's limit at zero for every later year, inflation increases included.

For shares acquired after September 27, 2010, the excluded gain is not an alternative minimum tax preference, and section 57(a)(7) now confirms that, so the 50% and 75% tiers do not create AMT.

5. The tests the company has to pass

These tests are measured at the company level, often years before anyone sells.

• C corporation. The issuer must be a domestic C corporation when the stock is issued and during substantially all of your holding period. S corporation stock and LLC units do not count.
• Original issuance. You must get the shares from the company, for money, property other than stock, or services. Shares bought from another shareholder do not qualify, though gifts and inheritances carry the status over.
• Gross assets. Cash plus the adjusted basis of other property must stay at or under $75,000,000 at all times before the issuance and immediately after it, counting the money raised in that round. Property contributed to the company is counted at fair market value.
• Active business. At least 80% of assets, by value, must be used in a qualified business during substantially all of your holding period. After the company's first two years, no more than 50% of assets can count as working capital, and real estate not used in the business is capped at 10%.
• Redemptions. A buyback from you or a related person within two years either side of your issuance, or buybacks totaling more than 5% of the company's stock value within a year either side, can disqualify the shares. Treasury Regulation 1.1202-2 ignores buybacks of $10,000 or less or of 2% or less of the relevant stock, and buybacks tied to leaving the job, death, disability or divorce.

6. Businesses that can never issue it

Section 1202(e)(3) excludes services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage. It also excludes any business whose principal asset is the reputation or skill of one or more employees, plus banking, insurance, financing, leasing, investing or similar businesses, farming, oil, gas and other extraction businesses that claim depletion, and hotels, motels, restaurants or similar businesses.

The new rules changed none of this. A software company qualifies. A consulting firm that builds software for clients may not, and that line is drawn on facts, not on what the pitch deck calls the company.

7. When your clock actually starts

For early employees, the three-year tier depends on the start date, and that date is often later than they assume.

• Options count from exercise. Until you exercise, you hold an option, not stock, and nothing has been issued to you.
• Restricted stock counts from vesting, unless you filed an 83(b) election. Under Treasury Regulation 1.83-4(a), the holding period starts just after the shares vest, or just after the transfer when an 83(b) election was made.
• LLC conversions count from the conversion. Stock received for property is treated as acquired on the exchange date, with QSBS basis no lower than the property's fair market value. Gain built up before the conversion is not excluded, and the higher basis also raises the 10-times-basis limb of the cap.

8. Rolling gain into new QSBS under section 1045

Section 1045 lets a taxpayer other than a corporation defer gain on QSBS held more than 6 months by electing the deferral and buying other QSBS within 60 days of the sale. Gain is recognized only to the extent the amount realized exceeds the cost of the replacement shares, and the deferred gain reduces their basis. You report it on Form 8949 with code R, per the Form 8949 instructions, and the excluded gain on a qualifying sale with code Q.

The holding period of the old shares carries over to the new ones under section 1223(13), except for the C corporation and active-business tests, which the replacement company has to pass on its own. Because section 1202 dates stock after that carryover, replacement shares bought today with proceeds of 2022 stock appear to stay on the old rules: $10,000,000 cap, more than five years, no tiers. Rolling over does not convert old stock into new stock.

9. Your state may tax the whole gain

The exclusion is federal. States decide for themselves. California does not conform to sections 1045 or 1202 at all, and its Schedule D (540) instructions tell residents to enter the entire gain. Every other state sets its own rule, so where you live in the year of sale belongs in the model alongside the federal tiers. If you plan to move before a sale, the residency rules take more than a change of address to satisfy.

10. What to do with shares you hold now

• Date every block. List each issuance, exercise and vesting date, and mark which side of July 4, 2025 it falls on.
• Find the binding limb. Compare the dollar cap with 10 times basis for each block. If basis already covers the gain, QSBS stacking across trusts adds nothing.
• Price the fifth year. Before agreeing to a sale at year 3 or 4, run the tax at each tier. On our example the fifth year was worth $1,192,500.
• Get the company's records now. Gross assets at each round, the active-business analysis and any redemptions. Reconstructing them during diligence is slower and less convincing.
• Check your state. In California, plan as if the exclusion does not exist.

The QSBS calculator runs the qualification questions and shows which limb of the cap applies. Our tax planning work takes it from there: we date each block, rebuild the gross assets history from the books, and model the after-tax result at years 3, 4 and 5, federal and state. Book a call with your stock certificates or cap table export, exercise and 83(b) records, and a rough exit value and date. If the shares do not qualify, you will know before you build a sale timeline around them.

General information for owner-operators, not tax advice. Thresholds change and state treatment varies; confirm current requirements for your own facts before acting.