What Are the QSBS Requirements? Definition, How They Work and Examples

Every test below must be met, and there is no partial credit. Run them in this order. The first three are fixed on the day the shares are issued. The last four run for as long as you hold the shares. What the exclusion is worth once they pass is explained in what is QSBS.

1. 1.0
   Domestic C corporationThe issuer is a US corporation taxed under subchapter C, so it pays its own income tax. LLC units and S corporation shares do not qualify. A company that converts to a C corporation can issue qualifying stock from then on.
2. 2.0
   Gross assets within the ceilingGross assets must not exceed $75 million for stock issued after July 4, 2025, or $50 million for earlier stock. The test applies at all times before the issuance, and immediately after it counting the new money.
3. 3.0
   Original issueYou got the shares from the company itself. You paid money or property other than stock, or you received the shares as pay for services. Shares bought from another holder fail this test.
4. 4.0
   Active businessFor substantially all of your holding period, at least 80% of the company’s assets by value are used in a qualified trade or business.
5. 5.0
   No disqualifying redemptionsA redemption is the company buying back its own stock. The company must not have bought back stock from you or a related person in a four-year window that starts two years before issuance. It also must not have bought back more than 5% of its stock in a two-year window that starts one year before.
6. 6.0
   The holding periodStock acquired after July 4, 2025 needs at least three years. That earns a 50% exclusion, rising to 100% at five years. Earlier stock needs more than five years.
7. 7.0
   The right taxpayerYou are an individual, a trust or an estate. Or you hold through a partnership or S corporation that meets the pass-through rules, which pass the gain on to its owners. A corporation holding the stock gets no exclusion.

Aggregate gross assets are the company’s cash plus the tax basis of everything else it owns. Tax basis is, roughly, what the company paid for an asset, adjusted for tax. The company’s valuation plays no part. A software company valued at $500 million can still pass if it holds little cash and its assets have a low basis. A company that has just banked an $80 million round fails on that day. Property contributed to the company counts at its fair market value when contributed.

The active-business test excludes whole sectors. Services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage do not qualify. Neither does any business whose principal asset is the reputation or skill of its people. Banking, insurance, financing, leasing and investing are out. So are farming, mineral extraction, and hotels and restaurants. Most technology, manufacturing and consumer-product companies are inside.

Two balance-sheet limits catch companies that are still small but hold too much passively. First, cash counts toward the 80% only if it is reasonably needed as working capital or will be spent on research within two years. Second, the active-business test fails for any period in which more than 10% of the company’s assets is real estate not used in the business. Regulated investment companies, real estate investment trusts (REITs) and cooperatives are never eligible.

Section 1202 also requires the company to agree to submit the reports the IRS may require. In practice, the holder carries the evidence. So ask for a statement of gross assets on each issuance date, while the company still has the people who can produce it.

The option itself does not qualify, but the stock you get on exercise can. An option is only a contract to buy shares later. So the tests are applied on the day the company issues the shares to you. That date fixes three things at once. It decides whether the company is still under the asset ceiling, whether the old or new Section 1202 rules apply and when the holding period starts. How to exercise stock options covers the mechanics.

Shares from settled RSUs (restricted stock units, a promise to deliver shares later) follow the same logic. They are acquired as pay for services on the day they are delivered, and that is when the tests and the clock start. Unvested shares, which you can lose if you leave before a set date, are acquired for tax purposes when they vest. The exception is an 83(b) election, a filing with the IRS within 30 days of receiving the shares. It moves the acquisition date back to the transfer. That can put the shares under the ceiling and start the clock years earlier.

Preferred stock converted into common stock of the same company keeps its status and its holding period. Shares received as a gift or by inheritance carry over the previous owner’s status and dates.

There is no application to file. How to qualify for QSBS comes down to meeting the tests above. You then claim the exclusion on your return for the year of the sale. You do this on Form 8949, the IRS form for reporting sales of investments, with code Q and the excluded gain entered as a negative adjustment. The burden of proof sits with you. Each risk below has a document that answers it.

Company was not a C corporation

Keep the certificate of incorporation and any conversion documents with the share certificate.

Assets over the ceiling on issuance

Ask for a written gross-asset statement dated to the issuance date, or to the exercise date for option shares.

Shares not acquired at original issue

Keep the stock purchase agreement or exercise notice showing the company as seller.

Business fell outside the 80% test

Ask the company for an annual confirmation of its activities while you hold.

Redemption around the issuance date

Ask whether the company bought back stock in the two years before and after you acquired yours.

Holding period counted from the wrong date

Note the exercise or settlement date, and keep any 83(b) election with proof of mailing.

One Delaware C corporation builds software. It had $8 million of gross assets in 2023 and $60 million after a round in March 2025. After a round in June 2026, it had $140 million. Three people hold its common stock.

The investor’s position is the common case in pre-IPO shares. A secondary purchase is not original issue, whether you buy directly or through an SPV, a vehicle that pools investors’ money for one deal. The employee’s case is the one that timing could have changed. The exercise date decided the asset test, and the grant date played no part.

• Treating valuation as gross assetsThe test uses cash and tax basis. The price of the last round does not enter it, so read the balance sheet.
• Exercising after a big roundThe asset test is run on the exercise date. A round that lands the cash first can close the door for every later exercise.
• Missing the 83(b) deadlineYou have thirty days from the transfer, with no extension. A late election leaves the acquisition date at vesting.
• Selling back to the companyA buy-back from you or a related person near the issuance date can disqualify shares that otherwise pass every test.
• Relying on a past answerThe active-business test runs for substantially all of your holding period. A pivot into consulting or investing can end it.

QSBS

Qualified small business stock: shares that pass every Section 1202 test. Their gain can be partly or fully excluded from federal tax.

C corporation

A US company taxed under subchapter C of the tax code. It pays its own income tax, separately from its shareholders.

Aggregate gross assets

Cash plus the adjusted tax basis of the company’s other property, with contributed property at fair market value. Tested before and immediately after each issuance.

Original issue

Acquiring shares from the company itself. Every secondary purchase, from another holder, fails this test.

Qualified trade or business

Any business outside the excluded fields, such as professional services, finance, farming, extraction and hospitality.

Redemption

The company buying back its own stock. Near an issuance date, it can disqualify the new shares.

Holding period

The time you own the shares, counted from the day they are issued to you. It sets whether and how much gain is excluded.

83(b) election

A filing within 30 days of receiving unvested stock that treats it as acquired on that day. It starts the tax and QSBS clocks then.

Related: how RSUs are taxed, ISO vs NSO, AMT and the 409A valuation that sets option prices.

Every test and threshold was checked against the US Code and the IRS on October 1, 2026. They reflect federal law as amended on July 4, 2025. The three holders are illustrative. State rules are not covered.