|
The Opinionated Daily of Technology & Code
GARRY'S TAKE
|
| Tuesday, March 3, 2026 · Deep Dive |
KNOWLEDGE DEEP DIVE |
|
DEEP DIVE
QSBS Section 1202: The Startup Founder's Tax Exclusion
How to exclude up to $10 million in capital gains from federal income tax when selling qualified C-corp stock.
By Garry Sandcastle
|
|
$10M
Max Exclusion
|
5 yr
Holding Period
|
$50M
Gross Assets Cap
|
0%
Federal Tax Rate
|
|
|
|
The Five Pillars of QSBS Eligibility
For stock to qualify under IRC 1202, both the corporation and the shareholder must meet five requirements simultaneously: (1) domestic C-corporation structure at time of issuance, (2) aggregate gross assets never exceeding $50 million at any point up to and immediately after each stock issuance, (3) at least 80% of assets used in active conduct of a qualified business, (4) stock acquired at original issuance (not secondary), and (5) held for more than 5 years.
|
|
|
The $50M Gross Assets Test
Gross assets means cash plus adjusted tax basis of all property -- not fair market value. This is measured at each separate stock issuance event. Critical nuance: once your shares are validly issued as QSBS, subsequent events that push gross assets over $50M do not retroactively disqualify your shares. The test is point-in-time at issuance. The 2025 OBBBA raised this to $75M for stock issued after July 4, 2025.
|
|
|
The California Caveat
California does not conform to the federal Section 1202 exclusion. State gains are fully taxable at up to 13.3%. For a founder with a $10M gain, this means roughly $1.33M in California state tax even with zero federal tax. Some founders relocate before a liquidity event; the rules around California source income for former residents are complex and aggressively enforced.
|
|
|
Stacking Exclusions Through Gifting
Each taxpayer gets their own $10M exclusion. Gifting QSBS to family members before a sale event can multiply the total exclusion. A founder who gifts shares to a spouse, children, or trusts could potentially shelter $30-50M+ in gains. The gifted shares inherit the donor's holding period and basis. This is the single most powerful QSBS planning technique.
|
|
THE EVIDENCE |
IRC 1202 Text
The statute requires stock to be "acquired by the taxpayer at its original issuance (directly or through an underwriter) in exchange for money or other property (not including stock) or as compensation for services." 26 U.S.C. 1202(c)(1).
2025 Law Change (OBBBA)
The One Big Beautiful Bill Act, signed July 4, 2025, raised the exclusion cap to $15M and gross assets limit to $75M for stock issued after the effective date. Existing founder shares use the prior $10M/$50M rules.
|
|
IMPLICATIONS
For YC-backed C-corp founders at seed stage with sub-$50M gross assets: you are sitting on QSBS gold. The window to preserve eligibility is now, before a large Series A pushes assets near the threshold. Document your gross assets at every issuance event. Consider gifting shares early. And talk to a tax attorney before any liquidity event -- this benefit is too large to leave on the table.
|
You are receiving this because you subscribed to Garry's Take.
If this issue was forwarded to you, subscribe for direct delivery. |