QSBS §1202 exclusion in 2026: the four tests, the cap, and Form 8949 mechanics

Internal Revenue Code Section 1202 (“Qualified Small Business Stock,” QSBS) allows non-corporate taxpayers to exclude up to 100 percent of the gain on the sale of QSBS held more than five years, subject to a per-issuer cap of the greater of $10 million or 10 times the taxpayer’s basis in the stock. The exclusion is one of the most tax-favored treatments in the entire Code; a single founder selling QSBS at the cap can exclude $10 million of capital gain from federal tax, and married founders can exclude $20 million in some structures through trust planning. The authority is IRC §1202, with reporting on Schedule D and Form 8949, and the broader investor reporting context appears in IRS Publication 550.

The 2026 environment for QSBS is that a wave of 2018-2021 venture-backed companies are reaching their five-year holding marker and the Section 1202 exclusion is being claimed at unprecedented dollar volumes. The IRS has signaled increasing scrutiny of QSBS claims, with form-changes to Form 8949 in recent years to require QSBS sales to be reported on Form 8949 with an “Q” or “X” adjustment code, depending on the eligibility category.

To qualify under §1202, the stock must satisfy four tests at the time it is acquired and during a substantial portion of the holding period.

1. Original issuance: The stock must be acquired by the taxpayer at original issuance from the corporation, in exchange for money or property (other than stock) or as compensation for services. Secondary-market stock is not QSBS in the acquirer’s hands.
2. Qualified small business corporation: The issuer must be a domestic C corporation with aggregate gross assets of $50 million or less (now $75 million for stock acquired after the 2024 amendments, where applicable) at all times before and immediately after issuance.
3. Active business requirement: The corporation must use at least 80 percent of its assets in the active conduct of one or more qualified trades or businesses for substantially all of the taxpayer’s holding period. Disqualified trades include health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, financial services, brokerage, banking, insurance, financing, leasing, investing, farming, and certain extractive industries.
4. Holding period: The taxpayer must hold the stock for more than five years before sale.

The percentage of gain excluded depends on when the stock was acquired. Stock acquired before February 18, 2009 gets a 50 percent exclusion. Stock acquired between February 18, 2009 and September 27, 2010 gets a 75 percent exclusion. Stock acquired on or after September 28, 2010 gets a 100 percent exclusion. For 2026 sales, almost all QSBS in play was acquired in the post-2010 period and qualifies for full 100 percent exclusion.

The portion of gain that is not excluded under §1202 (for pre-2010 stock with 50 or 75 percent exclusion) is taxed at a 28 percent capital gains rate under §1(h)(4), not the regular long-term capital gains rates. The excluded portion is also a preference item for the alternative minimum tax (AMT) at 7 percent of the excluded gain, although the AMT preference does not apply to the full 100 percent exclusion category for stock acquired after September 27, 2010.

The per-issuer cap on excluded gain is the greater of $10 million in lifetime gain on that issuer’s stock, or 10 times the taxpayer’s aggregate basis in the QSBS that was sold during the taxable year. The 10x basis test is especially valuable when the taxpayer’s basis is high (for example, a founder who contributed appreciated property at original issuance, or an early investor who paid a meaningful price per share) — the 10x multiplier can produce an exclusion ceiling well above $10 million.

The cap is per-issuer, not per-taxpayer-aggregate, so a taxpayer who holds QSBS from three separate companies can in principle stack three caps. The cap is also per-taxpayer, which is the basis for “QSBS stacking” planning involving non-grantor trusts: each non-grantor trust is a separate taxpayer for §1202 purposes, and gifts of QSBS to multiple non-grantor trusts can multiply the available cap, subject to the gift tax cost and the careful satisfaction of Section 1202’s holding-period and original-issuance rules at the trust level.

QSBS gain is reported on Form 8949 with the appropriate adjustment code. For 100 percent exclusion stock acquired after September 27, 2010, the adjustment code is “Q” with a negative adjustment equal to the excluded gain. For partial exclusion stock (50 or 75 percent), the same code “Q” with the partial adjustment. The remaining (non-excluded) portion is taxed at 28 percent capital gains under §1(h)(4) and the 28-percent calculation flows through the Schedule D worksheet.

Documentation required to support a QSBS position includes: the corporation’s status as a C corp at the time of acquisition; gross-assets evidence at acquisition; original-issuance evidence (the stock purchase agreement or service-grant document); active-business evidence for the holding period (financial statements showing >80 percent of assets in qualified business); and the holding-period calculation. The IRS can challenge any of these elements on examination, so contemporaneous documentation is the operator’s real defense.

If a taxpayer has held QSBS for at least six months but not yet the five-year QSBS holding period, the taxpayer can elect under IRC §1045 to roll over the gain into other QSBS within 60 days. The rollover preserves the original holding period and basis for the §1202 five-year clock and the §1202 exclusion cap math. The Section 1045 election is irrevocable and must be made by the due date of the return (including extensions) for the year of the sale.

Treating LLC interests as QSBS. LLC membership interests do not qualify; the issuer must be a C corporation. An LLC that converted to a C corp before issuing stock can qualify only as of the conversion date forward.

Disqualified trade or business misclassification. A consulting-flavored SaaS company can fall into the disqualified “consulting” bucket if the revenue truly is consulting-style services rather than software product. Founders should be explicit about how they characterize the business.

Secondary-market purchases. Buying shares from another shareholder, not from the company, breaks the original-issuance test. A bonafide exception applies for stock acquired by gift, inheritance, or partnership distribution under specific tacking rules.

Failing to track gross assets. The $50M / $75M aggregate gross-assets test at acquisition is a one-time test, but failing to document the company’s gross assets at that point in time leaves the QSBS position undefended on audit.

• IRC §1202: Partial exclusion for gain from certain small business stock — statute.
• IRC §1045: Rollover of gain from qualified small business stock to another QSBS.
• IRC §1(h)(4) — 28 percent capital gains rate on the non-excluded portion.
• IRS Publication 550: Investment Income and Expenses — investor reporting context.
• IRS Form 8949: Sales and Other Dispositions of Capital Assets — with QSBS adjustment code Q.
• IRS Schedule D (Form 1040): Capital Gains and Losses.