QSBS Limitations and Restrictions: Understanding Section 1202 Restrictions

While Qualified Small Business Stock (QSBS) offers significant tax benefits, there are numerous limitations and restrictions that taxpayers must understand. These include per-issuer dollar limits, holding period requirements, excluded businesses, redemption restrictions, and other limitations.

This page provides a comprehensive overview of the limitations and restrictions on QSBS benefits.

Per-Issuer Dollar Limitations

Basic Limit

The exclusion is subject to a per-issuer (per corporation) dollar limitation.

For Stock Acquired on or Before July 4, 2025:

• $10 million per issuer (or 10 times adjusted basis, if greater) [IRC §1202(b)(4)(A)]

For Stock Acquired After July 4, 2025:

• $15 million per issuer (or 10 times adjusted basis, if greater) [IRC §1202(b)(4)(B)]

How the Limit Applies

The limit applies to "eligible gain," which is gain from the sale or exchange of QSBS held for:

• At least 3 years (for stock acquired after the applicable date), or
• More than 5 years (for stock acquired on or before the applicable date) [IRC §1202(b)(2)]

Multiple Issuers

The limit applies per issuer, meaning taxpayers can exclude gains from multiple different QSBS issuers, subject to each issuer's separate limit.

Example: A taxpayer can exclude up to $15 million of gain from Issuer A and up to $15 million of gain from Issuer B (for post-applicable date stock), subject to separate limits for each.

10 Times Basis Alternative

The limit is the greater of:

• The dollar amount ($10 million or $15 million), or
• 10 times the aggregate adjusted bases of the QSBS disposed of during the taxable year

For high-basis stock, the 10-times-basis alternative may provide a higher limit.

Important: For purposes of the 10-times-basis calculation, adjusted basis is determined without regard to any addition to basis after the date on which such stock was originally issued. [IRC §1202(b)(1)]

Married Individuals

For married individuals filing separate returns:

• The $10 million limit becomes $5 million [IRC §1202(b)(3)(A)(i)]
• For post-applicable date stock, the $15 million limit is cut in half [IRC §1202(b)(3)(A)(ii)]

For joint returns, the exclusion amount is allocated equally between spouses for purposes of applying the limitation to subsequent taxable years. [IRC §1202(b)(3)(B)]

Inflation Adjustment

Beginning in 2027, the $15 million amount (for post-applicable date stock) is adjusted for inflation. [IRC §1202(b)(5)]

Holding Period Requirements

Minimum Holding Periods

Stock Acquired on or Before July 4, 2025:

• Must be held for more than 5 years to qualify for exclusion [IRC §1202(a)(1)(A)]

Stock Acquired After July 4, 2025:

• Must be held for at least 3 years to qualify for any exclusion [IRC §1202(a)(1)(B)]
• Exclusion percentage increases with longer holding periods (50% at 3 years, 75% at 4 years, 100% at 5 years)

No Exclusion for Short-Term Holdings: Stock held for less than the minimum period does not qualify for any exclusion.

Eligible Gain Limitation

Only "eligible gain" qualifies for exclusion. Eligible gain is gain from the sale or exchange of QSBS held for the required period. [IRC §1202(b)(2)]

Gain from stock held for less than the required period is not eligible gain and does not qualify for exclusion.

Excluded Businesses

Section 1202(e)(3) excludes certain types of businesses from QSBS qualification:

Professional Services

Any trade or business involving the performance of services in:

• Health
• Law
• Engineering
• Architecture
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services
• Brokerage services
• Any trade or business where the principal asset is the reputation or skill of one or more employees [IRC §1202(e)(3)(A)]

Financial Services

• Banking
• Insurance
• Financing
• Leasing
• Investing [IRC §1202(e)(3)(B)]

Farming

Any farming business, including the business of raising or harvesting trees. [IRC §1202(e)(3)(C)]

Natural Resources

Any business involving the production or extraction of products of a character with respect to which a deduction is allowable under Section 613 or 613A (oil, gas, minerals). [IRC §1202(e)(3)(D)]

Hospitality

• Hotels
• Motels
• Restaurants
• Similar businesses [IRC §1202(e)(3)(E)]

Corporate Status Restrictions

Must Be a C Corporation

QSBS must be stock in a C corporation. The following do not qualify:

• S corporations
• Partnerships
• Limited liability companies (LLCs)
• Other pass-through entities [IRC §1202(d)(1), (e)(4)]

Eligible Corporation Restrictions

The corporation must be an "eligible corporation," which excludes:

• DISCs or former DISCs
• Regulated investment companies (RICs)
• Real estate investment trusts (REITs)
• REMICs
• Cooperatives [IRC §1202(e)(4)]

Asset Test Restrictions

Gross Asset Limitation

The corporation's aggregate gross assets must not exceed $75 million (for stock issued after July 4, 2025; $50 million for stock issued on or before that date) at:

• All times from August 10, 1993, through the date of stock issuance, and
• Immediately after the issuance [IRC §1202(d)(1)]

Controlled Group Aggregation

All corporations in the same parent-subsidiary controlled group are treated as one corporation for asset test purposes, making it harder to meet the test. [IRC §1202(d)(3)]

Active Business Requirements

80% Asset Test

At least 80% (by value) of the corporation's assets must be used in the active conduct of one or more qualified trades or businesses. [IRC §1202(e)(1)(A)]

This requirement must be met during substantially all of the taxpayer's holding period. [IRC §1202(c)(2)(A)]

Portfolio Stock Limitation

A corporation fails the active business requirement if more than 10% of the value of its assets (in excess of liabilities) consists of stock or securities in other corporations that are not subsidiaries. [IRC §1202(e)(5)(B)]

Real Estate Limitation

A corporation fails the active business requirement if more than 10% of the total value of its assets consists of real property not used in the active conduct of a qualified trade or business. [IRC §1202(e)(7)]

Working Capital Limitation

For corporations in existence 2+ years, no more than 50% of assets may qualify under the working capital exception. [IRC §1202(e)(6)]

Redemption Restrictions

Redemptions from Taxpayer or Related Persons

Stock is disqualified if the corporation purchases stock from the taxpayer or related persons during a 4-year period beginning 2 years before issuance (subject to de minimis exceptions). [IRC §1202(c)(3)(A)]

Significant Redemptions

Stock is disqualified if the corporation makes significant redemptions (more than 5% of aggregate stock value) during a 2-year period beginning 1 year before issuance. [IRC §1202(c)(3)(B)]

Original Issue Requirement

Stock must be acquired at original issue directly from the corporation or through an underwriter. Stock purchased on the secondary market does not qualify. [IRC §1202(c)(1)(B)]

Taxpayer Eligibility

Section 1202 applies only to taxpayers other than corporations. C corporations cannot claim the Section 1202 exclusion. [IRC §1202(a)(1)]

Short Position Restrictions

If a taxpayer has an offsetting short position with respect to QSBS, the exclusion does not apply unless:

• The stock was held for the required period as of the first day there was a short position, and
• The taxpayer elects to recognize gain as if the stock were sold on that first day [IRC §1202(j)(1)]

Ordinary Income Exclusion

Section 1202 exclusion applies only to capital gain. Gain treated as ordinary income is not eligible for exclusion.

State Tax Non-Conformity

Section 1202 is a federal tax provision. States may not conform, meaning state tax may still be owed on gains excluded for federal purposes.

Key Takeaways

1. Per-issuer limits apply: $10-15 million per issuer (depending on acquisition date)

2. Holding period is required: 3-5 years minimum depending on acquisition date

3. Many businesses are excluded: Professional services, financial services, farming, natural resources, hospitality

4. Only C corporations qualify: S corps, partnerships, LLCs do not qualify

5. Asset test is restrictive: $75 million limit (with controlled group aggregation)

6. Active business requirements are strict: 80% asset test, portfolio limitations, real estate limitations

7. Redemption restrictions apply: Corporate redemptions can disqualify stock

8. Original issue required: Secondary market purchases don't qualify

9. State taxes may apply: Section 1202 is federal only

Sources and Citations

• IRC Section 1202(b): Per-issuer limitations
• IRC Section 1202(e)(3): Excluded businesses
• IRC Section 1202(d): Asset test
• IRC Section 1202(e): Active business requirements
• IRC Section 1202(c)(3): Redemption restrictions
• IRC Section 1202(j): Short position restrictions

Verification Date: January 2025

Note: This page reflects the law as of January 2025. QSBS rules include numerous limitations and restrictions that must be carefully considered. This information should not be construed as legal or tax advice. Consult with qualified tax counsel regarding limitations and restrictions applicable to your situation.