Qualified Small Business Requirements for QSBS: Corporate Eligibility Rules

For stock to qualify as Qualified Small Business Stock (QSBS), the issuing corporation must meet several requirements to qualify as a "qualified small business" under Section 1202(d). These requirements include corporate status, asset limitations, active business requirements, and restrictions on certain types of businesses.

This page provides a comprehensive guide to the requirements a corporation must meet to qualify as a qualified small business for QSBS purposes.

Corporate Status Requirements

Must Be a C Corporation

The issuing corporation must be a domestic C corporation. [IRC §1202(d)(1)]

Excluded Entities:

• S corporations
• Partnerships
• Limited liability companies (LLCs)
• Other pass-through entities

Rationale: QSBS benefits apply to corporate stock, and only C corporations issue stock for these purposes.

Must Be a Domestic Corporation

The corporation must be organized under the laws of the United States or any state. Foreign corporations do not qualify.

Eligible Corporation Requirements

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: The $75 Million Threshold

Gross Asset Limitation

The corporation's aggregate gross assets must not exceed $75 million (increased from $50 million for stock issued after July 4, 2025) at two critical points:

1. Before Issuance: At all times on or after August 10, 1993, and before the issuance, aggregate gross assets must not exceed $75 million [IRC §1202(d)(1)(A)]

2. After Issuance: Immediately after the issuance (determined by taking into account amounts received in the issuance), aggregate gross assets must not exceed $75 million [IRC §1202(d)(1)(B)]

Definition of Aggregate Gross Assets

"Aggregate gross assets" means the amount of cash and the aggregate adjusted bases of other property held by the corporation. [IRC §1202(d)(2)(A)]

Treatment of Contributed Property: For property contributed to the corporation, the adjusted basis is determined as if the basis were equal to the fair market value at the time of contribution. [IRC §1202(d)(2)(B)]

This prevents corporations from contributing low-basis property to artificially reduce aggregate gross assets.

Aggregation Rules

All corporations that are members of the same parent-subsidiary controlled group are treated as one corporation for purposes of the asset test. [IRC §1202(d)(3)(A)]

Parent-Subsidiary Controlled Group: Defined under Section 1563(a)(1), except that "more than 50 percent" is substituted for "at least 80 percent" (a more restrictive test than general controlled group rules). [IRC §1202(d)(3)(B)]

Planning Note: Corporations must consider controlled group members when determining if they meet the asset test.

Inflation Adjustment

Beginning in 2027, the $75 million amount is adjusted for inflation. [IRC §1202(d)(1) (second paragraph (4))]

Active Business Requirement

The corporation must meet active business requirements during substantially all of the taxpayer's holding period for the QSBS. [IRC §1202(c)(2)(A)]

If the corporation fails to meet these requirements at any point during the holding period, the stock may lose QSBS status retroactively.

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)]

Qualified Trade or Business

A "qualified trade or business" means any trade or business other than the following excluded businesses:

Excluded Businesses

1. 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)]

2. Financial Services:

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

3. Farming: Any farming business (including raising or harvesting trees) [IRC §1202(e)(3)(C)]

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

5. Hospitality:

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

Special Rules for Certain Activities

Certain activities are treated as active conduct of a qualified trade or business:

1. Start-up Activities: Activities described in Section 195(c)(1)(A) [IRC §1202(e)(2)(A)]

2. Research and Development: Activities resulting in payments or incurring of expenditures treated as research or experimental expenditures under Section 174 or 174A [IRC §1202(e)(2)(B)]

3. In-House Research: Activities with respect to in-house research expenses described in Section 41(b)(4) [IRC §1202(e)(2)(C)]

Note: These activities are treated as active business even if the corporation has no gross income from such activities.

Stock in Other Corporations

Subsidiaries: Stock and debt in subsidiary corporations are disregarded. The parent is deemed to own its ratable share of the subsidiary's assets and conduct its ratable share of activities. [IRC §1202(e)(5)(A)]

Subsidiary Definition: A corporation is a subsidiary if the parent owns more than 50% of the combined voting power or more than 50% in value of all outstanding stock. [IRC §1202(e)(5)(C)]

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)]

Working Capital

Assets held as reasonably required working capital needs, or held for investment and reasonably expected to be used within 2 years to finance research/experimentation or working capital needs, are treated as used in active business. [IRC §1202(e)(6)]

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

Real Estate Holdings

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)]

Ownership of, dealing in, or renting real property is not treated as active conduct of a qualified trade or business.

Computer Software Royalties

Rights to computer software that produces active business computer software royalties (within the meaning of Section 543(d)(1)) are treated as assets used in active conduct of a trade or business. [IRC §1202(e)(8)]

Reporting Requirement

The corporation must agree to submit such reports to the Secretary and to shareholders as the Secretary may require to carry out the purposes of Section 1202. [IRC §1202(d)(1)(C)]

Continuous Compliance

Holding Period Requirement

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

Key Point: If a corporation ceases to meet the active business requirement during the holding period, the stock may lose QSBS status retroactively.

Planning: Corporations must maintain compliance throughout the holding period, not just at issuance.

C Corporation Status

The corporation must remain a C corporation during substantially all of the holding period. Conversion to an S corporation, partnership, or other entity would disqualify the stock. [IRC §1202(c)(2)(A)]

Special Rules

Small Business Investment Companies

Specialized small business investment companies licensed under Section 301(d) of the Small Business Investment Act of 1958 are treated as meeting the active business requirements. [IRC §1202(c)(2)(B)]

Research Activities

Corporations engaged in research activities may qualify even before generating income, provided the activities are in connection with a future qualified trade or business.

Key Takeaways

1. Must be a C corporation: S corps, partnerships, and LLCs do not qualify

2. $75 million asset test: Aggregate gross assets cannot exceed $75 million (at issuance and historically)

3. 80% active business: At least 80% of assets must be used in active conduct of qualified trade or business

4. Excluded businesses: Professional services, financial services, farming, natural resources, and hospitality are excluded

5. Controlled groups aggregate: All members of a controlled group are treated as one for asset test

6. Continuous compliance: Must meet requirements throughout the holding period

7. 10% portfolio limit: No more than 10% of assets can be portfolio stock

8. 10% real estate limit: No more than 10% of assets can be non-business real estate

Sources and Citations

• IRC Section 1202(d): Qualified small business definition
• IRC Section 1202(e): Active business requirements
• IRC Section 1202(d)(3): Aggregation rules
• IRC Section 1202(e)(3): Excluded businesses

Verification Date: January 2025

Note: This page reflects the law as of January 2025. The asset threshold increased from $50 million to $75 million for stock issued after July 4, 2025. Tax law changes frequently, and corporate qualification requirements are complex. This information should not be construed as legal or tax advice. Consult with qualified tax counsel regarding corporate structure and QSBS eligibility.