Strategies to Maximize Section 1202 Gain Exclusion Amount

Since Congress recently enhanced Section 1202 of the Internal Revenue Code, angel investors and company owners now enjoy significant tax benefits. Under current law, investors can exclude up to 100% of startup investment earnings under Section 1202.

• For QSBS issued before July 5, 2025: Exclusion up to $10 million per investment or 10X basis
• For QSBS issued on or after July 5, 2025: Exclusion up to $15 million per investment or 10X basis

But here’s the catch: Section 1202 benefits don’t happen automatically. They require careful planning, meticulous documentation, and strategic execution from day one. Miss a single requirement, and your entire exclusion could evaporate. This guide will show you exactly how to capture every dollar of tax savings available under the enhanced 2025 rules.

Key Takeaways for 2025 and Beyond

The enhanced Section 1202 benefits for QSBS issued on or after July 5, 2025, create significant new planning opportunities:

• Larger companies now qualify: The $75 million gross assets limit allows larger startups to issue QSBS
• Greater exclusion per investor: The $15 million base exclusion (indexed for inflation) provides 50% more tax savings per taxpayer
• Multi-taxpayer strategies become more powerful: Splitting ownership among family members, trusts, and entities can now generate cumulative exclusions exceeding $100 million
• Strategic timing matters: Consider the issue date carefully, as QSBS issued after July 5, 2025 qualifies for the enhanced benefits

What is Section 1202? 

Certain small business stock capital gains are exempt from federal taxes under Internal Revenue Code (IRC) Section 1202, often called Small Business Stock Gains Exclusion. Only shares of qualifying small businesses purchased after September 27, 2010, and held for over five years, are covered under Internal Revenue Code Section 1202. 

Section 1202 is an initiative to encourage taxpayers who are not corporations to invest in startups and small businesses. However, the small business distributing the shares must qualify as a QSB and a QSBS.

Key limits based on issue date:

• Before July 5, 2025: Up to $10 million or 10X basis, whichever is greater
• On or after July 5, 2025: Up to $15 million or 10X basis, whichever is greater

How do Section 1202 Gain Exclusion work for partnerships and S corporations holding QSBS?

Holding QSBS via a fund treated as a limited liability company (“LLC”) can significantly enhance the total amount of Section 1202 gain exclusion. Each partner or investor is recognized as a distinct taxable entity with an individual regular $10 Million Cap and a particular 10X Basis Cap in the case of a partnership or S corporation owning an issuer’s QSBS. The distribution of Section 1202 gains passing via the pass-through firms among partners and S corporation shareholders are governed by specific procedures. The amount of Section 1202 gain and accompanying sale profits that may be awarded to partners holding carried interests may be subject to restrictions.

How does Section 1202 Gain Exclusion apply to QSBS? 

Qualified small business stock, or QSBS, is the stock of a corporation that meets the requirements for a “qualified small business” (QSB) under Internal Revenue Code Section 1202. The common name for QSBS is Section 1202 stock.

Let’s examine the criteria:

• The company issuing the stock must be an active, domestic C-corporation.
• The company’s assets immediately before and after issuance may be $50 million.
• The company’s primary objective must be a qualified business or trade.
• 80% or more of the corporate assets must come from one of the listed eligible trades or businesses.

Note: The retail, manufacturing, wholesale, and technology industries are just a few examples of the numerous qualifying businesses. Particularly unacceptable are the industries and professions of hospitality, finance, agriculture, mining, and personal care services.

Strategies to maximize Section 1202 Gain Exclusion

The following planning strategies will help QSBS investors to maximize the Section 1202 gain exclusion. These strategies are even more powerful with increased limits for QSBS after July 5, 2025.

Take Advantage of the 10X Basis Cap

Using the 10X Basis Cap, a taxpayer who owns shares of QSBS with Section 1202 tax basis may be able to exclude a cumulative gain.

Example for post-July 5, 2025 QSBS: If a taxpayer has a $5 million basis in QSBS, they can exclude up to $50 million in gains (10X × $5 million), which far exceeds the $15 million base cap.

Strategic timing of sales can maximize this benefit. For instance, if a taxpayer owns both shares of QSBS with Section 1202 tax basis and shares of QSBS with no tax basis, the taxpayer can sell the shares without any tax basis or with a low tax basis in the first year, and the shares with a more significant tax basis in following years.

Dividing an Issuer’s QSBS Among Multiple “Taxpayers”

If an issuer’s QSBS is divided among more than one taxable individual, each gets their own exclusion cap. For post-July 5, 2025 QSBS, this means each taxpayer gets a $15 million or 10X Basis Cap.

Example: A founder could structure ownership to include:

• Themselves ($15 million exclusion)
• Their spouse ($15 million exclusion)
• Adult children (each with $15 million exclusion)
• Non-grantor trusts ($15 million exclusion per trust)

This strategy can create cumulative exclusions of $60 million, $75 million, or more, depending on the number of taxpayers involved.

The fact that any individual liable to any internal revenue tax is included in the Internal Revenue Code’s definition of “taxpayer” allows for many planning strategies. Individuals, entities like spouses, grown offspring, non-grantor trusts, limited partnerships, LLCs, and S companies may all invest in QSBS.

Use Multiple Corporations for Section 1202 Planning

Each QSBS issuer’s gain exclusion ceiling is established independently.

With the increased $75 million gross assets limit (for QSBS issued after July 5, 2025), founders have more flexibility to operate separate qualifying businesses through multiple C corporations. Each corporation can now grow to $75 million in gross assets while still qualifying for QSBS treatment.

Important: Each company must be involved in a stand-alone qualifying small business. Operating a unified firm across many companies is unlikely to enhance the gain exclusion if no company acting alone would be a stand-alone qualifying small business.

Reinvest Section 1202 Gain in Multiple Issuers

This allows for tax-deferred rollovers and potential expansion of exclusion benefits.

One planning consideration is whether profits from the sale of QSBS that are reinvested into other QSBS investments under Section 1045 retain their original identification for Section 1202 gain-exclusion cap purposes, or whether doing so allows one to increase the gain-exclusion cap by spreading the proceeds of one issuer’s QSBS across several QSBS investments.

Report Section 1202 Gain Exclusion

It’s crucial for holders of qualified small business stock (QSBS) to understand what to do when you report the Section 1202 exclusion on your taxes.

Requirements for Section 1202 Gain Exclusion

Investors should be aware that Section 1202’s exclusion of profits from the sale of shares is subject to four conditions.

Qualified small business requirements

According to Sections 1202(c)(1) and 1202(c)(2)(A), the issuing company must be a “qualified small business” as of the date of issue. A domestic company is referred to as a “qualified small business” under IRC Section 1202(d)(1) if:

For QSBS issued on or after July 5, 2025:

• This corporation’s total gross assets must not have exceeded $75 million at any time before the issue of the stock.
• The corporation’s total gross assets do not exceed $75 million immediately after the issue of the stock.
• The corporation undertakes to provide any “reports” that the IRS requires to carry out for Section 1202.

The stock of a Subchapter C Corporation should be Acquired at an “Original Issuance”

According to IRC sections 1202(c)(1) and 1202(c)(1)(B), QSBS is stock in a C corporation that was originally issued if such shares are obtained in return for cash, other property, or as payment for services rendered for a corporation. The seller seeking the Section 1202 tax advantage must be the seller who originally purchaserd of the QSB shares. QSBS must be purchased straight from the issuer in return for money, other assets, or as payment for services rendered to the issuing company. 

Five-Year Holding Period

To exclude profits, QSBS must be kept for a minimum of five years. Regardless transaction, the holding period generally starts on the day of the issue. Special law applies to the calculation of the holding period if.

• The QSBS is changed into another stock of the same company
• The stock is obtained as a gift
• The stock is obtained via inheritance
• The stock is obtained as a transfer from a partnership

Active business requirements

As per Internal Revenue Code Section 1202(c)(2), a company’s stock cannot be regarded as QSB stock unless it is a subchapter C corporation and fulfills the “active business criteria” of Internal Revenue Code Section 1202(e) during virtually the whole of the taxpayer’s holding period. For any time, a company is deemed to have satisfied the “active business requirement” of section 1202(e) if:

• The company actively engages in one or more qualified trades or businesses, with at least 80% of its assets employed for such purposes.
• This business qualifies as an eligible corporation.

How to report Section 1202 Gain Exclusion

Filing the following forms is a requirement in reporting Section 1202 gain exclusions:

• Form 1099-DIV – On Schedule D, line 13 of your individual tax return, the gain from Section 1202 will be recorded. It will show in box 2(c) of the form. Enter as a positive integer the amount of your exclusion permissible 2nd line of the 28% Rate Gain Worksheet on lines 18 and 19 of Schedule D. Enter the name of the company sold in column (a) of Form 8949, Part II. On Form 8949, you must also put “Q” in column (f) and a negative figure for the excluded gain’s amount in column (g).
• Form 1099 – Whether box two on the 1099-B is selected for short- or long-term gain and whether it was or was not reported to the IRS, one may check one of four boxes on Form 8949. Enter the company’s name sold in column (a) of Form 8949, Part II. You must also put “Q” in column (f) and a negative figure for the excluded gain’s amount in column (g).
• Form 1099-CAP – The profits from the sale or exchange of shares will be reported on Form 8949 and Schedule D in box 2 of the form, per the instructions above.
• Form 1099-MISC – In the form’s box 3, labeled “other income” the QSBS will be shown. Enter the company’s name sold in column (a) of Form 8949, Part II. On Form 8949, you must also put “Q” in column (f) and a negative figure for the excluded gain’s amount in column (g). Enter the amount your Section 1202 exclusion does not cover on line 2 of the 28% Rate Gain Worksheet as a positive figure on lines 18 and 19 of Schedule D.
• Schedule K-1 – On line 10 of the k-1 obtained via the 1120S (S Corporation) tax return or line 11 of the k-1 obtained through a 1065 (Partnership) tax return, QSBS profits obtained through a pass-through business must be recorded. A statement detailing each sale or exchange will be attached to the K-1 and include the following information:
  • (a) the name of the company that issued the QSB stock;
  • (b) the partner’s portion of the partnership’s adjusted basis and sales price;
  • (c) the dates the QSB stock was purchased and sold.
• Form 2439 – The Section 1202 gain will be recorded in box 1(c) of the form, and box 1(a) will contain the whole gain. Fill out Schedule D, line 11, and include the whole gain from box 1(a).Follow standard Form 8949 procedures for reporting the exclusion.
• Form 6252 – When a QSBS gain is acquired via an installment sale, Form 6252 is used to document the transaction. On line 11 of Schedule D, the long-term gain declared on Form 6252 shall also be declared. By increasing the exclusion by a percentage of the profits received each year of the installment schedule, you must figure out the eligible gain for each installment’s reporting year.

Why choose Eqvista to manage and track your QSBS? 

Maximizing Section 1202 benefits requires meticulous documentation and compliance from day one. With the enhanced thresholds now in effect, the potential tax savings of $15 million or more per investor make proper QSBS management more valuable than ever.

Eqvista offers professional QSBS attestation letters that provide crucial documentation for your investors. Our attestations are prepared by valuation experts who understand the nuances of QSBS compliance, including the updated $75 million gross assets threshold. With Eqvista, you don’t just manage equity, you build an audit-ready record.