QSBS Eligibility Checklist for Founders (Section 1202)

Section 1202 lets a non-corporate taxpayer exclude part or all of the gain on qualifying stock, up to a limit per issuer. Individuals, trusts and partnerships holding through pass-through can qualify, but the C corporation itself can't claim it.

The benefit attaches to the shares, not to you, so each grant or purchase gets tested separately. A founder might hold three tranches, one that qualifies, one that doesn't because it was issued while the company was an LLC and one that misses on a technicality. That's why records matter more than memory.

Work through these in order, because a failure at any step can end the analysis:

1. C corporation at issuance. The company must be a domestic C corporation when the stock is issued. An S corporation or an LLC taxed as a partnership doesn't qualify for stock issued during that time.
2. Original issuance. You must acquire the stock directly from the company, not from another shareholder. Gifts and inheritance can carry the status forward in some cases, but purchases on a secondary market generally don't.
3. Consideration. You paid with cash, property or services. Stock issued for services counts, which is why founder stock and early grants can qualify.
4. Gross assets test. The company's aggregate gross assets had to be under a statutory limit at issuance and immediately after. Congress has changed this limit, so confirm the one for your issue date.
5. Active business. During substantially all of your holding period, the company must use most of its assets in a qualified trade or business.
6. Holding period. The clock runs from issuance, or from exercise for options. Congress changed the holding periods for stock issued after July 4, 2025, so check which regime applies.
7. Redemptions. Significant company buybacks around the time of issuance can taint the stock.

Many service businesses are excluded from qualifying, including health, law, consulting, financial services, and hospitality such as hotels and restaurants. Farming and mining are excluded too. Software and hardware product companies usually fit, but companies that blend software with services sit in a gray area, and the answer depends on how revenue and assets are used.

If you're in a borderline category, document what the company actually does: how revenue splits between product and services, what the employees work on and how assets are used. A business that started as a consultancy and shifted to software may pass now but need a closer look for the period before the pivot.

Also keep an eye on investment holdings. If the company holds a large amount of cash or securities beyond what it needs for operations, it can fail the asset-use test.

Options don't start the holding period at grant. The clock starts when you exercise and receive shares, so early exercise, where your plan allows it, can matter. Talk to your advisors about the tax consequences of early exercise before you do it.

SAFEs and convertible notes are less settled. Investors and lawyers differ on when the holding period starts for the shares that come out of a conversion, so ask your CPA how they'd treat yours.

If you began as an LLC and converted to a C corporation, the stock issued in the conversion is tested as of the conversion date. Gain that built up before then generally isn't eligible for the exclusion, so record the company's value on the conversion date.

State treatment varies as well: some states, California among them, don't follow the federal exclusion. See QSBS stacking and trust structures for more advanced planning, and the guide on R&D tax credit eligibility for software startups if you're planning around both.

Buyers, lawyers and the IRS may all ask you to prove each requirement years after the fact. Build a file now:

• Certificate of incorporation and any conversion documents showing the C corporation start date.
• Stock purchase agreements, board approvals and receipts for each issuance.
• A cap table showing original issuance to you, tied to the cap table template or your platform records.
• A gross assets calculation at each issuance date, using tax basis for property and fair market value for contributed property.
• A short memo describing the business activities in each period.
• Records of any company redemptions in the year around each issuance.

A cap table platform such as Carta or Pulley can keep issuance records in one place, and the guide on moving a cap table off a spreadsheet shows how to migrate cleanly. Your CPA or tax attorney should make the final eligibility call.