Many business owners start small – building their companies from the ground up. In the beginning, the focus is often on survival: growing revenue, hiring the right people, and keeping the business moving forward. But just as important as how you build your business is how you structure it – and eventually, how you exit it. The way you approach these decisions can have a major impact on how much of your business’ legacy you’re able to keep.
Take, for example, a founder we’ll call Mark. He started a construction company ten years ago and like with many founders, the early years were lean. Every dollar earned was reinvested back into the company. With time he built a strong team and a solid foundation but knew he would need capital to keep growing.
After securing an outside investor, Mark issued shares in the company. At the time, the company qualified as a C-Corporation with less than $50 million in gross assets – an important detail, though not one Mark thought much about at the time. His focus was on growth – scaling operations, managing challenges, and navigating the next round of funding.
The Exit Opportunity
Fast forward thirteen years. That scrappy startup had grown into a major player in its industry. When a large construction firm approached Mark with an acquisition offer, he was thrilled – but also anxious. Selling the business meant a massive life change: stepping away from day-to-day work, realizing a life-changing windfall, and potentially facing a multi-million-dollar tax bill.
Before moving forward, Mark sat down with his CPA to talk through the implications of the sale. That’s when he discovered that his shares might qualify for the Qualified Small Business Stock (QSBS) exclusion under Section 1202 of the Internal Revenue Code – a powerful but often overlooked tax benefit.
What is Section 1202 and QSBS?
Section 1202 allows eligible business owners and early investors to exclude some (or all) of the capital gains from the sale of the QSBS from federal income tax.
Major Requirements:
- Issued by a US C-Corporation
- At the time of the issuance and immediately after, the company has less than $50 million in assets
- The stockholder held the shares for at least 5 years
- The stockholder acquired the shares directly from the company
- The company operated in a qualified industry (certain businesses like hotels, real estate, financial services, etc. are excluded)
- The stock must have been acquired after August 10th, 1995 to be eligible for any QSBS exclusion. Note that the percentage of capital gains that can be excluded varies based on when the stock was acquired
- When QSBS stock is gifted, it retains both its QSBS status and the original holding period from the person who transferred it
Benefit:
- You may exclude up to $10 million in capital gains OR
- Up to 10x your cost basis – whichever is greater – from federal capital gains tax
Mark’s QSBS Tax Exclusion Scenario
Detail | Value |
Shares Issued | 1,000,000 |
Initial Share Price | $1.00 |
Cost Basis | $1,000,000 |
Sale Proceeds (2025) | $15,000,000 |
Total Capital Gain | $14,000,000 |
QSBS Exclusion Comparison
Exclusion Option | Calculation | Taxable Gain |
Option 1: $10M Gain Cap Excluded | $14M – $10M = $4M | $4,000,000 |
Option 2: 10x Basis Rule | 10 × $1M = $10M excluded | $4,000,000 |
In this case, both exclusion limits result in the same benefit and Mark legally avoids paying tax on $10 million of capital gains – saving him over $2 million in federal taxes.
Planning Ahead Matters
The QSBS rules can be incredibly powerful – but only if you plan ahead. The right structure, documentation, and timeline all matter. If you’re a business owner, early employee or startup investor, it’s worth having a conversation now to see whether QSBS could apply to your situation or how you might qualify in the future.
Disclosure: This is a hypothetical scenario presented for illustrative purposes only and does not represent actual client experience. Individual results will vary. This material is not intended as, and should not be construed as, tax or legal advice. Consult with a qualified tax advisor regarding your personal situation. Aldrich Wealth does not provide tax or legal advice.
