The exclusion
Section 1202 allows non-corporate taxpayers to exclude from income gain on the sale of qualified small business stock (QSBS) held more than five years. The exclusion is 100% for stock acquired after September 27, 2010 — a powerful benefit that can shelter millions of dollars from federal capital gains tax.
Per-issuer cap
The exclusion is capped at the greater of $10 million OR 10x the basis of the stock, per issuer per taxpayer. Multiple shareholders of the same QSBS each get their own cap. Strategies like "QSBS stacking" (gifting stock to family members or trusts) can multiply the cap, though they require careful planning.
Eligibility requirements
The issuer must be (a) a domestic C-corporation, (b) with gross assets under $50 million immediately before AND immediately after issuance, (c) actively engaged in a qualified trade or business (most service businesses — health, law, finance, consulting — do not qualify), (d) the taxpayer must have acquired the stock at original issuance for cash, services, or property (not from another shareholder).
Why C-corp matters here
QSBS is one of the few tax provisions that strongly favors C-corps over pass-throughs. Founders planning to build a venture-scale company often choose C-corp status partly to preserve QSBS eligibility. Pass-through owners (sole prop, S-corp, LLC taxed as partnership) cannot claim QSBS regardless of how the business otherwise performs.
Section 1045 rollover
If you sell QSBS before the 5-year holding period, Section 1045 lets you defer the gain by reinvesting in new QSBS within 60 days. The rollover preserves the original basis and tacks the holding periods together — useful when an early-exit acquisition would otherwise terminate the QSBS holding period.
Worked example with numbers
Consider a sole prop with $100,000 in gross receipts and $30,000 in legitimate Schedule C deductions, including this category. Each additional $1,000 of qualifying expense reduces Schedule C net profit by $1,000, which reduces self-employment tax by approximately $1,000 × 92.35% × 15.3% ≈ $141, and reduces income tax by $1,000 × marginal rate. At a 22% federal marginal rate, the combined federal tax savings on each additional $1,000 of legitimate deduction is roughly $361, and state savings sit on top of that. The math is why disciplined categorization throughout the year pays for itself.