Section 1202 of the Internal Revenue Code is arguably the single most generous tax break in the U.S. tax code for early-stage equity holders. Get the facts right and you can sell up to $10 million of startup stock (or 10× your basis — whichever is greater) and exclude the gain from federal income tax entirely. Get one requirement wrong and the exclusion is zero.
The Five Eligibility Tests (All Must Be True)
| # | Requirement |
|---|---|
| 1 | Stock is in a domestic C-corporation (LLCs and S-corps do not qualify — conversions can, with rules). |
| 2 | Company’s gross assets were under $50M at the time the stock was issued. |
| 3 | Stock was acquired at original issuance — not on the secondary market. |
| 4 | You held the stock for more than 5 years. |
| 5 | The company was in a qualified trade or business (most tech, SaaS, biotech; not law, health services, consulting, finance). |
How the $10M / 10× Cap Works
The per-issuer exclusion is the greater of:
- $10,000,000 of gain, or
- 10 times your aggregate adjusted basis in the stock.
Basis example: if you early-exercised ISOs for $200,000, your 10× ceiling is $2M — but the $10M floor still applies, so your effective cap is $10M. If you bought founder shares for $1M, your 10× ceiling is $10M, matching the floor.
ISO Early Exercise + QSBS: The Double Benefit
Employees with Incentive Stock Options at an early-stage C-corp can stack advantages:
- Early-exercise at a low strike price to start the 5-year QSBS clock immediately.
- File an 83(b) election within 30 days to lock in ordinary income at the tiny bargain element.
- Hold 5 years + 1 day, then sell during the exit for federal tax-free gain up to the cap.
The risk is real: if the company fails, you paid real money for worthless shares. This is why QSBS planning belongs in a broader equity-comp framework — see the RSU and equity compensation playbook linked below.
State Tax Is Separate
Section 1202 is a federal provision. California, Pennsylvania, Mississippi, and a few others do not conform. If you live in CA during the sale, expect full state-level capital gains tax even if federal is zero. Relocation planning is legal but requires a clean change of domicile — not just a temporary move.
Stacking Exclusions Across Family Members
Because the $10M cap is per-taxpayer-per-issuer, gifting QSBS shares to a non-grantor trust or to adult children before sale can multiply the exclusion. This is advanced estate planning and should only be attempted with a qualified attorney.