Section 1202 QSBS Regulations Are Coming — Here’s What to Document Now
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For founders, early employees, and investors in qualifying C corporations, the Section 1202 gain exclusion represents one of the most valuable tax benefits in the U.S. tax code — and it just got bigger.
The United States Treasury Department is working with the IRS to develop regulations to implement recent statutory enhancements to the qualified small business stock (“QSBS”) gain exclusion under Section 1202, a Treasury attorney-adviser told the American Bar Association Tax Section at its May meeting in Washington, D.C.[1]
Early-stage companies focused on developing their businesses should not take for granted the need to substantiate that QSBS is issued. Their shareholders investing in early financing rounds or their shareholders who receive shares as compensation for services can be eligible for the QSBS exclusion. Treasury guidance will likely affirm this substantiation requirement.
What Is the Section 1202 QSBS Exclusion and What Has Changed?
Enacted in 1993, Section 1202 lets founders, early employees, and early investors in qualifying C corporations exclude capital gains on the sale of stock held for the requisite period. In 2025, the One Big Beautiful Bill Act (P.L. 119-21) expanded the tax benefit by increasing the maximum exclusion, shortening the required holding period in certain circumstances, and raising the aggregate gross asset threshold so larger companies can qualify — broadening the universe of eligible taxpayers and issuers, and prompting many early-stage companies and investors to focus on eligibility.
Why QSBS Documentation Can’t Wait for Regulations
Treasury’s renewed attention to QSBS is a useful reminder:
QSBS eligibility is fact-dependent and documentation is essential to substantiate a claimed exclusion.
The U.S. Court of Federal Claims’ decision in Ju v. United States[2] illustrates the point. Here, the court held that shares the taxpayer received in 2015 to settle a dispute with his former university employer did not qualify under Section 1202 because they had originally been issued to the university, not to him at original issuance, among other issues. On a separate block of shares the taxpayer did acquire at original issuance in 2003, the court denied summary judgment because the taxpayer’s only evidence that the business met the qualified small business requirement when issued came from 2009–2011 — years after the actual share issuance — leaving a factual dispute as to whether such shares were issued at a time the business was considered a qualified small business.
QSBS Documentation Checklist for Founders, Employees, and Investors
Forthcoming regulations may clarify the expanded regime, but they will not displace the statutory requirements taxpayers must satisfy. Founders, early employees, early investors, and issuers should:
- Confirm and document acquisition of shares at original issuance;
- Maintain contemporaneous records of the issuer’s (i.e., the corporation issuing the stock) aggregate gross assets immediately before and after each qualifying issuance;
- Track each block’s holding period separately; and
- Substantiate that the active business requirement is satisfied by the issuer (including engagement in a qualified trade or business).
For further information about how to substantiate QSBS, please contact your KBF Advisor.
KBF’s Emerging Growth Companies and Income Tax Planning teams work with founders and investors at every stage. Contact us to review your QSBS eligibility and documentation before regulations are finalized.
[1]Michael Rapoport, “Treasury Working on Rules for Expanded Startup Tax Break,” Bloomberg Tax (May 9, 2026); Edward Beeby, Qualified Small Business Stock Guidance May Limit Stacking, 2026 Tax Notes Today (Federal) 91-5 (May 12, 2026).
[2] Ju v. United States, 170 Fed. Cl. 266 (2024).