Why Startup Founders Can Sell $10 Million in Stock and Owe Zero Federal Tax

A founder who sells $10 million of stock in a startup can owe no federal income tax on the gain, provided the shares meet the qualified small business stock (QSBS) rules in Section 1202. Under the statute, gross income “shall not include” the excluded share of gain from qualified small business stock (26 U.S.C. § 1202(a)(1)). The rule matters right now because private fundraising is running at a high rate. SEC Form D data show 5,137 operating-company offerings that sold $176,270,064,134 in the third quarter of 2026. Every share issued in those rounds could qualify, but only if both the company and the stock pass each test.

Which Companies and Shares Qualify

• C corporation with limited assets: The issuer must be a domestic C corporation whose total gross assets did not exceed $75,000,000 at any time before the issuance or immediately after it (§ 1202(d)(1)(A)-(B)). That ceiling applies to stock issued after July 4, 2025. Earlier issuances are tested against the prior $50,000,000 limit.
• Original issue: You must get the stock directly from the company in exchange for money, property other than stock, or services (§ 1202(c)(1)(B)).
• Active business: The company must use at least 80% (by value) of its assets in a qualified trade or business. It must also remain a C corporation during substantially all of your holding period (§ 1202(c)(2)(A)).
• Excluded fields: Health, law, engineering, accounting, consulting, financial services, banking, farming, hotels and restaurants do not count as qualified businesses (§ 1202(e)(3)(A), (B), (C), (E)).

Your Acquisition Date Sets the Holding Period and Exclusion

The Working Families Tax Cuts law (Pub. L. 119-21) set an “applicable date” of July 4, 2025. Your exclusion depends on which side of that date you acquired the stock.

Any eligible gain that is not excluded is taxed as 28% rate gain, according to IRS Publication 550.

How the Per-Company Cap Works: $10 Million, $15 Million or 10 Times Basis

The excludable gain from any one issuer is capped at the greater of two amounts: the applicable dollar limit, or 10 times your adjusted basis in the shares of that company you sold during the year (§ 1202(b)(1)). The dollar limit is $10,000,000 for stock acquired on or before the applicable date (§ 1202(b)(4)(A)). It increases to $15,000,000 for stock acquired after that date (§ 1202(b)(4)(B)). Both limits shrink by the gain you excluded in earlier years. These cap rules apply to taxable years beginning after July 4, 2025.

The $15 million figure is indexed for inflation for taxable years beginning after 2026 (§ 1202(b)(5)(A)). Use the IRS-published figure for the tax year of your sale. One catch: once your gain passes the limit, the limit for every later year drops to zero (§ 1202(b)(5)(B)).

Worked Example: A Founder’s $10 Million Sale

A hypothetical cofounder of a software C corporation bought founder shares at issuance in 2018 for $50,000 in cash. In 2026, the founder sells all of them for $10 million.

• Gain: $9,950,000
• Cap: the greater of $10,000,000 or 10 times basis ($500,000), so $10,000,000 applies
• Exclusion: 100%, because the stock was acquired after 2010 and held more than five years
• Federal income tax on the gain: zero

Now say the founder acquired the same stake after July 4, 2025 and sold after three years. Only $4,975,000 would be excluded, and the other $4,975,000 would be taxed as 28% rate gain. The alternative minimum tax preference in Section 57 reaches only stock acquired on or before the 2010 Small Business Jobs Act (§ 57(a)(7)).

Traps That Can Wipe Out the Exclusion

• Vesting without an 83(b) election: For restricted stock, the holding period starts only once the shares vest. If you file a Section 83(b) election, it starts just after the transfer (26 CFR 1.83-4(a)).
• Company buybacks: Stock loses QSBS status if the company buys back more than a de minimis amount from you or a related person in the four-year period that begins two years before issuance (26 CFR 1.1202-2(a)(1)). A buyback counts as more than de minimis only if it tops $10,000 and 2% of your holdings.
• State tax: California’s code states that “Section 1202 of the Internal Revenue Code… does not apply” (Cal. Rev. & Tax. Code § 18152). California also prohibits the Section 1045 rollover (§ 18038.4). The zero in the headline applies to federal tax only.

A Decision Framework, and Who It Doesn’t Suit

Work through these questions before counting on the exclusion: Was the company a C corporation when your shares were issued? Was the stock original issue? Did you file an 83(b) election? Which acquisition date applies to your shares? Do your company’s records show it met the asset and active-business tests? If you need to sell early, Section 1045 allows you defer gain on QSBS held more than 6 months by buying replacement QSBS within 60 days (§ 1045(a)).

QSBS is a poor fit for founders of excluded service firms, holders of post-2025 stock who need cash before three years, companies likely to pass the asset ceiling before key issuances, and founders who would get more from pass-through losses. Look for the IRS’s indexed dollar limit for 2027, which Rev. Proc. guidance will set.

Contact [email protected] for any questions or corrections.