Increased Tax Savings Under the “New” Section 1202 on Sale of Your Pre-IPO Stock

This article was published in CEOWorld Magazine on May 27, 2026.

For many C-suite and senior executives, one of the biggest motivations for joining a startup or emerging growth company is the opportunity to receive pre-IPO stock with the potential for extraordinary appreciation. The upside is further enhanced by provisions in the Section 1202 of the Internal Revenue Code which permits holders of Qualified Small Business Stock (“QSBS”) to exclude millions of dollars in capital gains from federal taxation upon sale, resulting in substantial after-tax wealth.

Now, recent changes enacted under the 2025 One Big Beautiful Bill Act have made these potential tax benefits even more attractive, with their update of old Section 1202 into a new and even more potentially beneficial section of the tax law. The new legislation increased from $10 to $15 million the income amount excluded from Federal taxation, expanded the size limitations applicable to qualifying companies, and introduced more flexible phased holding period so that significant exclusions from taxation would be available with much shorter holding periods. These changes will likely substantially increase the after-tax value of your pre-IPO stock.

This article explains how Section 1202 works, when your stock may qualify as QSBS, the bigger tax savings now available under the new law, and key strategies that can help you take advantage of these valuable benefits.

Does Your Pre-IPO Stock Qualify As QSBS?

Under IRS Code Section 1202, a stock that qualifies as QSBS must be originally issued and sold to you by a Qualified Small Business (QSB) and not purchased through a secondary transaction.

How do you know if your company is a Qualified Small Business? To qualify under Section 1202, the company must be a domestic C Corporation engaged in an active trade or

business. During substantially all of your holding period, at least 80% of the company’s assets must be used in active business operations. Real estate owned, for example, is counted against this amount.

Certain businesses are excluded from QSBS tax exemption, including many professional service businesses such as law, accounting, consulting, health care, engineering, and financial services businesses such as banking and insurance.

However, most high-growth innovation companies—including many AI, software, technology, cybersecurity, life sciences, biotech, robotics, and advanced manufacturing companies—are likely to qualify. What if the company is an LLC or S Corporation? Many startups begin life as LLCs, partnerships, or S corporations before later converting into C corporations as institutional investment or rapid growth approaches. If, following your company’s conversion to a C-Corp, your ownership interest is converted into the C corporation’s shares in a tax-free exchange, the resulting shares may qualify as QSBS going forward and the tax basis and holding period will start on the conversion date.

To find out whether your company qualify as a QSB and your pre-IPO stock qualify as QSBS, it is best to consult an experienced executive employment attorney.

How Much Can You Save Under the Expanded Section 1202 Rules?

The tax savings can be enormous.

The 2025 One Big Beautiful Bill Act significantly expanded the benefits in Section 1202. The law increased:

• the maximum gross asset threshold for qualifying companies from $50 million to $75 million; and
• the gain dollar-based exclusion amount from $10 million to $15 million.

As a result, many more startups and emerging growth companies may now qualify for QSBS treatment, and executives may potentially exclude even larger gains from taxation

Under the updated law, if your shares qualify as QSBS and satisfy the applicable holding period requirements, you may exclude up to:

• $15 million in gains (“dollar-based”); or
• 10 times your tax basis in the shares (“multiple-based”), whichever is greater.

This exclusion removes not only Federal taxes on capital gains, but also Federal taxes on the net investment income tax. Many states also provide their own state tax QSBS exclusions.

The $15 million exclusion amount applies to QSBS issued after July 4, 2025, the effective date of the tax law that increased the maximum dollar-based exclusion amount from $10 million previously in effect.

If you hold substantial equity positions in successful startups, the new gains dollar-based maximum $15 million exclusion can potentially save you $3.5 million in Federal taxes! And for some early-stage executives and investors, who would exclude more under the multiple-based exclusion, it could save you even more.

The One Big Beautiful Bill Act also liberalized the holding period rules. Previously, you needed to hold QSBS for five years to obtain any exclusion. Under the new law, partial exclusions may now apply earlier:

• 50% exclusion after a 3-year holding period;
• 75% exclusion after 4 years; and
• 100% exclusion after 5 years.

This change is especially important in today’s acquisition market, where many startups are sold before executives can realistically satisfy a full five-year holding period.

The phased exclusions are available for QSBS issued after July 4, 2025, the effective date of the tax law that liberalized holding period terms from those previously in effect.

Making the 83(b) Election to Avoid Ordinary Income Taxes

Though acquiring and holding QSBS shares can potentially eliminate taxes on gains if the shares are held long enough, Section 1202 does not protect executives from a potentially dangerous tax ambush if proper planning is not undertaken at the outset.

Typically, startup shares issued to executives are subject to vesting requirements. If you leave the company before vesting is complete, some or all of the shares may be forfeited or repurchased by the company at cost. If the shares appreciate, you will be taxed on the increase in value as vesting occurs. Importantly, this tax is treated as ordinary income, and you must pay it even though the shares have not been sold and remain illiquid.

To avoid this, you should make an 83(b) election within 30 days after the shares are issued. This allows you to be taxed at the time the shares are granted rather than as they vest over time. Because startup shares are often issued at a very low valuation initially, the immediate tax cost is typically minimal. More importantly, future appreciation will not be taxed until the shares are sold, when you can then take advantage of the Section 1202 benefits, and when in any case you have cash to pay any tax (for example if you held less than 5 years so that your exclusion was partial and not 100%).

Failing to timely file the 83(b) election can be one of the costliest mistakes a startup executive can make.

Section 1045 Rollovers: Extending Your Section 1202 Benefits

What if your company is likely to be sold before you satisfy the 3-year, 4-year, or 5-year holding period requirements?

Section 1045 of the Internal Revenue Code may provide an important solution.

Under Section 1045, proceeds from the sale of QSBS may be reinvested into other qualifying QSB shares within 60 days, allowing the executive to defer taxation and “tack” the prior holding period onto the new investment.

This means you may continue building toward the applicable exclusion thresholds while diversifying into new startup investments that also qualify as QSBS.

Thus, an executive approaching a liquidity event may preserve substantial future tax savings by properly structuring a timely rollover.  Timely planning is critical because the reinvestment window is short.

Your Rollover Strategy When a Sale Is Expected

There is usually a due diligence period before a sale.  During this time, you should begin to explore startups that may issue QSBS.  Thus, if and when the sale closes, you will be positioned to reinvest promptly.  To rollover tax free, you will need to close your reinvestment within 60 days of receiving your sale proceeds.  You will need to move quickly.

For my clients who hold QSB shares and expect a liquidity event, I advise acting early to join one or more angel investor networks and attend their meetings.  You want to develop familiarity with a number of potential QSB companies.  When you pull the trigger to make one or more investments, you want to do so in the company of other experienced and successful angel investors.

There is still the old caution in the tax law field: “Don’t let the tax tail wag the business dog.”

Angel investing carries big risks. Many and perhaps most startups do not succeed. Still, others will not produce a liquidity event.  In other words, your money is at risk.

Hence, I encourage a hedge.  Keep 30-40% of the sale proceeds in cash and pay your capital gains taxes. But if you have found 4 or 5 QSB companies with strong management teams that you and other seasoned angel investors believe in, then make those investments to give yourself the chance of both further appreciation and a later tax-free sale using the Section 1045 rollover.

Don’t Miss Out on These Tax Savings

The One Big Beautiful Bill Act has significantly increased the potential tax advantages available under Section 1202.

For executives considering a move to a startup or emerging growth company, these expanded rules may dramatically increase the after-tax value of your pre-IPO equity compensation.

At the same time, obtaining these benefits requires careful planning. Issues such as company qualification, holding periods, stock structure, 83(b) elections, rollover strategies, and liquidity-event planning all can materially affect whether you ultimately realize these substantial tax savings.

In this area, it is wise to work with experienced executive employment and tax counsel who understands both startup compensation structures and the complex tax rules governing QSBS. Proper planning may help ensure that you fully benefit from both the upside potential of startup equity and the significant tax savings now available under the expanded Section 1202 rules.