Qualified Small Business Stock (Section 1202) tax

Qualified small business stock can exclude millions of gain from federal tax entirely. The 2025 rules changed both the cap and the holding period, and which set applies depends on when the stock was issued.

Two taxable events, not one Equity compensation creates two taxable events: (1) ordinary income when shares vest or options are exercised, (2) capital gain/loss when shares are sold. Misunderstanding this two-layer structure is the most expensive equity tax mistake.

What changed in 2025, and which rules apply to you

Founders and early investors in qualifying C corps can exclude up to 100% of capital gains. Most powerful wealth-building provision in the tax code for startup equity.

For stock issued after July 4, 2025, the exclusion cap rose from $10,000,000 to $15,000,000, and the holding period became tiered: 50% excluded at three years, 75% at four, 100% at five or more. Stock issued before that date still needs the full five years.

Cap: Greater of ($15M post-July-2025 stock / $10M pre-July-2025 stock) OR (10 x adjusted basis). Use higher.

Compare the instruments

The other equity instruments

RSU tax The equity mistake that costs the most: under-withholding at vest. ISO tax The equity mistake that costs the most: AMT on an exercise you never sold. NSO tax The equity mistake that costs the most: tax due on exercise with no cash to pay it. ESPP tax The equity mistake that costs the most: selling one day too early. Phantom stock & SARs tax The equity mistake that costs the most: expecting capital-gains treatment on a cash bonus.

Equity is two taxable events, not one

Vesting or exercising is ordinary income; selling later is a capital gain or loss. The costliest equity mistakes come from treating that two-layer structure as one: underestimating the vesting-day bill, or missing a holding period that would have turned ordinary income into a lower capital-gains rate. Work out both layers before the vest, not at filing.

Model the sale side

What this covers

Federal treatment for the 2026 tax year, from the verified dataset.
Single filer taking the standard deduction in the worked figures.
Equity income stacks on top of salary, so it fills your highest brackets, the figures reflect that rather than taxing it in isolation.
Informational only, not tax advice. Equity decisions are worth a professional's time.