Turning Your Idea Into the Next Big Thing: How Section 1202 Can Help You Get There
Have you ever had an amazing idea that could completely disrupt an industry?
Maybe you’ve dreamed of creating a product that simplifies a tedious task, or building a business that could lift your local community into a new era.
You might not be Google, Apple, or Amazon yet, but every major company started with an idea, a vision, and the right investment to bring it to life. If you’re an entrepreneur with big ambitions, there’s a section of the tax code you should know: Section 1202 of the Internal Revenue Code.
Section 1202 was designed by Congress to encourage investment in small businesses. It provides a major tax incentive for investors who take a chance on early-stage companies allowing them to exclude some or even all the gain when they sell Qualified Small Business Stock (QSBS).
In simple terms, if you form a C-Corporation that qualifies as a “qualified small business” and an investor buys shares directly from your company, they may later exclude most (or all) of their profit from federal income tax when they sell those shares. That’s a huge motivator for investors to get behind small business growth.
“Qualified Small Business Stock” (QSBS) refers to any stock (common or preferred) in a domestic C-Corporation that meets the following criteria:
The stock is acquired at its original issue (directly from the corporation, not through a secondary purchase).
The corporation’s aggregate gross assets do not exceed $75 million on or immediately after issuance.
The corporation agrees to provide certain reporting requirements to the IRS and its shareholders.
Section 1202 isn’t new. It’s evolved over time. Before 2009 section 1202 allowed taxpayers to exclude 50% of their gain after 5 years. In 2009, the exclusion amount was increased to 75%. In 2010, the Small Business Jobs Act increased the exclusion amount to 100% after 5 years. Then came the One Big Beautiful Bill (OBBB), which made Section 1202 even more attractive.
The OBBB increased both the asset threshold and flexibility for investors. The aggregate gross asset limit rose from $50 million to $75 million, meaning more companies can qualify. A new tiered holding-period system was introduced, rewarding investors who stay invested for at least three years. Now, the exclusion amounts are as follows:
3 years
50% exclusion
4 years
75% exclusion
5 years
100% exclusion
The law also raised the annual exclusion cap for QSBS from $10 million or 10 times the investor’s basis to $15 million or 10 times the investor’s basis for QSBS acquired after 2026.
I would be remiss not to mention that every business cannot take advantage of Section 1202. Certain industries are specifically excluded, including:
Service businesses in fields like law, accounting, consulting, health, or financial services
Banking, insurance, financing, or investment companies
Farming businesses
Natural resource extraction (e.g., oil, gas, minerals)
Hospitality such as hotels, motels, or restaurants
However, a host of other businesses generally remain eligible such as manufacturing, technology, software, biotech, and product-based ventures. Essentially, Section 1202 is a powerful tool for innovative entrepreneurs.
Many founders may wonder: “What if my company grows past the small-business threshold?”
Well, Section 1202 measures a company’s size based on aggregate gross assets, which equals cash plus the adjusted basis of other property held by the corporation. Adjusted basis reflects the cost of property (with certain adjustments), it often remains much lower than current market value.
This means your company could be worth more than $75 million while still technically qualifying under Section 1202 for a period of time. That window can make a big difference as your idea scales into the next household name.
The bottom line is that Section 1202 is one of the most entrepreneur-friendly incentives in the tax code. It rewards early investment, attracts capital to growing businesses, and provides a meaningful path for founders and investors alike to benefit when innovation pays off.
The OBBB only made this incentive sweeter—particularly for investors who want flexibility in their holding periods.
Of course, Section 1202 comes with nuances: active-business requirements, industry exclusions, redemption rules, and detailed reporting obligations. That’s where professional guidance matters most.
If you’re building or investing in a startup and want to ensure your structure qualifies for Section 1202 benefits, Razaa Law Firm can help. We’ll walk you through the requirements, structure your entity correctly, and help position you to take advantage of this powerful incentive so you can focus on what really matters: building your business.