The 5-year hold — and the 3-year / 4-year tiers OBBBA introduced

How the hold-period clock starts

The hold-period clock starts on the date of issuance— when the C-corp issued the QSBS to you in exchange for money, property, or services per §1202(c)(1). Vesting events don't reset the clock once the stock has been issued. Early exercise of an option paired with a timely §83(b) election under §83(b)(1)(B) sets the clock to the exercise date, even though full vesting is years out — the §83(b) treats the exercise as the realization event for compensation-income purposes, and §1202 follows that treatment for hold-period purposes.

For unrestricted option exercise (no §83(b), shares vest later), the clock starts at vesting because the §83(a) inclusion event aligns with the issuance event for §1202 purposes. For RSUs, the clock starts at settlement (vesting) for the same reason. For founder shares acquired at incorporation, the clock starts at the incorporation issuance date — typically a $0.00001 or $0.001 per-share basis lot on the founding cap table.

Pre-OBBBA — the binary rule

Stock issued on or before 2025-07-04 follows the original §1202 binary rule under §1202(a)(4): hold 5+ years from issuance to qualify; otherwise no exclusion. If you exit under 5 years, the corrective path is §1045 — within 60 days you can roll proceeds into replacement QSBS to defer the gain and tack the holding period for the replacement portion. The pre-OBBBA rule set continues to govern pre-OBBBA stock forever, even for sales decades after the OBBBA cutover; see the pre vs post-OBBBA issuance pillar for the boundary mechanics.

Post-OBBBA — three tiers

Stock issued after 2025-07-04 follows the tiered exclusion under P.L. 119-21 §70431(a)(1)-(3) (per Cornell LII amendment footnote; primary-source confirmation against the bill text pending):

• 3 years: 50% federal exclusion. Unexcluded 50% taxed at 28% under §1202(a). (P.L. 119-21 §70431(a)(1).)
• 4 years: 75% federal exclusion. Unexcluded 25% taxed at 28%. (P.L. 119-21 §70431(a)(2).)
• 5+ years: 100% federal exclusion. Nothing left to tax at the 28% rate. (P.L. 119-21 §70431(a)(3) / §1202(a)(4).)

The tier boundaries are computed against the actual elapsed days. The decoder uses holdYears = (saleDate − issuanceDate) / 365.25 and selects the tier whose threshold is satisfied (≥ 3, ≥ 4, ≥ 5). A hold of exactly 1095 days (3.00 years) clears the 3-year tier on day 1095; a hold of 1094 days does not.

Worked example — the cliff between tiers

Founder F received post-OBBBA QSBS on 2025-09-01 at $0 basis. Three sale scenarios on a $4M gain:

• Sale 2028-12-01 (≈ 3.25y hold): Step 1: holdYears = (2028-12-01 − 2025-09-01) / 365.25 ≈ 3.25 — clears the 3-year tier per P.L. 119-21 §70431(a)(1). Exclusion 50% × $4M = $2M excluded. Unexcluded $2M × 28% §1202(a) = $560,000 federal (plus 3.8% NIIT under §1411 ≈ $76,000 on the unexcluded slice).
• Sale 2029-12-01 (≈ 4.25y hold): clears the 4-year tier per §70431(a)(2). Exclusion 75% × $4M = $3M excluded. Unexcluded $1M × 28% =$280,000 federal (+ NIIT ≈ $38k).
• Sale 2030-12-01 (≈ 5.25y hold): clears the 5-year tier per §70431(a)(3) / §1202(a)(4). Exclusion 100% × $4M = $4M excluded. Federal §1202 tax on the in-cap slice = $0.

The marginal value of the year between the 4-year and 5-year sales is $280,000 + ~$38k NIIT = ~$318,000 of federal tax on a $4M gain. That is a 7.9% all-in marginal return on the last year of hold — before state conformity overlays. For a Californian, which decouples per Cal. Rev. & Tax. Code §17131, the state tax at 13.3% applies to the full $4M regardless of tier; the additional federal-tier value still stands. Run any of these in the decoder to verify.

Why the 28% rate matters

The unexcluded slice of a §1202-eligible gain is taxed at 28%under §1202(a)'s reference into §1(h)(4) — that's higher than the standard 20% LTCG rate at the top bracket — and it applies before the §1411 NIIT (3.8%). The 28% rate is also why some founders look at the 75% tier and choose to hold one more year: the marginal last-year-of-holding return at typical exit sizes is enormous.

This is the most common practitioner error in §1202 reporting: a CPA flowing the §1202 gain to Schedule D Part II and applying the regular 20% top LTCG rate (or the 15% middle-bracket rate) instead of the 28% §1202 rate. The fix is to use the Schedule D 28% Rate Gain Worksheet on line 18 to capture the §1202 portion at the correct rate. The Form 8949 walkthrough documents the line-by-line entries.

The §1045 corrective path

If you sell QSBS before 5 years and don't qualify for any post-OBBBA tier (or hold pre-OBBBA stock that needs the full 5 years), IRC §1045 gives you a 60-day window to roll the proceeds into replacement QSBS. The replacement stock inherits a tacked holding period for purposes of testing the §1202 5-year rule again under §1045(b)(4) (which routes through §1223 via §1045(b)(5)) — and the deferred gain is recognized only when you eventually sell the replacement. Detailed mechanics and a chained worked example are in the §1045 rollover pillar.

Tacked holding period — §1202(h)

§1202(h) defines several events that preserve the holding period across changes in ownership or stock form:

• §1202(h)(2)(A) — gift transfers.A gift of QSBS to a non-spouse tacks the donor's holding period and basis (under §1015) onto the donee. If Founder F gifts 4-year-held QSBS to their child and the child sells after one more year, the child satisfies the §1202 5-year test by tacking.
• §1202(h)(2)(B) — inheritance.Inherited QSBS receives the §1014 basis step-up but tacks the decedent's holding period. The heir can therefore qualify under §1202 immediately at the decedent's tacked hold; however, the basis reset under §1014 often makes the 10x-basis cap path dominant — see the cap-arithmetic pillar for the interaction.
• §1202(h)(1)(A) — §351 transfers and §368 reorganizations. A §351 contribution of QSBS to a holdco, or a §368(a)(1)(E) recapitalization, or a §368(a)(1)(F) re-incorporation, all preserve the original §1202 status and holding period. A Delaware-flip via §368(a)(1)(F) is the classic post-Series-A structure where this matters.
• §1041 spousal transfers. Spousal transfers under §1041 carry over both basis and holding period for §1202 purposes.
• §1202(h)(4) — S-to-C conversion. The §1202 clock starts at the issuance of QSBS-eligible (C-corp) stock. The pre-conversion S-corp holding period does NOT tack. This is the most-missed §1202 trap for founders who started as S-corps to absorb early losses and later converted: the conversion date becomes the §1202 clock-start for every share that existed pre-conversion.

Common-mistake ladder

• Mistake 1: applying 20% LTCG to the unexcluded slice.The §1202(a) rate is 28%, applied via Schedule D's 28% Rate Gain Worksheet. This error under-taxes by 8 percentage points and creates a clean notice exposure.
• Mistake 2: starting the clock at grant for options. The clock starts at issuance, which for options means exercise (with §83(b)) or vesting (no §83(b)) — never the grant date. Grant dates are tax non-events.
• Mistake 3: assuming S-corp tenure tacks. §1202(h) does not bridge the S-to-C boundary. The C-corp issuance starts a fresh §1202 clock for every share that existed pre-conversion.
• Mistake 4: confusing the 1-year LTCG hold with the §1202 hold. §1202 always treats the gain as long-term regardless of hold length once the relevant tier is hit, but the §1202 tiers (3/4/5 years) are entirely separate from the 1-year §1222 LTCG hold. A 14-month §1202 sale at $4M gain on post-OBBBA stock = LTCG but NO §1202 exclusion (no tier yet).
• Mistake 5: forgetting the redemption-disqualification window. Treas. Reg. §1.1202-2 disqualifies QSBS if aggregate redemptions exceed both $10,000 AND 2% of taxpayer-held stock during a 4-year window centered on issuance. A modest buyback by the issuer can silently break §1202 eligibility; review issuer redemption activity before claiming the exclusion.
• Mistake 6: ignoring state conformity. Federal §1202 treatment is only half the picture. Californiadecouples entirely under Cal. Rev. & Tax. Code §17131; Pennsylvania and other states partially decouple. The 50-state grid maps every state's position.

The 83(b)-and-§1202 stack — worked example

Employee E received a 2026-01-15 option grant with 4-year vesting (1-year cliff, monthly thereafter) and a $1,000 strike. E exercises early on 2026-02-01 for the full grant at FMV equal to strike (so no §83 ordinary income on exercise) and files a §83(b) election within 30 days per Treas. Reg. §1.83-2(c). E's §1202 clock starts on 2026-02-01. E sells in 2031-02-15 (≈ 5.04y after exercise) for $8M gain.

• Step 1: holdYears = (2031-02-15 − 2026-02-01) / 365.25 ≈ 5.04 — satisfies §70431(a)(3) / §1202(a)(4) 5-year tier.
• Step 2: cap = greater of $15M (post-OBBBA fixed) OR 10 × $1,000 basis = $15M. In-cap gain $8M.
• Step 3: exclusion 100% × $8M = $8M excluded. Federal §1202 tax = $0.

Without the §83(b), E's §1202 clock would have started at vesting (≈ 2030-01-15 for the last tranche), and the 2031-02-15 sale would be a 1.08-year hold — no §1202 tier, no exclusion. The §83(b) election is therefore worth the entire $8M federal exclusion plus state-conformity overlay in this scenario.

Marginal-year-of-hold return at typical exit sizes

At post-OBBBA tier mechanics, the marginal value of pushing the sale from the 4-year tier to the 5-year tier on a $0-basis lot is:

• $1M gain: 25% × $1M × 28% = $70,000 (+ NIIT ≈ $9,500) ≈ $79,500.
• $4M gain: 25% × $4M × 28% = $280,000 (+ NIIT ≈ $38,000) ≈ $318,000.
• $10M gain: 25% × $10M × 28% = $700,000 (+ NIIT ≈ $95,000) ≈ $795,000.
• $15M gain (at cap): 25% × $15M × 28% = $1,050,000 (+ NIIT ≈ $142,500) ≈ $1,192,500.

Above-cap gain is unaffected by the tier — it's ordinary LTCG (20% + NIIT) at either hold length, taxed identically under §1202(b)(1). The marginal-year value is purely within the cap. See the cap pillar for the in-cap vs over-cap split.

State conformity overlay

The federal hold-period and tier mechanics described above are only the federal side. State conformity determines the state-level outcome:

• California:full decoupling under Cal. Rev. & Tax. Code §17131. The state taxes the entire QSBS gain at the 13.3% top rate regardless of federal exclusion or tier.
• Pennsylvania: partial conformity at the 3.07% flat rate; PA treats the federal-excluded portion as taxable state-level gain.
• New Jersey: partial decoupling on NJ-1040 Schedule B; state-level gain stands.
• Texas and other no-tax states: federal exclusion is the entire picture.

The decoder applies the state-conformity overlay automatically. See the 50-state grid for the full map and the per-state pages for residency-test mechanics that matter for pre-exit relocators.

Mixed-tier portfolio planning

Founders with both pre-OBBBA and post-OBBBA issuances face an asymmetric hold calculus. Pre-OBBBA shares need 5 years for any exclusion; post-OBBBA shares can hit 50% at 3 years. The decoder models both together so you can see whether a staggered exit (5y+ on pre-OBBBA, 4y on post-OBBBA, etc.) is the right structure. See the OBBBA cutover page for the mixed-portfolio worked example. For the methodology behind every formula and citation, see /methodology; for the underlying Cornell LII / eCFR / IRS source URLs, see /sources.

Informational, not tax advice. Consult a CPA or Enrolled Agent before acting on a corrective distribution.