QSBS Section 1202 for US Founders Living in the UK

Qualified small business stock (QSBS) under IRC section 1202 lets a non-corporate shareholder exclude gain on the sale of stock in a qualifying domestic C corporation from US federal income tax — potentially the entire gain, subject to a per-issuer cap. The relief has no counterpart anywhere in UK law. So a US founder who has moved to the UK and then sells can find that the United States charges nothing and the United Kingdom charges capital gains tax on the whole gain, with no foreign tax credit available because there is no US tax to credit.

This is general information, not advice on a particular holding. Outcomes turn on facts: when the stock was issued, what the company owned that day, what it does, and when UK residence began.

Key takeaways

• Section 1202 applies only to stock in a domestic C corporation, so a UK limited company can never issue QSBS. The classic requirement is more than five years of holding; for stock acquired after 4 July 2025 the statute now also provides partial exclusions at shorter periods — see the note below.
• The company's aggregate gross assets must not have exceeded $75 million, or $50 million if the stock was issued on or before 4 July 2025, per the IRS.
• The UK has no QSBS equivalent. A UK-resident seller faces UK capital gains tax at 18% or 24%, and the treaty does not fix this — if the US exempts the gain there is no US tax to credit.
• For a founder in their first four years of UK residence after a long absence, the 4-year foreign income and gains (FIG) regime may relieve the gain in the UK. That is the most valuable planning point here.

What section 1202 actually does

Section 1202 is a deliberate subsidy for people who put money into small operating companies and keep it there. If the conditions are met, gain on sale is excluded from gross income — not deferred, not rate-reduced, simply excluded.

The exclusion is capped per issuer: the limit is the greater of a dollar figure or ten times the shareholder's aggregate adjusted basis in that issuer's QSBS disposed of in the year. For a founder who subscribed at a nominal price, it is the dollar cap that bites. The relief is also per shareholder, per issuer, which is why early-stage gifting of QSBS to family members and trusts is a recognised US strategy.

One point is easy to miss: the part of the gain that is not excluded is 28% rate gain. IRS Topic no. 409 states that the taxable part of gain from selling section 1202 stock "is taxed at a maximum 28% rate" — so a partial exclusion is worth less than it looks.

The holding period, and the newer shorter tiers

The historic rule is simple. The Instructions for Schedule D (Form 1040) put it plainly — "the section 1202 exclusion applies only to QSB stock held for more than 5 years." The percentage excluded has long depended on when the stock was acquired: up to 50% on or before 17 February 2009, up to 75% after that and before 28 September 2010, and up to 100% after 27 September 2010.

The 2025 federal tax legislation changed the architecture. As codified, 26 U.S.C. section 1202 now draws a line at an "applicable date" and, for stock acquired after it, applies a graduated applicable percentage by holding period rather than a flat figure tied to the acquisition year. The asset threshold change, below, is the part irs.gov already confirms.

This needs confirming before anyone relies on it. The codified statute sets out an applicable percentage of 50% at three years, 75% at four years and 100% at five years or more for stock acquired after the applicable date, and an increased per-issuer dollar cap of $15,000,000 against $10,000,000 for earlier stock, indexed for inflation for tax years beginning after 2026. The applicable date is identified as 4 July 2025. The current IRS Instructions for Schedule D do not yet set out these tiers or the increased cap, and the effective-date split between them and the gross-asset change should be confirmed against the enacted legislation before any figure is relied on.

The eligibility tests

A domestic C corporation. The issuer must be, in the words of the Schedule D instructions, a domestic C corporation. This test disqualifies most founders who build outside the US, and also the two structures founders most often hold. An LLC is not a C corporation unless it has elected corporate treatment, and an S corporation is not a C corporation. Stock issued while a company was an S corporation is not QSBS, and converting to C status later does not retroactively qualify shares already issued.

Acquisition at original issue. The stock must be acquired at original issue from the corporation — for money, other property, or as compensation for services. Buying from an existing shareholder on the secondary market does not produce QSBS in the buyer's hands, and options and RSUs do not count until exercised or settled into actual stock, which is when the clock starts.

The gross-asset test. Aggregate gross assets must not have exceeded the threshold at any time before the issuance, and must not exceed it immediately after. The Schedule D instructions give total gross assets of $75 million — or $50 million if the stock was issued on or before 4 July 2025 — or less. Assets of predecessors count, and companies in the same parent-subsidiary controlled group are treated as one. Crucially this is tested at issuance, not at sale: a company can grow to a multi-billion-dollar valuation and its early shares remain QSBS, while a shareholder who comes in after the balance sheet has crossed the line holds non-qualifying stock in the same company.

The active business requirement. At least 80% by value of the corporation's assets must be used in the active conduct of one or more qualified trades or businesses for substantially all of the holding period. Several sectors are excluded by statute, including health, law, accounting, consulting, financial services, banking, insurance, farming, extraction and hospitality. A company sitting on a large cash pile relative to its operations can also fail the 80% test — a real risk after a big round.

Why a UK-incorporated company can never be QSBS

This needs stating bluntly because it is the most common misunderstanding we see. A company incorporated in England and Wales, Scotland or Northern Ireland is not a domestic corporation for US purposes, so it cannot issue qualified small business stock. It does not matter that it is small, that it trades actively, that its shareholders are American, or that it would sail through every other section 1202 test. The entity test is about place of incorporation, and a UK limited company fails it.

Nor is there a workaround by migrating later. Flipping a UK company under a newly formed Delaware holding company does not convert existing UK shares into QSBS, and the exchange has its own consequences in both countries. The holding period and the gross-asset test are measured against the new US stock; the old UK holding period does not simply carry across. This needs US counsel before anything is signed.

The honest conclusion: if QSBS matters to a founder's exit, the US C corporation has to exist and the stock has to be issued early — while the balance sheet is still under the threshold.

The cross-border problem: the US exempts, the UK charges

Here is the scenario that brings people to us. A founder incorporated a Delaware C corporation, took founder stock at formation, ran the business for several years, then moved to London. Two years later the company is acquired. Her US position is excellent: the holding period is satisfied, the company qualified at issuance, and the gain within the cap is excluded from US federal income tax.

Her UK position is a different matter. UK residents are, as a rule, within UK tax on their worldwide gains, and there is no UK relief that mirrors section 1202. The UK's small-company reliefs — EIS, SEIS, VCTs, business asset disposal relief — each have their own conditions, and none is a general exclusion for small-company gains. A gain on US C corporation shares simply falls into the ordinary capital gains computation.

Per gov.uk, for gains from 6 April 2026 the main CGT rates for individuals on assets other than residential property are 18% within the basic rate band and 24% above it, with an annual exempt amount of £3,000 for 2026-27. So a gain Congress decided not to tax at all can attract up to 24% in the UK.

The treaty does not rescue the position. Under the US-UK double taxation convention, Article 13(5) provides that gains on property not covered by the earlier paragraphs of that article "shall be taxable only in the Contracting State of which the alienator is a resident." For a UK-resident seller of US company shares, that points at the UK. Article 1(4) then preserves the United States' right to tax its own citizens as if the convention had not come into effect. The UK has the primary claim; the US retains a citizenship-based one.

Why the foreign tax credit does not help

Article 24(6) of the convention contains the special rules for US citizens resident in the UK. In outline: the UK is not bound to credit US tax on items sourced outside the United States; for US-source items the UK counts only the US tax that could have been imposed under the convention on a UK resident who is not a US citizen; the US then credits the UK tax, the items being treated as arising in the UK solely to relieve that double taxation.

Apply that to an excluded QSBS gain and the asymmetry is obvious. Because Article 13(5) allocates the gain to the UK, the US tax imposable on a non-citizen UK resident is nil — so the UK gives no credit. The US side is meant to balance this by crediting the UK tax. But if section 1202 has excluded the gain, there is no US tax on it, and a credit against nothing is worth nothing. The UK tax is a real, final cost.

This conclusion needs professional review on your facts. Credit mechanics depend on the character and source of the gain, the timing of the two tax years, and whether any part of the gain is taxable in the US.

The one genuine escape: the FIG regime

For founders who have recently arrived, the UK's own rules can solve the problem.

From 6 April 2025 the UK replaced the remittance basis with the 4-year foreign income and gains (FIG) regime. Per gov.uk guidance, a "qualifying new resident" can claim relief from UK tax on foreign income and gains arising in their first four years of UK residence, provided those years follow at least ten consecutive tax years of non-UK residence. Relief for gains covers gains on assets situated outside the UK, is claimed source by source, and is uncapped within the qualifying period.

For a US founder who lived in the US for a decade or more and then moved to London, a gain on US C corporation shares is capable of being a relievable foreign gain — no UK CGT and no US tax, the outcome the founder expected all along. Confirm the situs analysis for the particular shares, and note the regime's exclusion treating assets deriving 75% or more of their value from UK land as UK-situated.

The price of a claim is real. Per HMRC's manual, claiming costs you the personal allowance and the annual exempt amount for that year, and foreign losses arising in a claim year cannot be claimed. A claim is made for each year separately on the SA109 pages; confirm the filing deadline against the current HS266 helpsheet. Our guide to the FIG regime for US citizens in the UK has the mechanics.

The timing point is stark. A sale in year four of UK residence may be fully relieved; the same sale in year five is not.

Section 1045 rollover

Section 1045 is the deferral cousin of section 1202. Per 26 U.S.C. section 1045, a non-corporate taxpayer who sells QSBS held for more than six months may elect to recognise gain only to the extent the amount realised exceeds the cost of replacement QSBS bought within the 60-day period beginning on the date of sale. The unrecognised gain reduces the basis of the replacement stock, and only the first six months of the replacement stock's holding period count towards the section 1202 five-year test.

It is useful for a founder who exits before the five-year mark and intends to reinvest. But the 60-day window is unforgiving, and the UK does not recognise a section 1045 rollover — the US election does not defer the UK disposal, so a UK-resident founder can elect out of US tax and still face a UK charge in the year of sale, with no US tax to credit. The same asymmetry in a different costume.

BADR is not a substitute

UK business asset disposal relief helps, but far less than founders hope.

Per gov.uk, BADR charges qualifying gains at 18% for disposals from 6 April 2026 (14% between 6 April 2025 and 5 April 2026; 10% on or before 5 April 2025), and HMRC's manual at CG63956 confirms a £1 million lifetime limit for disposals on or after 11 March 2020. A share disposal requires you to have been an employee or office holder, and the company to have been a trading "personal company" — at least 5% of shares and voting rights plus a 5% economic entitlement — for at least two years before the sale.

So the advantage over the 24% main rate is modest, and the lifetime limit relieves a thin slice of a large exit. Confirm whether the conditions can be met by a non-UK-incorporated trading company on your facts — the statutory tests concern the company's trade and the shareholder's role rather than its place of incorporation, but confirm rather than assume. Our guide to business asset disposal relief on a UK exit covers the UK mechanics; selling a UK business as a US citizen covers the mirror-image case.

Side-by-side

| | US: section 1202 | UK: capital gains tax |

|---|---|---|

| Company must be | Domestic C corporation | Any company; no QSBS equivalent |

| Core holding period | More than 5 years (shorter tiers for post-4-July-2025 stock — confirm) | None for main rates; 2 years for BADR |

| Size test | Gross assets $75m / $50m at issuance | None |

| Relief | Gain excluded, capped per issuer | None general; BADR capped at £1m lifetime |

| Rate on non-relieved gain | Max 28% on taxable section 1202 gain | 18% / 24% from 6 April 2026 |

| Relief for new arrivals | n/a | FIG regime, first 4 years after 10 abroad |

Planning points and traps

• Decide the jurisdiction of the holding company before value is built. QSBS is won at incorporation, not at exit — and document the gross-asset position at each issuance, because reconstructing balance sheets years later for a buyer's diligence team is painful.
• Model the UK charge before the US exclusion, and map your residence years against the FIG window. Four years is a short runway and the relief does not roll over.
• Watch the temporary non-residence rules if you leave the UK to sell. Per HMRC's HS278 helpsheet, gains realised while temporarily non-resident can be charged in the year of return where you were UK resident in at least four of the seven tax years before departure and the absence is five years or less.
• Remember currency. The UK computes gains in sterling using rates at acquisition and disposal, so exchange movement alone can create or enlarge a UK gain on a dollar asset.
• Do not treat a flip as retroactive, hold through an LLC or S corporation, or buy founder shares from a co-founder and expect QSBS. And re-verify both systems' figures at the date of the deal.

⚠ This is an area that needs professional review

Several positions here are genuinely contentious — in particular the credit analysis for a partially excluded gain, and the situs and FIG treatment of US company shares. Nothing here should be used to decide an exit, make an election or sign a share purchase agreement without advice on your own facts.

Primary sources

26 U.S.C. 1202 and 1045; IRS Instructions for Schedule D and Topic no. 409; gov.uk on CGT rates, BADR (CG63956) and the FIG regime (RFIG43000); and the US-UK double taxation convention, Articles 1(4), 13(5) and 24.

When to get help

If you hold stock in a US C corporation and you are now, or soon will be, UK resident, the work worth doing is sequencing: whether the stock qualifies at all, the UK charge on a realistic exit value, and whether the FIG regime or the timing of the sale changes the answer. That analysis is cheap against the tax it can save, and close to worthless after completion.

We work on exactly this intersection as US-UK tax specialists, modelling both systems in both currencies and preparing the returns on both sides, with an IRS Enrolled Agent who is also ACCA-qualified reviewing and signing off the filings. If that is where you are, book a consultation.