The Treasury has put a number on QSBS: $140 billion in Section 1202 exclusions claimed between 2012 and 2022. The number is not new. The working paper behind it was published in January 2025. What is new is the attention. Practitioners picked the paper up this spring, alongside a run of regulatory signals, and it is changing the conversation.

Section 1202 used to be a niche provision. It is no longer niche. The combination of OBBBA’s expansion in July 2025, a Treasury working paper quantifying the exclusion’s scale, and Section 1202’s appearance on the Treasury-IRS Priority Guidance Plan has put founder QSBS planning under real scrutiny. The exclusion itself is intact. What is changing is the standard of documentation founders will likely need to defend it.

This guide covers what is driving rising QSBS audit risk, what auditors actually look at, where trust stacking changes the picture, and four things founders can do this quarter to make their files audit-ready.

Why QSBS audit risk is rising in 2026

Treasury’s working paper, Quantifying the 100% Exclusion of Capital Gains on Small Business Stock (Office of Tax Analysis Working Paper 127, January 2025), drew renewed practitioner attention this spring. Four findings stand out:

  • $140B in Section 1202 exclusions claimed between 2012 and 2022
  • Individuals excluding more than $1M in total account for roughly 90% of excluded gains
  • In 2021, the peak year, complex trusts claimed about 13% of excluded gains
  • Roughly 25% of QSBS-claiming taxpayers claim the exclusion over multiple years

Read together, those numbers describe a high-dollar, high-concentration provision whose use is increasingly routed through trust structures. That is exactly the profile the IRS tends to resource audit attention for.

Two other developments point the same direction:

  • Section 1202 appears on the 2025–2026 Priority Guidance Plan, released September 30, 2025, as a broad item: guidance under §1202 regarding the exclusion, listed under OBBBA implementation. A broad item is not a roadmap, but it is a signal of active regulatory attention.
  • At the May 2026 ABA Tax Section meeting, a Treasury attorney-adviser said the §1202 project’s scope is expanding beyond OBBBA’s statutory changes, with trust-stacking arrangements under review and an acknowledged drafting error in the inflation-indexing language. Commentators have speculated the project could also reach SAFEs and convertible notes, though Treasury has not said so. Separately, an academic proposal for issuer reporting (a “Form 1099-QSBS”) has been getting attention; it is a law professor’s idea, not a Treasury proposal.

None of this signals the exclusion is at risk. It signals that the IRS is resourcing the area, not deprioritizing it.

What auditors actually look at

A Section 1202 audit reconstructs the moment of stock issuance. Auditors tend to work the same five requirements:

  1. C-corporation at issuance, not LLC, S-corp, or partnership. The corporate form has to be in place when the stock was issued, not after.
  2. Active trade or business: the 80% asset test. The business generally has to be actively operating, with at least 80% of assets by value used in qualified business activity, for substantially all of the holding period.
  3. Gross assets under the threshold: $75M post-OBBBA, $50M pre-OBBBA, at all times before and immediately after issuance. This is the requirement most likely to fail silently. Gross assets are a moving number, and founders rarely record the figure at the moment shares are issued. See our $75M gross-asset test guide for the mechanics.
  4. Original issuance: the stock generally has to be acquired directly from the company. Secondary purchases usually do not qualify unless received through specific carryover rules.
  5. Holding period met: 5+ years for the full exclusion; 3+ and 4+ years for the 50% and 75% partial tiers under OBBBA.

The weakest link is usually issuer-side documentation. Corporations are not currently required to certify QSBS eligibility. (Section 1202(d)(1)(C) contains a dormant hook, requiring corporations to agree to file reports the Secretary requires, but the Secretary has never required any.) That means the evidentiary burden lands on the shareholder at audit. The most common gaps:

  • No contemporaneous 409A valuation report at the issuance date
  • Gross-asset records reconstructed years after the fact
  • Stock certificates that do not clearly establish original-issuance status (mixed with secondary acquisitions on the same line)
  • Board consents and cap-table snapshots that exist but were never linked to the specific issuance event

You cannot recreate the moment of issuance later. The records either exist contemporaneously or they do not.

Where trust stacking changes the audit picture

The Treasury attorney-adviser’s comments at the ABA Tax Section meeting put trust stacking squarely in the regulatory crosshairs. That focus is understandable: the mechanic is powerful. Each properly formed non-grantor trust is a separate taxpayer under the tax code, with its own $15M exclusion. Four taxpayers (one founder plus three trusts) can exclude up to $60M of QSBS gain on a single liquidity event. (For the underlying mechanics, see our QSBS trust stacking guide.)

That mechanic is grounded in the statute. What Treasury appears to be reviewing is whether specific stacking arrangements have substance, or whether they look like form-over-substance attempts to “multiply the §1202(b) limitation beyond what Congress intended” (paraphrased from Tax Notes commentary, May 12, 2026).

What tends to stand up under scrutiny:

  • Trusts funded before the stock has materially appreciated, with documented gift valuations
  • Trustees who exercise genuine independence: no retained grantor strings, no informal arrangements directing distributions
  • Trust situs in a QSBS-conforming jurisdiction with a functioning administrative footprint
  • Holding-period tacking documented at the moment of the gift. The federal holding period generally carries over from the founder’s original issuance, but only if the gift itself is documented cleanly.
  • A real planning window before the anticipated liquidity event. Practitioners commonly recommend 12 to 24 months, and many treat about 18 months as a prudent minimum. This is not a legal threshold. It is the substance signal that distinguishes a thoughtful structure from an exit-eve rearrangement.

What tends not to stand up: trusts funded weeks before an LOI, identical decision patterns across “independent” trusts, thin documentation around the gift itself.

4 things to do this quarter

You do not need a Treasury regulation to start improving the audit profile of your QSBS file. The following four steps are within reach this quarter:

1. Pull and centralize every issuance-era record. Cap table snapshots, 409A reports, gross-asset records, stock certificates, board consents, and 83(b) elections where applicable. All of it, in one place, indexed by issuance date. If you cannot find a record now, it will not get easier to find later.

2. Run an internal audit dress rehearsal. Walk through each issuance event against the five Section 1202 requirements. Confirm the corporation was a domestic C-corp at the time, that the 80% active-business test was met, that gross assets stayed under $75M (or $50M pre-OBBBA), that the stock was originally issued, and that you have a documented holding-period start. If any requirement is uncertain at any issuance, flag it now and raise it with the company’s tax counsel.

3. Document substance on any trust stacking. For each non-grantor trust, confirm: trustee independence in writing, gift valuation contemporaneous with the funding, holding-period tack from the founder’s original issuance, and a trust situs that is consistent with where the trust actually administers. The substance is the audit defense.

4. Get a QSBS attestation when records are fresh. A written attestation produced near the issuance date, when the 409A is current, the cap table is clean, and management can speak to the active-business operations, tends to be far stronger than one assembled years later under exit-deal pressure. If you have not produced an attestation yet, this quarter is a good time. Promissory’s QSBS attestation product is built to leave exactly this kind of audit-grade file.

What is likely to change, and what is not

The exclusion is still law. OBBBA’s $15M cap, the 3/4/5-year tiered holding period, and the $75M gross-asset threshold are in place. None of the recent developments point to a rollback. If anything, the regulatory work appears aimed at defining the boundaries more clearly, which should favor founders whose structures already sit comfortably inside them.

What is changing is the documentation expectation. Founders who treat Section 1202 the way they would treat any other large tax position (records contemporaneous, substance defensible, structures built well in advance of exit) put themselves in a strong position to keep the benefit. Founders who treat it as a paperwork exercise at exit time risk losing it through evidentiary failure rather than statutory disqualification.

The good news: the audit-grade work is the same work that makes a good QSBS plan in the first place. The two converge.

If you want to walk through your file with a planning team, schedule a call. Promissory’s trust formation and attestation products are designed to leave a clean, audit-defensible record from issuance through exit.

This is general information, not tax or legal advice. The details of your situation matter; confirm them with your own advisors.