Overview
The recently passed One Big Beautiful Bill Act (OBBBA) makes significant and immediate changes to the tax rules surrounding qualified small business stock (QSBS) under Section 1202 of the Internal Revenue Code. These rules have long provided one of the most powerful tax breaks available to founders, early employees, and investors. While the core benefit – excluding gain from US federal income tax after a multiyear holding period – remains in place, the new law reshapes how much of the gain can be excluded, the timeline, and who qualifies and under what circumstances.
In Depth
Background: Section 1202 pre-OBBBA
Prior to the OBBBA, Section 1202 permitted noncorporate taxpayers to exclude up to 100% of the gain realized on the sale or exchange of QSBS held for more than five years, subject to certain limitations. These included:
- A cap on the excluded gain per corporation, generally the greater of:
- $10 million (or $5 million for married taxpayers filing separately), reduced by prior exclusions with respect to the same corporation, or
- 10 times the taxpayer’s aggregate adjusted basis in QSBS of the corporation disposed of in the same year.
- A requirement that the issuing corporation’s tax basis in aggregate gross assets not exceed $50 million at any time before or immediately after the issuance of the QSBS.
What changed?
- Tiered gain exclusion based on holding period. For stock acquired after July 4, 2025, shareholders no longer need to wait a full five years to see tax benefits. Instead:
- If the stock is held for at least three years, the shareholder may exclude 50% of the gain.
- If the stock is held for at least four years, the shareholder may exclude 75% of the gain.
- If the stock is held for at least five years, the shareholder may exclude 100% of the gain.
This introduces more flexibility for exits before the five-year mark, which could be especially relevant for founders or investors in earlier-stage companies where exits tend to happen sooner. Businesses operating as partnerships planning a near-term exit may want to consider converting the partnership to a C corporation to take advantage of the Section 1202 benefits.
- Bigger lifetime caps on gains up to $15 million. Previously, the lifetime cap for the QSBS exclusion was typically $10 million per issuer. That limit is still in place for stock acquired before July 4, 2025, but for new stock purchased after that date, the cap increases to $15 million, indexed annually for inflation.Caution: If you exceed the $15 million cap in any year for a particular company, you cannot claim additional exclusions for that company in future years based on the inflation-adjusted amount.
- Higher company size thresholds up to $75 million. The maximum asset threshold for a company to issue QSBS increases from $50 million to $75 million. This is a big win for startups raising larger seed or Series A rounds, especially in capital-intensive industries such as technology, life sciences, and manufacturing. This increased threshold may also have an impact on how mergers and acquisitions (M&A) transactions are structured. For example, in lower mid-market M&A deals, private equity buyers might be more inclined to structure their acquisition vehicle as a C corporation as opposed to a partnership.The $75 million threshold is based on a corporation’s “aggregate gross assets,” which are composed of the corporation’s cash plus aggregate adjusted bases of other property. This increased threshold combined with the OBBBA’s new allowance of immediate expensing of business and research and experimental expenditures will allow a corporation to maintain its qualified small business (QSB) status even when it has raised more than $75 million of capital, potentially significantly above the new threshold.
Example: A robotics company raises $60 million in venture capital on July 6, 2025. The corporation spends $40 million on research and experimental expenditures by December 31, 2025. Due to the immediate expensing provisions of Section 174 and Section 174A of the OBBBA, the corporation’s aggregate gross asset should be $20 million on January 1, 2026. Therefore, it may raise up to an additional $55 million of capital in 2026 or thereafter without losing QSB status.
What has not changed?
- QSBS still must be held for at least five years to receive the full 100% exclusion.
- The definition of qualified trade or business has not been modified.
- As under prior law, excluded gain under Section 1202 is not treated as a preference item for alternative minimum tax purposes, preserving a valuable benefit for high-income taxpayers.
- Eligibility still requires stock to be acquired at original issuance (not purchased on the secondary market), and the company must be a domestic C corporation engaged in active business.
- The QSBS regime may still be applicable in conjunction with the Qualified Opportunity Zone program.
