The One Big Beautiful Bill Act of 2025 (OBBBA) significantly impacts federal taxes, credits, and deductions. A key change relating to Qualified Small Business Stock (QSBS) allows greater tax-free gains for investments in startups and other qualifying small businesses. Company founders and other investors should understand how the enhanced tax strategy works or risk missing out on significant savings.
Qualified Small Business Stock Overview
Section 1202 of the Internal Revenue Code (26 U.S. Code § 1202) was enacted to encourage investment in small businesses. It allows a taxpayer to claim an exclusion from capital gains in connection with the sale or exchange (including redemption) of qualified small business stock (QSBS).
Section 1202(c)(1) defines the term "qualified small business stock" to mean any stock in a C corporation which is originally issued after the date of enactment in 1993 if as of the date of issuance, such corporation is a qualified small business, and, except as otherwise provided, such stock is acquired by the shareholder at its original issue in exchange for money or other property (not including stock) or as compensation for services.
The amount of the gain excludible under Section 1202 depends on the date of investment in the corporation. Taxpayer gains on qualifying small business stock obtained after September 27, 2010 qualify for 100 percent exclusion. Additionally, if the QSBS is held for at least six months, Section 1045 generally permits a tax-free rollover of gain on the sale of the QSBS if the proceeds are reinvested into other QSBS investments within 60 days of the sale of the QSBS.
Changes Under the OBBBA
QSBS must satisfy several requirements to qualify for Section 1202 gain exclusion. Some relate to the taxpayer, while others relate to the issuing corporation. The OBBBA made several changes to these requirements, all of which are beneficial to taxpayers.
Shorter Holding Period
Section 1202 provides that the stock must be held for more than five years before it is disposed. Under the OBBBA, QSBS held for five years is still eligible for a 100 percent exclusion. However, the law also establishes additional, shortened holding periods:
- 50 percent exclusion for gain recognized if the QSBS is held for three years
- 75 percent exclusion for gain recognized if the QSBS is held for four years
The shortened holding period requirement applies to stock acquired after the date of enactment of OBBBA (July 4, 2025).
Increase in Gross Asset Value Limitation
The OBBBA increases the number of companies that fall under the definition of "small business" under Section 1202. Previously, the corporation could not have had more than $50 million of tax basis in its assets at any time between August 11, 1993, through the moment immediately after the issuance of the stock.
Under the OBBBA, an issuer must not have a gross asset value greater than $75 million at any time during that time period. Beginning in 2027, the asset value cap will be increased annually by an inflation adjustment, potentially further expanding the universe of companies that can benefit from the exclusion.
Higher Per-Issuer Flat Cap on Capital Gains
Prior to the effective date of OBBBA, eligible taxpayers were permitted to exclude capital gains with respect to a single issuer up to the greater of $10 million or 10 times the adjusted basis of the taxpayer in the QSBS stock.
The OBBBA increased the per-taxpayer gain exclusion cap from $10 million to $15 million for QSBS issued after July 4, 2025. The cap will also be adjusted for inflation beginning in 2027.
Finally, it is worth noting that many QSBS requirements were not amended under the OBBBA. Notably, the types of business activities that may be treated as a "qualified trade or business" remain the same, meaning that certain services businesses, such as farming, law, health, engineering, architecture, hotels, banking and consulting, are still excluded.
How We Can Help
Individual taxpayers and businesses should review their tax positions in light of these changes. For instance, the availability of the QSBS exemption should be considered when start-ups determine the form, tax characterization, and capital structure of their entity. Investors in early stage ventures should also consider the enhanced benefits of the QSBS incentive, such as more flexible holding requirements and a higher flat cap on gains, when making investment decisions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
