This series of blog posts is intended to highlight some key tax planning strategies resulting from the sweeping tax changes contained in the One Big Beautiful Bill Act (OBBBA). This post focuses on the benefits of Qualified Small Business Stock (QSBS) under Section 1202, which have become even more attractive for certain startup and growth-company investments under OBBBA. In a prior post, we discussed the potential advantages of Sections 1202 and 1244 for investors in small businesses, but the newly expanded benefits have made QSBS an even more important planning opportunity for founders and investors.
What Is QSBS & Why Does It Matter?
Section 1202 applies to gain from the sale or exchange of QSBS held by a taxpayer other than a corporation. For eligible taxpayers, QSBS can provide a powerful federal tax benefit by allowing some or all of the gain from the sale of qualifying stock to be excluded from income. For many business owners and investors, this exclusion can translate into substantial tax savings at exit.
To qualify, QSBS generally must be:
- Issued by a domestic C corporation
- Acquired at original issuance (or certain tax-free transactions)
- Received in exchange for cash, property, or services
- Issued by a corporation that meets the gross-assets test
- Held while the corporation satisfies the active business requirements
What Changed?
Tiered gain exclusion
For stock acquired after September 27, 2010, taxpayers generally focused on the 100% exclusion after a holding period of more than five years. The 5-year 100% exclusion rule still applies to older stock, but for QSBS acquired after July 4, 2025, the law now provides a phased exclusion schedule:
- 50% exclusion for stock held at least 3 years
- 75% exclusion for stock held at least 4 years
- 100% exclusion for stock held at least 5 years
The new phased exclusion structure for newer stock is meaningful for founders and investors because it creates earlier liquidity opportunities for shareholders who do not expect to hold stock for a full five years but still want to benefit from Section 1202.
Increased gross-assets threshold
Another important change for stock issued after July 4, 2025 is the increase in the corporation-level gross-assets threshold from the prior $50 million threshold. Under the new provisions, a qualified small business generally means a domestic C corporation whose aggregate gross assets did not exceed $75 million at all times on or after August 10, 1993 and before issuance, and do not exceed $75 million immediately after issuance. Inflation adjustments are also provided after 2026.
Increased exclusion cap
Section 1202(b) limits the amount of gain eligible for exclusion on a per-taxpayer, per-issuer basis. For stock acquired after July 4, 2025, the statute now provides a higher dollar cap:
- $15 million per-taxpayer, per-issuer, reduced by prior eligible gain taken into account with respect to that issuer, or
- 10 times the aggregate adjusted bases of QSBS of that issuer disposed of during the year.
For tax years beginning after 2026, the $15 million cap is indexed for inflation. The cap remains tied to the greater of $10 million or 10 times basis for stock acquired on or before July 4, 2025.
Which Businesses Qualify?
The active business rule generally requires that at least 80% of the corporation’s assets (by value) be used in the active conduct of one or more qualified trades or businesses. Certain businesses generally do not qualify; these businesses include health, engineering, architecture, law, accounting, consulting, financial services, brokerage services, hospitality and restaurant operations, and other excluded service-based businesses and trades listed in the statute.
Common QSBS Pitfalls
These rules are highly technical, and it is easy to make mistakes. Some common issues include:
- Failing the original issuance requirement
- Problems with redemptions or stock buybacks
- Changes in business activities that affect the active business test
- Inadequate documentation of stock issuance and holding periods
- Assuming pass-through structures automatically prevent QSBS benefits
The original issuance requirement states that taxpayers must acquire the stock at its original issue, directly or through an underwriter, in exchange for money, property other than stock, or services. There are important exceptions for certain transfers, including gifts, transfers at death, some partnership distributions, and certain Section 351 or Section 368 transactions. These requirements make documentation especially important when stock has moved through estate planning, partnership, or reorganization transactions.
Businesses with pass-through structures may be eligible for QSBS benefits – gain flowing through from a pass-through entity such as a partnership or S corporation can qualify if all other statutory requirements are met. These qualifications include: the entity must have held the QSBS for the required period, and the taxpayer generally must have held the entity interest from the date the entity acquired the stock through the date of disposition. This eligibility for the QSBS benefit can be especially relevant for venture funds, family investment entities, and startup holdings structured through partnerships.
Why Planning Early Is Important
More opportunities may be available when businesses start planning for this benefit at formation or during early-stage growth. Entity choice, capitalization strategy, stock issuance timing, and transaction structuring can affect whether shareholders ultimately qualify for the exclusion. If QSBS planning is not done properly from the beginning, it can limit or eliminate the benefit later.
Section 1202 remains one of the most significant tax incentives available for founders, investors, and closely held businesses. With the changes enacted by OBBBA, this planning opportunity may offer even more flexibility and value.
If your business is organized as a C corporation, or if you are considering that option, you might want to evaluate QSBS as part of your overall tax planning strategy. Please reach out to the GYF Tax Team at 412-338-9300 for assistance.
Related Posts:
Tax Planning Strategies: SALT Deductions
Tax Planning Strategies: 100% Depreciation with New QPP Rule
Tax Planning Strategies: R&E Expensing
