QSBS gets a makeover: What tax pros need to know about Sec. 1202’s new look

Editor: Michael J. Mondelli, J.D.

QSBS gets a makeover: What tax pros need to know about Sec. 1202’s new look

The law commonly known as the One Big Beautiful Bill Act (OBBBA), H.R. 1, P.L. 119–21, became law on July 4, 2025, bringing significant tax changes to individuals and businesses. Sec. 1202, in particular, was thrust into the forefront after having received limited legislative attention for more than a decade.

Sec. 1202 pre-OBBBA

Sec. 1202 was originally enacted as part of the Omnibus Budget Reconciliation Act of 1993, P.L. 103–66, and was designed to encourage investment in small businesses by allowing noncorporate taxpayers to exclude capital gains from the sale of qualified small business stock (QSBS). Since its inception, Sec. 1202 has provided business owners and investors with a potentially robust tax–saving mechanism. Prior to the passage of the OBBBA, Sec. 1202, in general, allowed noncorporate taxpayers who acquired stock originally issued by a domestic C corporation and held that stock for more than five years to potentially exclude from capital gain recognition of the greater of $10 million or 10 times the taxpayer’s basis in the stock. Sec. 1202 provided that the stock–issuing C corporation’s gross assets before and immediately after the stock issuance could not exceed $50 million, and at least 80% of the corporation’s assets had to be used in an active qualified trade or business. Certain types of trades or businesses, including those involving the performance of services in designated fields, are excluded from treatment as a qualified trade or business (Sec. 1202(e)(3)).

Sec. 1202 post-OBBBA

While most of the pre–OBBBA Sec. 1202 rules remain untouched, several alterations did occur that tax practitioners, business owners, and investors might find interesting and potentially lucrative. Notably, the OBBBA introduced a new tiered holding period with graduated exclusions, an increased per–issuer gain exclusion cap, and a higher aggregate gross asset threshold.

Tiered holding period with graduated exclusions: Prior to the OBBBA, noncorporate taxpayers who acquired QSBS had to hold the stock for more than five years in order to reap the benefits of capital gain exclusion (Sec. 1202(a)(1), prior to amendment by the OBBBA). Sec. 1202 provided that, after holding stock for more than five years, taxpayers were eligible to exclude anywhere between 50% and 100% of capital gains, depending on the stock’s acquisition date. Specifically, stock acquired before Feb. 18, 2009, was eligible for a 50% exclusion; stock acquired between Feb. 18, 2009, and Sept. 27, 2010, was eligible for a 75% exclusion; and stock acquired after Sept. 27, 2010, was eligible for a 100% exclusion.

Under the new OBBBA rules, the five–year holding period is no longer a “must,” as the legislation introduced a tiered holding period ranging from three to five years. Now, if a stock owner holds the stock for at least three years, gains are eligible for a 50% exclusion, and the exclusion increases to 75% for stock held for at least four years (Sec. 1202(a)(5)). The same 100% gain exclusion still applies for stock held for at least five years. This new tiered system applies to QSBS acquired after July 4, 2025.

Increased per-issuer limitation on taxpayer’s eligible gain: Sec. 1202 allows taxpayers to exclude “eligible gain” from a QSBS disposition. Since Sec. 1202’s enactment in 1993, a taxpayer’s limitation on eligible gain qualifying for exclusion consisted of the greater of $10 million or 10 times the aggregate adjusted basis of the QSBS disposed of by the taxpayer during the tax year (Sec. 1202(b)(1)).

The OBBBA increased the per–issuer gain limitation to $15 million, which will be subject to annual inflation adjustments starting in 2027 (new Sec. 1202(b)(4)). Taxpayers will still be subject to the same limitation of 10 times the aggregate adjusted basis of the QSBS that has been in place since 1993.

Higher aggregate gross asset threshold: Prior to the OBBBA, in order for a corporation’s stock to qualify for QSBS treatment, the entity’s aggregate gross assets could not exceed $50 million immediately before or after the stock issuance. The term “aggregate gross assets” remains the same post–OBBBA and means cash and “the aggregate adjusted bases of other property held by the corporation” (Sec. 1202(d)(2)(A)). The adjusted basis of property contributed to the corporation is “equal to its fair market value as of the time of such contribution” (Sec. 1202(d)(2)(B)).

The OBBBA increased the aggregate gross asset limitation to $75 million, indexed for inflation beginning in 2027 (Sec. 1202(b)(4)). This new limit will apply to stock issued after July 4, 2025, and the $50 million aggregate gross asset threshold remains intact for stock issued prior to the OBBBA’s enactment.

Considerations and key takeaways

Tax practitioners, in particular, need to be aware of state conformity issues that may arise, depending on the corporation’s location. Practitioners might also suggest that clients currently structured as anything other than a C corporation evaluate the possibility of converting their business to a C corporation, since stock issuances would then be subject to the more favorable post–OBBBA rules. Importantly, practitioners need to be aware that any unexcluded capital gain for stock held for three or four years is subject to a 28% capital gain rate rather than the 15% and 20% rates generally used for stock sales.

The newly enacted tiered gain exclusion should allow business owners and investors faster access to, and more flexibility in, potential gain exclusion, since the five–year holding period is no longer mandatory for QSBS acquired after July 4, 2025. In addition, the increased gross asset threshold should allow more entities, particularly those with significant early–stage cash influxes, to take advantage of Sec. 1202’s generous tax saving opportunities.

Editor

Michael J. Mondelli, J.D., is a director in the Tax Advisory Group, with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mondelli at mmondelli@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.