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Key changes to Qualified Small Business Stock exclusions that founders, investors, and tax professionals need to know.

What Is the Section 1202 QSBS Exclusion?

Section 1202 allows certain noncorporate taxpayers to exclude a significant portion of capital gains from the sale of Qualified Small Business Stock (QSBS). It has long been one of the most powerful tax incentives for startup founders and early-stage investors. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, has substantially expanded its scope and its benefits for taxpayers.

Pre-OB3 Rules (Quick Recap)

For QSBS acquired after September 27, 2010, taxpayers could exclude 100% of eligible gain, provided they held the stock for more than five years. Stock acquired before that date was only partially excludable: generally, 50% for stock acquired after August 10, 1993, and before February 18, 2009, and 75% for stock acquired between February 18, 2009 and September 27, 2010 again, assuming a holding period of more than five years. The exclusion was capped at the greater of $10 million per issuer or 10 times the stock's adjusted basis. To qualify, the issuing C corporation's gross assets could not exceed $50 million, and at least 80% of its assets had to be used in the active conduct of a qualified trade or business.

Three Key Changes Under the OBBBA

All changes listed below apply to QSBS acquired after July 4, 2025. Pre-enactment stock follows the old rules.

• Tiered Gain Exclusion with Shorter Holding Periods: The mandatory five-year hold is replaced by a graduated schedule. 3 years for 50% exclusion (~15.9% effective federal rate), 4 years for 75% (~7.95%), and 5+ years for 100% (0%). This enables those with earlier liquidity events to not forfeit the entire benefit. It is important to note that the non-excluded portion is subject to a special 28% capital gain rate, so standard preferential rates (0%/15%/20%) do not apply to the non-excluded portion.
• Higher Per-Issuer Cap: The excludable gain cap increases from $10 million to $15 million (the 10x basis alternative remains). The $15 million cap will be inflation-indexed starting in 2027.
• Increased Gross Asset Threshold: The corporate gross asset ceiling rises from $50 million to $75 million (inflation-indexed from 2027). This is significant for later-stage venture-backed companies that previously exceeded the $50 million cap.

AMT Relief

For post-OBBBA QSBS, the 7% AMT preference item add-back has been eliminated for gains excluded under the new tiered system. Taxpayers using the 50% or 75% exclusion tiers will not face AMT leakage.

Planning Considerations

• Dual-block Tracking: Taxpayers holding QSBS acquired both before and after July 4, 2025 must track each block separately under different rules.
• Entity Selection: Only domestic C corporations can issue QSBS. The expanded benefits may favor C corp status for startups anticipating significant growth, though double taxation of earnings must be weighed.
• Multi-issuer Stacking: The per-issuer cap means investors with QSBS in multiple qualifying companies can exclude gains from each independently.
• State Nonconformity: California, New Jersey, Pennsylvania, and several other states do not conform to the federal exclusion. Gain excluded federally may still be fully taxable at the state level.
• Section 1045 Rollovers: Taxpayers who don’t meet the 3- or 4-year holding period can still roll proceeds from QSBS held for over 6 months into new QSBS within 60 days. However, the anti-abuse rules prevent “restarting” holding periods by exchanging pre-enactment for post-enactment stock.

What Hasn’t Changed
The Core requirements remain unchanged: the issuer must be a domestic C corporation, at least 80% of assets must be used in a qualified trade or business (excluding health, law, accounting, consulting, financial services, and others), stock must be acquired at original issuance, and QSBS status must be maintained for substantially all of the holding period (85–95%).

Key Takeaway

The OBBBA represents the most significant expansion of QSBS since 1993. Shorter holding periods, higher caps, and a more generous asset threshold create real opportunities, but also raise the stakes for documentation and compliance. Founders and investors should review existing positions and consult a tax advisor to optimize their strategy under the new rules.