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New Jersey has aligned its Gross Income Tax with the federal exclusion of capital gains on Qualified Small Business Stock (QSBS) under Section 1202 of the federal Internal Revenue Code of 1986 (“IRC”). The New Jersey exclusion is effective for tax years beginning January 1, 2026.

IRC § 1202 allows individuals to potentially exclude all, or a significant portion, of the capital gains realized from the sale of shares of a U.S. C corporation that meet specific requirements set forth under IRC § 1202, as amended by the federal One Big Beautiful Bill Act (OBBBA), which became effective on July 4, 2025. OBBBA, made several significant changes to IRC § 1202. See: QSBS Tax Benefits Enhanced Under the OBBBA.

As modified by OBBBA, QSBS stock is issued by a domestic C corporation with gross assets of $75 million or less at the time the stock is issued. The corporation must be engaged in a qualified trade or business, excluding certain industries like personal services, banking, finance, hotels, or restaurants. active business and cannot be a holding company. Additionally, the stock must be acquired directly from the issuing corporation (not from another shareholder) and must be held for a minimum holding period—generally at least three years. To be QSBS, stock issued before July 4, 2025, must meet the stiffer qualifications of pre-OBBBA IRC § 1202.

P.L. 2025, Chapter 67 (A4455) incorporates in the New Jersey Gross Income Tax Act (the “GIT”) the federal exclusion of I.R.C. § 1202. The new law provides an exemption from New Jersey gross income for capital gains derived from the sale or exchange of QSBS to the extent that such gains are exempt for the purposes of federal taxation pursuant to IRC § 1202. The New Jersey change applies to taxable years beginning on or after January 1, 2026. Beginning in 2026, all gains excluded under IRC § 1202 for federal tax purposes are also excluded under the GIT, even if the shares were issued before 2026. New Jersey does not exclude IRC § 1202 gains realized before 2026. Aciu v. Director, Div. of Taxation, 26 N.J. Tax 532 (2012).

The new law was approved on June 30, 2025, shortly before passage of OBBBA. Informally, the Division of Taxation confirmed the OBBBA changes to the federal exemption should apply to the exclusion to be allowed under the GIT. Website guidance from the Division of Taxation regarding the application of IRC § 1202, as amended by the OBBBA, is expected.

The GIT incorporates federal principles of gross income only in those instances where the Legislature specifically refers to federal principles. Smith v. Dir., Div. of Tax’n, 108 N.J. 19, 527 A.2d 843 (1987); Tischler v. Director, Div. of Taxation, 17 N.J. Tax 283 (1998). Specific references in the GIT to the IRC are generally dynamic, meaning federal tax changes to specifically referenced sections of the IRC “flow through” to the GIT. For example, the Legislature specifically amended the GIT to uncouple from changes to the federal depreciation and expensing rules of IRC §§ 168 and 179 which otherwise would have applied to the GIT after the federal change. Compare: N.J.S.A. §§ 54A:5-1.2a (1) and (2) which anchor the federal depreciation and expensing rules to the IRC as in effect on December 31, 2001 or 2022, respectively.

The drafting history of A4455 supports the view that the New Jersey Legislature intended the bill’s specific reference to IRC § 1202 to be dynamic. As originally proposed, A4455 included a comprehensive New Jersey counterpart to IRC § 1202. While largely patterned after the federal exclusion, the GIT 1202 counterpart provision would have limited the state gain exemption to “New Jersey QSBS,” stock of qualified small business corporations meeting a New Jersey based payroll test. The Assembly Appropriations Committee amended A4455, substituting the comprehensive New Jersey 1202 counterpart provision simply with a specific reference to “section 1202 of the federal Internal Revenue Code of 1986 (26 U.S.C. s.1202)” and that reference was not anchored to the IRC in effect on a particular date.

The House version of OBBBA, which passed the House on May 22, 2025, did not include any provisions affecting IRC § 1202. The OBBBA provisions addressing QSBS were first included in the Senate Finance Committee proposal released on June 16, 2025. The A4455 substitute was adopted by the Assembly Budget Committee 10 days later on June 26, 2025. Oddly, the June 26, 2025 statement of the Assembly committee to the substitute for A4455 describes only the pre-OBBBA provisions of IRC § 1202, without reference to the Senate’s proposed changes.

The statutory language of A4455 suggests that by adopting IRC § 1202 without reference to a specific date, the Legislature intended a dynamic reference that would incorporate the changes from OBBBA into the GIT. Website guidance from the Division of Taxation confirming the application of IRC § 1202, as amended by OBBBA, to the GIT is anticipated.