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Since its enactment as part of the Omnibus Budget Reconciliation Act of 1993, Section 1202 of the Internal Revenue Code has provided an exclusion for gain from the sale of qualified small business stock (QSBS) held for more than five years.

To qualify as QSBS, the stock must be from a United States C corporation with assets not exceeding $50 million before and after issuance. The C corporation must be engaged in an active trade or business during substantially all of a stockholder’s holding period that is not a disqualified business. Disqualified businesses include specified personal service businesses, certain finance businesses, farming, extraction and hotel, restaurant, and similar businesses. The shares must be acquired directly from the C corporation in exchange for cash, property or as compensation for services. and the issuer must actively conduct business outside of disqualified industries.

Depending on the QSBS issuance date, up to 50%, 75%, or 100% of gains may be excluded, subject to a per-issuer limitation.

On July 4, 2025, President Trump signed the One Big Beautiful Bill Act (OBBBA) into law. OBBBA makes significant enhancements to the QSBS regime which will benefit growing companies, their founders, investors, and employees. The enhancements shorten the holding period for eligible stock, increase the maximum exclusion allowed and allow larger companies to issue QSBS.

What are the Changes?

Tiered Gain Exclusion

The OBBBA replaces the five-year “cliff” holding period with a tiered exclusion for stock acquired on or after July 5, 2025. The exclusion percentage depends on the taxpayer’s holding period for the QSBS.

Holding Period	Exclusion Percentage
Three years	50%
Four years	75%
Five years or more	100%

 

Increased Per-Issuer Gain Exclusion Limitation

The per issuer limitation sets a cap on the amount of gain an individual taxpayer can exclude under Section 1202 with respect to the stock of any single qualified small business. This means that no matter how much QSBS an investor acquires and sells in a particular company, there is a maximum aggregate gain exclusion per issuer (i.e., per company) that can be claimed by a taxpayer.

The per issuer limitation was the greater of:

• $10 million, reduced by the amount of eligible gain taken in prior years from the same issuer by the same taxpayer, or
• Ten times the taxpayer’s aggregate adjusted basis in the QSBS issued by the corporation and disposed of during the taxable year (the “10x basis” rule).

The OBBBA increases the per-issuer gain exclusion cap from $10 million to $15 million. The cap amount will be indexed annually for inflation from 2027. The alternative 10x basis rule remains unchanged.

Expanded Company Eligibility

To qualify as a “qualified small business” before the OBBBA changes, the issuing corporation could not have aggregate gross assets exceeding $50 million at any time before or immediately after the issuance of the stock. “Aggregate gross assets” are defined as the amount of cash and the adjusted basis of other property held by the corporation. If the corporation’s assets exceed the threshold, the stock does not qualify as QSBS, and investors cannot claim the Section 1202 gain exclusion.

The OBBBA increases the aggregate gross asset threshold from $50 million to $75 million. The aggregate gross assets amount will be indexed annually for inflation from 2027.

When do the Changes Apply?

• The OBBBA changes apply only to QSBS issued after July 4, 2025.
• QSBS issued before July 5, 2025 remains subject to the pre-OBBBA five-year holding period and $10 million cap.

Implications & Recommendations

• The tiered exclusions benefit investors by providing early-stage QSBS with more favorable liquidity if QSBS is sold before the five-year mark.
• Raising the aggregate gross asset threshold from $50 million to $75 million significantly broadened the pool of companies eligible for qualified small business status under IRC Section 1202. This higher limit enables more growing businesses—particularly those in capital-intensive sectors such as technology, manufacturing, and life sciences—to attract investments by offering potential tax benefits to investors.
• Raising the per-issuer cap allows investors to exclude more gains from federal tax on QSBS sales, boosting after-tax returns and encouraging investment in these growth companies.
• For QSBS acquired after September 27, 2010, the excluded Section 1202 gain continues to be exempt from alternative minimum tax (AMT) calculations. However, if the QSBS was acquired before September 28, 2010, and held for more than five years, a portion of the gain was excluded under IRC Section 1202. For QSBS acquired before February 18, 2009, Section 1202 allows a 50% exclusion. For QSBS acquired between February 18, 2009, and September 27, 2010, the exclusion rate increases to 75%. For AMT purposes, 7% of the excluded amount when using the 50% or 75% exclusion is treated as a preference item. This means that even though a portion of the gain may be excluded from regular income tax, it can still increase a taxpayer’s AMT liability.
• Consider the potential application of IRC Section 1045, a companion provision for QSBS, which allows holders of QSBS to defer recognizing capital gains if they sell their QSBS before satisfying the required holding period by reinvesting proceeds from the sale of QSBS in new QSBS within 60 days. This rollover provision enables investors to preserve their opportunity to eventually qualify for the Section 1202 exclusion on capital gains, provided the new QSBS is held for the remainder of the required holding period.
• The IRS is expected to examine QSBS claims closely. Comprehensive documentation from issuing corporations is recommended to substantiate eligibility. Stock must still be acquired at original issuance from a domestic C corporation engaged in active business. The issuing corporation and investors must maintain records which clearly document the qualifications of the issuing company and the issuance of the stock. The investor must maintain records confirming their holding period for the stock. Proper documentation and adherence to reinvestment timelines are essential for taking advantage of Section 1045 benefits.

State Tax Considerations

A majority of states which tax personal income allow an exclusion for IRC Section 1202 gain. New Jersey recently incorporated the provisions of IRC section 1202 into its Gross Income Tax Act for tax years beginning in 2026. However, not all states fully align with IRC Section 1202. For instance, Alabama, California, Mississippi, and Pennsylvania are nonconforming, while other states, including Hawaii, Massachusetts, and New York, have only partial conformity.

Conclusion

The OBBBA represents the most significant expansion of QSBS tax benefits in over a decade. By shortening the required holding period for partial exclusions, raising exclusion caps, and expanding company eligibility, it delivers substantial incentives for investment in domestic startups. Effective tax planning, particularly in light of state-level difference, is critical to maximizing these new benefits.