Alert
Leverage Recent Changes to Qualified Small Business Stock Benefits
The newly enacted HR 1—commonly known as the One Big Beautiful Bill Act—introduces several changes to Internal Revenue Code Section 1202 that broaden the availability of qualified small business stock (QSBS) benefits to eligible shareholders and expand the amount of gain that can be excluded by:
- Permitting shareholders with shorter holding periods to exclude a percentage of their gain upon selling QSBS
- Increasing the amount of gain that can be excluded by increasing the per-issuer exclusion limitation
- Increasing the number of corporations that may be considered qualified small businesses by increasing the gross asset threshold
Explore a summary of the changes to Section 1202 and how to leverage them with the following insights.
Background
Section 1202 permits eligible shareholders of stock in certain C corporations to exclude from gross income up to 100% of their gain from the sale or exchange of QSBS.
To qualify, there are certain shareholder and corporate level requirements that need to be met, including but not limited to the original issuance requirement, the gross assets test, and the active business test, which require careful measurement during the shareholder’s entire holding period—and, in some instances, before the stock is even acquired.
Other than increasing the percentage of gain that can be excluded and providing for different effective dates for the exclusion, there have been no significant changes to Section 1202 until now.
Increase in Per Issuer Limitation
Under prior law, the aggregate amount of gain that could be excluded under Section 1202 couldn’t exceed the greater of:
- $10,000,000, reduced by any gain excluded by the taxpayer in the same corporation in prior years—the per-issuer limitation or
- 10 times the taxpayer’s adjusted basis in the stock that was disposed of
These rules still apply to QSBS acquired on or before July 4, 2025.
For QSBS acquired after July 4, 2025, the act increases the per-issuer limitation from $10,000,000 to $15,000,0000, subject to reduction for amounts previously or concurrently excluded under Section 1202. For tax years beginning after 2026, the $15,000,000 per issuer limitation will be adjusted annually for inflation.
In addition, the act clarifies that the per-issuer limitation for a married individual filing separately is one-half the adjusted limit in effect for the tax year. Thus, for shares acquired on or before July 4, 2025, the limitation is $5,000,000—same as prior law. For shares acquired after July 4, 2025, and held for three, four, or five years, the limitation is $3,250,000, $5,625,000, and $7,500,000, respectively.
Increase in Gross Asset Test Threshold
Under prior law, to qualify as a qualified small business, the aggregate gross assets of the corporation couldn’t exceed $50,000,000 at all times prior to the issuance and immediately after the issuance.
Aggregate gross assets refer to the amount of cash and adjusted basis of other property held by the corporation, except the adjusted basis of contributed property is deemed to be equal to the property’s fair market value.
These rules still apply to QSBS issued on or before July 4, 2025.
For stock issued after July 4, 2025, the act increases the gross asset threshold to $75,000,000. For tax years beginning after 2026, the threshold will be adjusted annually for inflation.
Example of Enhanced Benefits
Suppose a taxpayer purchases QSBS on April 1, 2026, for cash. Taxpayer sells the stock on October 1, 2030, holding it for 4.5 years. The total gain on the sale is $20 million. The taxpayer hasn’t previously used any QSBS exclusion for stock in this corporation.
Since the stock was held for at least four years but less than five years, 75% of the gain may be excluded, or $15,000,000. Since this amount doesn’t exceed the per issuer limitation of $15,000,000, the full amount may be excluded, resulting in over $3,500,000 in federal income tax savings—assuming a 23.8% federal income tax rate and ignoring state tax impacts.
If the stock instead had been acquired for cash on April 1, 2025, and held for 4.5 years, none of the gain would be eligible for exclusion because the stock wasn’t held for at least five years.
If the stock was acquired for cash on April 1, 2025, and sold after five years, the taxpayer would only be able to exclude $10,000,000, because that was the pre-issuer limitation in place for the stock. The changes and exclusion amount are based on when the stock was acquired, not when it was sold.
The act didn’t scale back or otherwise limit existing strategies taxpayers have been using to structure into QSBS eligibility or maximize their gain exclusions. On the contrary, the act’s changes may have created new avenues for proactive and properly executed tax planning.
Takeaways and Next Steps
In addition to the increased gross asset threshold, more corporations are expected to meet the gross asset test because of the act’s changes that permit the expensing of domestic research and experimentation (R&E) expenditures in lieu of mandatory capitalization. The act also clarifies that both domestic and foreign R&E activities qualify under the active business test.
Due to the increased tax savings associated with acquiring, holding, and disposing of QSBS, it’s important to consult with your tax advisor regarding eligibility and qualification for QSBS benefits.
The act doesn’t resolve ambiguities in Section 1202 and it’s still possible to fail one or more requirements and inadvertently disqualify the stock.
We’re Here to Help
To learn more about the changes to Section 1202 and how you can best leverage the changes to benefit your investment outcomes, contact your firm professional.