Section 1202 QSBS: Expanded Tax Benefits Under the OBBBA

The Qualified Small Business Stock (QSBS) exclusion, governed by Section 1202 of the tax code, has historically provided a crucial incentive for investment in eligible C-corp startups. This benefit allowed founders and early investors to exclude up to $10 million in capital gains, or 10× the investment basis, from federal taxation, provided the stock was held for a minimum of five years.

On July 4, 2025, the OBBBA was signed into law, enacting the most significant changes to the QSBS provisions since 2010. This legislation introduces an updated and expanded QSBS framework that presents new optimization opportunities for the startup ecosystem. The post-OBBBA rules for 2025 enhance the existing benefit by increasing exclusion limits, reducing holding periods for quicker relief, and broadening eligibility criteria for qualifying companies. It is important to note that a dual tax structure now exists: one set of rules applies to QSBS acquired before July 4, 2025, and a separate set applies to stock acquired after that effective date.

QSBS Fundamentals: Establishing the Prior Statutory Framework

It is necessary to establish a clear understanding of the foundational requirements and limitations that existed under the prior statutory framework.

Core Requirements for QSBS Eligibility (Pre-OBBBA)

For stock to qualify as QSBS prior to the OBBBA, the issuing corporation and the shareholder were required to satisfy several strict criteria throughout the holding period.  

First, the Issuer Status requires that the stock must be in a domestic C corporation for U.S. federal income tax purposes. The shareholder receiving the benefit must not be a C corporation.  

Second, the stock must be acquired at Original Issuance. This means the non-corporate taxpayer must have received the stock directly from the corporation or an underwriter—either in exchange for money, property (excluding stock of other corporations), or as compensation for services rendered to the corporation.  

Third, the Active Business Requirement (ABR) mandates that during substantially all of the taxpayer’s holding period, the corporation must be engaged in an active trade or business. This generally requires that at least 80% of the corporation’s assets must be used in the active conduct of a qualified business. 

Fourth, the Gross Asset Test mandated that the corporation’s aggregate gross assets (defined as the adjusted basis of all property held by the corporation plus cash) must not have exceeded $50 million at any time prior to or immediately after the stock issuance. 

Under the pre-OBBBA rules, the benefit was subject to a stringent, “all-or-nothing” holding period requirement. For QSBS acquired after September 27, 2010, taxpayers were required to hold the stock for more than five years to qualify for the 100% gain exclusion. Crucially, there was no partial exclusion available for holding periods of four years, three years, or any duration less than five years.  

The maximum amount of excludable gain was subject to a cap, calculated per taxpayer and per issuer, as the greater of:  

1. $10 million (reduced to $5 million for married taxpayers filing separately), or
2. 10 times the taxpayer’s aggregate adjusted basis in the QSBS sold during the taxable year

The OBBBA Legislative Mandate

The OBBBA’s changes are highly specific regarding applicability, creating two separate QSBS regimes based on the date of stock acquisition.

The One Big Beautiful Bill Act was signed into law on July 4, 2025. The new, expanded QSBS benefits apply exclusively to stock acquired after July 4, 2025 (i.e., on or after July 5, 2025).  

This rigid effective date creates a necessity for meticulous transition planning. Any QSBS acquired on or before July 4, 2025, remains subject to the Pre-OBBBA rules, regardless of when the stock is ultimately sold. This means that older stock holdings retain the $10 million cap and require the strict five-year holding period for 100% exclusion.

Analysis of OBBBA’s  QSBS Expansions

The One Big Beautiful Bill Act QSBS changes include several permanent amendments to Section 1202 at the federal level. Major updates are discussed below-

Shorter Holding Periods and the New Tiered Exclusion Structure

Under the OBBBA QSBS tax changes 2025, founders and investors no longer have to wait a full five years to get any tax benefit.

For QSBS acquired on or after July 5, 2025, the following exclusion tiers apply:

• 3-Year Holding Period: QSBS held for at least three years, but less than four years, qualifies for a 50% gain exclusion.
• 4-Year Holding Period: QSBS held for at least four years, but less than five years, qualifies for a 75% gain exclusion.
• 5-Year Holding Period: QSBS held for five years or more retains the maximum 100% gain exclusion.

The former QSBS provision, which mandated a full five-year holding period to qualify for any exclusion, has been substantially relaxed. The new rules introduce a graded system of tax relief based on the duration the qualified stock is held. This significant adjustment encourages and facilitates earlier exits, as founders and investors can now shelter a notable percentage of their gains even if liquidity occurs prior to the fifth year. Specifically, this partial relief structure means a sale after three years can result in a 50% tax exclusion, and a sale after four years can yield a 75% exclusion, benefits that were entirely unavailable under the preceding tax code.

To demonstrate the significant value of this tiered system, we can examine the effective federal tax rates for top-bracket investors. Given that the typical statutory long-term capital gains rate is 23.8% (20% federal capital gains plus the 3.8% Net Investment Income Tax or NIIT), the new partial exclusions provide substantial savings.

Based on these specific rates, the estimated effective federal tax rates are:

• 3-Year Holding (50% Taxable): The effective federal tax rate is approximately 9% (50% of 28% plus NIIT).
• 4-Year Holding (25% Taxable): The effective federal tax rate is approximately 95% (25% of 28% plus NIIT).
• 5-Year Holding (0% Taxable): The effective federal tax rate is 0%.

Increased Per-Issuer Gain Exclusion Cap

The maximum gain exclusion threshold available to an individual taxpayer for qualified QSBS from one company has been revised upward. Under the previous regulations (pre-OBBBA), the exclusion was limited to the greater of $10 million or 10× the investment basis. With the passage of the OBBBA, the fixed dollar is now $15 million for all subsequently issued QSBS. Also, with the QSBS tax changes 2025, the new $15M cap will be indexed for inflation in future years. Starting in 2027, the $15M limit is set to adjust upward to keep pace with inflation. (For example, if inflation were 3% per year, the cap might rise to ~$16 million or more by the late 2020s.)  However, note that once an investor has used up the $15 million exclusion for a particular company, inflation adjustments won’t increase the cap for that same issuer. In practice, this means if your gain from one startup already hit $15M tax-free, you can’t later claim more due to inflation. The indexing would mainly benefit those who have not yet maxed out their QSBS benefit for that company.

It’s also important that “coordinating rules” prevent double-dipping between the pre-OBBBA QSBS and post-OBBBA QSBS shares. You cannot treat the $10M and $15M caps as separate buckets for the same company. In other words, if you hold stock acquired before July 4, 2025, and also stock acquired after, you can’t automatically stack the caps to exclude $25M from one company.

Expansion of Corporate Eligibility: The $75 Million Gross Asset Threshold

The increase in the Gross Asset Test expands the functional definition of a “small business” for the purpose of incentivizing investment.  

The new threshold requires that for QSBS acquired on or after July 5, 2025, the corporation’s aggregate gross assets must not exceed $75 million (up from $50 million) immediately before and immediately after the stock issuance. This 50% increase provides essential flexibility for high-growth companies.  

This change enables startups to raise more substantial rounds of capital post-incorporation while still maintaining QSBS eligibility.