The recently enacted One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, delivers sweeping tax reforms aimed at fueling entrepreneurship, capital formation, and small business investment. A particularly notable change for founders, investors, and advisors is the modernization of Section 1202 of the Internal Revenue Code, which governs the Qualified Small Business Stock (QSBS) gain exclusion.
Below, we break down the key changes to Section 1202 under the OBBBA and offer practical insights for navigating this evolving landscape.
What is Section 1202?
Historically, Section 1202 has allowed non-corporate taxpayers to exclude up to 100% of the capital gain realized from the sale of QSBS, provided certain requirements are met:
- The stock must be acquired at original issuance.
- The issuing corporation must be a C corporation with gross assets not exceeding $50 million at the time of issuance.
- The stock must be held for more than five years.
- At least 80% of the company’s assets must be used in an active trade or business during the holding period.
The provision has historically offered a powerful tool for startup founders and early-stage investors to reduce federal tax liabilities upon exit. However, the OBBBA expands and modernizes these rules in several key ways. Read more at Section 1202 Qualified Small Business Exclusion Could Become Even More Attractive.
Key Enhancements Under the OBBBA
1. Expanded Period-Based Exclusion
Historically, taxpayers needed to hold QSBS for five years to qualify for the full 100% capital gain exclusion. Under the OBBBA, a tiered exclusion regime now applies for QSBS acquired after the law’s enactment:
Holding Period | Gain Exclusion |
3 Years | 50% |
4 Years | 75% |
5 Years | 100% |
2. Increased Exclusion Cap
The per-issuer gain exclusion limit has been increased from $10 million (not indexed for inflation) to $15 million, indexed for inflation. This enhancement boosts the utility of QSBS for successful
exits and may warrant renewed attention from ultra-high-net-worth investors with sizable equity stakes in qualifying companies. Notably, the alternative exclusion limit — 10 times the taxpayer’s basis in the QSBS – remains unchanged. Taxpayers can exclude the greater of $15 million or 10 times their original investment basis, preserving a potentially more favorable outcome for those who acquired their QSBS at a relatively low valuation.
3. Expanded Gross Asset Threshold
The gross asset ceiling for qualifying corporations has been raised from $50 million to $75 million, also inflation-adjusted going forward. This opens the door to a broader universe of “qualified small businesses,” especially later-stage startups and growth-stage companies that were previously disqualified due to capitalization levels.
Planning Considerations
Grandfathering of Pre-OBBBA QSBS
QSBS issued before July 4, 2025 remains subject to the original five-year holding requirement for full exclusion. The new tiered holding period schedule introduced by the OBBBA does not retroactively apply. As a result, investors holding legacy QSBS should continue tracking their five-year holding periods carefully.
Taxpayers expecting to liquidate QSBS over time may want to prioritize selling pre-OBBBA stock first to maximize the benefit of the more favorable exclusion rules. Strategically spreading sales across tax years can further optimize tax incomes. Careful lot identification and recordkeeping are essential to ensure that shares sold are properly traced to their issuance date and basis, particularly when holdings include both pre- and post-OBBBA stock.
Interplay with State Taxation
Not all states conform to the federal QSBS exclusion, and the OBBBA does not mandate state-level conformity. High-tax jurisdictions like California may still tax these gains regardless of federal exclusions. Multistate taxpayers should consult their advisors to model net tax outcomes.
Who Should Reevaluate Their Strategy?
- Startup founders considering new C-corporation formations post-OBBBA should analyze QSBS eligibility early and coordinate with counsel.
- Early-stage and growth investors should assess current and prospective holdings for Section 1202 qualification.
- Qualifying investors should revisit exit planning, entity structure, and gifting strategies to fully leverage the enhanced QSBS rules. A powerful technique includes using non-grantor trusts and gifting QSBS to family members. By doing so, investors may effectively “stack” multiple Section 1202 exclusions — each eligible trust or individual can potentially claim their own exclusion amount. This can significantly amplify tax-free gain on a successful exit. Proper structuring and compliance with trust rules and timing requirements are critical.
Final Thoughts
The OBBBA’s expansion of Section 1202 represents a significant policy shift designed to reward entrepreneurial risk-taking and long-term investment in small businesses. For founders and investors alike, the new framework offers greater flexibility, larger exclusions, and broader eligibility—making proactive planning more critical than ever.
Given the complexity of the rules and the interaction with other sections of the tax code, thoughtful structuring and documentation are essential. If you are contemplating a business sale or looking to invest in private companies, now is the time to reexamine how Section 1202 fits into your broader tax and estate planning strategy.
Disclosure: This content is for informational purposes only and not investment advice.
