Taxpayer-Friendly Changes to the “Qualified Small Business Stock” Rules Made by the One Big Beautiful Bill Act

Section 1202 of the Internal Revenue Code[1] permits, under certain conditions, eligible taxpayers[2] to exclude from their gross income certain gains from the sale or exchange[3] of “qualified small business stock.”  The ability to exclude gains from gross income –which means that such gains are effectively exempted from federal income taxation– is a powerful tax planning tool that can make an attractive investment even more attractive on an after-tax basis.  The One Big Beautiful Bill Act (the “OBBBA”), signed into law by the President on July 4, 2025, made several taxpayer-friendly changes to the “qualified small business stock” rules.  Below is a discussion of these changes in the context of the operation of Section 1202.[4]

Holding Period(s).[5]  In general, a noncorporate taxpayer who holds QSBS for a specified holding period can exclude 100% of the gain realized on the sale of such stock.[6]  For QSBS acquired on or before July 4, 2025 (the “Applicable Date”), the taxpayer must have held such QSBS for more than 5 years in order to be eligible for the 100% exclusion[7], and an otherwise eligible taxpayer that held QSBS for any shorter period generally would not be eligible for any exclusion.  The OBBBA changed this holding period requirement to allow a 50% exclusion of the gain from sale of QSBS held for at least 3 but not as many as 4 years , a 75% exclusion of the gain from sale of QSBS held for at least 4 but not as many as 5 years, and a 100% exclusion of the gain from sale of QSBS held for 5 years or more.[8]
Under pre-OBBBA law (and for current and future sales of QSBS that was acquired on or before the Applicable Date) an otherwise eligible taxpayer who sold QSBS after, say, 4 years and 11 months was not permitted any gain exclusion at all, and even a taxpayer who held the QSBS for exactly 5 years.  For QSBS acquired after the Applicable Date, such a taxpayer would be eligible for a 75% exclusion after a holding period of 4 years and 11 months, and for a 100% exclusion after a holding period of 5 years or more.  

Per-Issuer Limitation.  The amount of gain from the sale of QSBS otherwise eligible for exclusion from gross income by a taxpayer is not unlimited.  Rather, the selling taxpayer must determine whether and to what extent the gain otherwise eligible for exclusion is subject to the “per-issuer limitation.”   As its name suggests, this limitation is applied by a taxpayer on an issuer-by-issuer basis; that is, a taxpayer who sells QSBS issued by multiple corporations would calculate this limitation separately for each such issuing corporation.  Only the amount of otherwise eligible gain that does not exceed the per-issuer limitation is permitted to be excluded from gross income in whole or in part under Section 1202.  The per-issuer limitation is the greater of (i) a specified dollar limit and (ii) 10 times the aggregate adjusted bases of QSBS of that issuer sold during that taxable year.

The OBBBA increased the specified dollar limit for dispositions of QSBS that was acquired after the Applicable Date.[9]  For QSBS acquired on or before the Applicable Date, the specified dollar limit applicable to a taxpayer with respect to a particular QSBS issuer for a taxable year is $10 million, reduced by the aggregate amount of gain previously taken into account by the taxpayer under Section 1202 in prior taxable years with respect to QSBS of the same issuer.
For QSBS acquired after the Applicable Date, the specified dollar limit applicable to a taxpayer with respect to a particular QSBS issuer for a taxable year is $15 million,[10] reduced by the sum of (i) the aggregate amount of gain previously taken into account by the taxpayer under Section 1202 in prior taxable years with respect to QSBS of the same issuer and (ii) the aggregate amount of gain previously taken into account by the taxpayer under Section 1202 for the taxable year and attributable to stock acquired on or before the Applicable Date.

The “greater of” rule used to determine the per-issuer limitation is obviously taxpayer friendly, and the increase from $10 million to $15 million as enacted by the OBBBA adds to this taxpayer friendliness.  Worth noting in this context, although it is a pre-existing rule rather than one enacted by the OBBBA, is a special basis rule used for purposes of Section 1202, including for purposes of the per-issuer limitation.  Under this special basis rule, in a case where a taxpayer transfers property (other than money or stock) to a corporation in exchange for such corporation’s stock, the basis of such stock in the hands of such taxpayer shall in no event be less than the fair market value of the property exchanged.  Without this special basis rule, a taxpayer that contributes low-basis but high value property to a corporation in exchange for QSBS would have a lower per-issuer limitation in connection with a later sale of QSBS of that corporation. 

The effective dates of the OBBBA’s changes to the holding period rules and per-issuer limitation can potentially cause confusion, because multiple dates are referenced –the date of acquisition of the QSBS, the date of disposition of the QSBS, and the date the OBBBA became effective.  An illustration of the dates of applicability of these rules (simplified for ease of use) is shown in the two charts immediately below:

QSBS acquired after July 4, 2025

Taxpayer’s Holding Period for QSBS Sold	Percentage Exclusion of Eligible Gain	Dollar Amount Used in Determining Per-Issuer Limitation (subject to taxpayer-specific adjustment, and inflation adjusted after 2026)
At least 3 years	50 %	$15 million
At least 4 years	75 %	$15 million
At least 5 years	100 %	$15 million

 
QSBS acquired on or before July 4, 2025

Date of Acquisition of QSBS	Taxpayer’s Holding Period for QSBS Sold	Percentage Exclusion of Eligible Gain	Dollar Amount Used in Determining Per-Issuer Limitation (subject to taxpayer-specific adjustment)
Before February 17,  2009	More than 5 years	50 %	$10 million
Between February 17, 2009 and September 27, 2010	More than 5 years	75 %	$10 million
After September 27, 2010 and on or before July 4, 2025	More than 5 years	100 %	$10 million

 
Definition of QSBS. In order to take advantage of Section 1202 and the holding period and per-issuer limitation changes made by the OBBBA that are discussed above, a taxpayer must in the first place own stock that meets the definition of QSBS.[11]  The OBBBA made a significant taxpayer-friendly change that affects the definition of QSBS issued after the Applicable Date.  QSBS generally is defined by reference to the taxpayer who acquires, holds, and later disposes of the stock, as well as by reference to the corporation that issues such stock.  In order to be classified as QSBS, (1) the stock must be stock of a C corporation[12]; (2) the corporation that issued the stock must have been a “qualified small business” as of the date of issuance; (3) the stock must have been acquired by the taxpayer at its original issue (either directly from the issuing corporation or through an underwriter) either in exchange for (i) money or property other than stock, or (ii) as compensation for services provided to such corporation (other than as an underwriter of such stock) and (4) during substantially all of the taxpayer’s holding period for such stock, such corporation must meet an “active business” requirement.[13] 

In order to be classified as a “qualified small business” at the time of issuance of stock, a corporation must meet a maximum “aggregate gross assets” test under which its aggregate gross assets, determined in accordance with specified rules in Section 1202, may not exceed a specified dollar value at any time prior to the issuance of such stock[14] and may not exceed that specified dollar value immediately after the issuance (taking into account amounts received in the issuance).
The OBBBA increased the maximum dollar value used to determine qualified small business status to $75 million, from $50 million under pre-OBBBA law.  Thus the potential qualified small business status of a corporation that issues stock after the Applicable Date is tested using a $75 million maximum for aggregate gross assets, whereas the potential qualified small business status of a corporation that issued stock prior to or on the Applicable Date is tested using a $50 million threshold for aggregate gross assets.  The OBBBA’s increase in the size of a potential qualified small business is very taxpayer friendly, as it allows some businesses that would not have qualified previously to qualify, and it also potentially facilitates a higher per-issuer limitation for certain shareholders because shareholders generally will have the opportunity to contribute property of greater value, or a larger amount of cash, in exchange for stock without violating the limit on the issuing corporation’s aggregate gross assets.

The changes to the QSBS rules made by the OBBBA will provide additional opportunities to taxpayers such as founders and employees of, and investors in, start-up and small businesses to make equity investments in a way that, if all required conditions are met, could end up providing them with significant tax savings on the sale of appreciated stock.