In a previous article, The Often-Overlooked Benefits of Qualified Small Business Stock, I discussed the significant benefits available to taxpayers holding qualified small business stock (“QSBS”), which is defined under Section 1202 of the Internal Revenue Code (“IRC”). While significant then, the recently enacted One Big Beautiful Bill (“OBBB”)[1] amended IRC § 1202[2] to substantially amplify the benefits available to QSBS-holding taxpayers. Despite the benefits provided under IRC § 1202 prior to the OBBB, most originating small businesses continued to form and operate as partnerships or S corporations for Federal income tax purposes. Now, given the recent amendments made pursuant to the OBBB, planners should consider the dramatically increased tax benefits of QSBS and consider the same when advising clients on their respective structuring and operations.
The Increased Benefits, Generally
The OBBB amended IRC § 1202 in three material ways.
- First, the period which taxpayers must hold QSBS to qualify for exclusion was decreased from five years to three years, provided that the exclusion is decreased if disposed in years three or four.
- Second, the definition of “qualified small business” was amended to include domestic C corporations whose aggregate gross assets have never exceeded $75,000,000, largely increasing the number of eligible “qualified small businesses.”
- Third, the maximum amount of capital gain that can be excluded by any one individual increased from $10 million to $15 million. Importantly, both the newly increased gross asset value and gain exclusion thresholds will be annually increased for inflation, carrying forward the utility QSBS provides.
The Shortened Holding Period
To qualify for the benefit of capital gain exclusion under IRC § 1202, taxpayers previously had to hold the stock for more than five years. The OBBB amended IRC § 1202(a) to provide certain capital gain exclusions to QSBS held for just three and four years. For QSBS held just three years, the applicable exclusion amount is fifty percent (50%), and for stock held for four years, the exclusion amount increases to seventy-five percent (75%). Like before the OBBB, QSBS held for five or more years (and issued after September 27, 2010[3]) is eligible for exclusion of one hundred percent (100%) of capital gain upon disposition.
It is important to note that this reduced holding period only applies to QSBS issued after the enactment of the OBBB (being July 4, 2025). QSBS issued prior to such date must still satisfy the five-year holding period requirement to be eligible for the exclusion. Notwithstanding this limitation, going forward, the reduced holding period should incentivize investors, providing flexibility to those who are otherwise concerned with liquidity, allowing them the opportunity to exit in years three and four should high market prices offset the reduced exclusion amount.
The Increased Gross Asset Value Threshold
Previously, a “qualified small business” was any domestic C corporation whose aggregate gross assets have never exceeded $50,000,000 since August 10, 1993[4] and at least 80% (by value) of the assets of the corporation are used in the active conduct of one or more qualified trades or businesses.[5] Now, the OBBB amended IRC § 1202(d)(1) to include domestic C corporations whose aggregate gross value assets have never exceeded $75,000,000. Like the reduced holding period requirement, this increase in gross asset value only applies to stock issued after July 4, 2025. Nevertheless, this $75,000,000, adjusted annually for inflation, dramatically increases the number of qualified small businesses and thus also the number of taxpayers eligible for gain exclusion upon disposition of their QSBS.
Increase to the Maximum Excludable Amount
Prior to the OBBB, for each individual issuer (C corporation) of which a taxpayer holds QSBS, the taxpayer may only take capital gain exclusions upon the disposition of QSBS to the greater of (i) $10,000,000, or (ii) ten times the aggregate adjusted bases of the QSBS, determined without regard to any adjustment after the date of issuance.[6] The OBBB amended IRC § 1202(b) to increase the flat cap from $10,000,000 to $15,000,000, adjusted annually for inflation, and the alternative “ten times aggregate adjusted bases” alternative still remains in effect. This limitation is applied per taxpayer, and while beyond the scope of this article, provides a plethora of opportunities for planners going forward to capture as exclusion as possible by spreading the issuance of QSBS across multiple taxpayers, including non-grantor trusts.
Accounting for the Recent Changes, what is Qualified Small Business Stock?
Summarizing the recently amended subsections of IRC § 1202, QSBS is simply stock, originally issued to a shareholder in exchange for contributions or services provided, of a C corporation, which since August 10, 1993 has never held more than $50,000,000 in assets (for stock issued prior to July 4, 2025), or $75,000,000 in assets (for stock issued after July 4, 2025), that uses at least 80% of its assets in the active conduct of its trade or business, which may not be one of the trades or businesses contemplated in the immediately preceding paragraph.
Tax Benefits for QSBS Issued Prior to July 4, 2025
When a taxpayer (other than a corporation) sells QSBS and held for at least five years, a certain portion of gain from the sale of the QSBS will be excluded from the taxpayer’s gross income depending on when the QSBS was issued to the taxpayer.[7] For QSBS issued from August 10, 1993 through February 17, 2000, 50% of gain resulting from the sale of the QSBS will be excluded from the taxpayer’s gross income.[8] For QSBS issued from February 18, 2009 through September 27, 2010[9], 75% of gain resulting from the sale of QSBS will be excluded, and for QSBS issued after September 27, 2010, 100% of the gain resulting from the sale of QSBS will be excluded from the taxpayer’s gross income.
Tax Benefits for QSBS Issued After July 4, 2025
Subject to the newly increased thresholds, a taxpayer who sells QSBS issued after the enactment of the OBBB and (i) held for more than three years but less than four years will receive a 50% capital gain exclusion; (ii) held for more than four years but less than five years will receive a 75% capital gain exclusion; and (iii) held for five or more years will receive a 100% exclusion of capital gains upon disposition of the respective QSBS.[10]
Conclusion
Despite the tax benefits provided by QSBS, C corporations may not be the most advantageous entity under which many taxpayers should form and operate their business[11]. Nevertheless, given the recent amendments under the OBBB, taxpayers and their respective planners should not overlook the benefits provided under IRC § 1202 to QSBS holders. Taxpayers who desire to grow rapidly, reinvest profits into their company, and eventually exit should seriously consider C corporation status to take advantage of the enormous tax incentives of QSBS.
Furthermore, multiple planning opportunities arise given the recent amendments under the OBBB, including the ability to further leverage the increased $15 million exclusion by “stacking” QSBS in non-grantor trusts. For example, a taxpayer holding QSBS may gift[12] portions of such QSBS to incomplete non-grantor trusts[13] established for the benefit of his two children[14], thereby increasing the maximum exemption amount threefold to $45 million. This planning opportunity also offers the ability to take advantage of other amendments under the OBBB, including the heightened SALT deduction cap as well as the extension of qualified business income, as each non-grantor receives its own threshold for such purposes.
In short, the tax incentives associated with QSBS under IRC § 1202, particularly in light of the recent amendments under the OBBB, should cause every business owner, entrepreneur, and their respective planners to consider whether C corporation status makes sense going forward. If such individuals plan to sell the stock of their business in the future, such may very well be the most prudent option. As a bonus, in Mississippi, a taxpayer undertaking such plan can also enjoy the benefits of state income tax exclusion under Miss. Code Ann. § 27-7-9(f)(10), which provides for exclusion of gain upon the sale of interests in domestic corporations.[15]
[1] See the OBBB here: https://www.congress.gov/bill/119th-congress/house-bill/1/text
[2] Note that IRC § 1202 was amended under Section 70431 of the OBBB.
[3] See my previous article, linked above, to see the applicable percentage of gain exclusion for stock issued between 1993-2010.
[4] IRC § 1202(d)(1).
[5] IRC § 1202(e)(1)
[6] IRC § 1202(b).
[7] IRC § 1202(a)(1).
[8] IRC § 1202
[9] The date of enactment of the Creating Small Business Jobs Act of 2010.
[10] Note that gain exceeding the QSBS exclusion limitations will be taxed at a higher 28% rate pursuant to IRC § 1(h)(4).
[11] This is due to multiple factors, including without limitation the double taxation related to C corporations, as well as unilateral gain exclusion for contribution of property under IRC § 351.
[12] Notwithstanding the original issue requirement, IRC § 1202(h) provides that a transfer of QSBS by gift will result in the transferee being treated as holding originally issued stock for the same holding period as the transferor.
[13] See my previous articles on ING Trusts here: https://www.esapllc.com/ing-trusts-for-salt-overview-2023/; https://esapllc.com/ing-trusts-2022-apd/
[14] Subject to IRC § 643(f).
[15] Note such exception also applies to domestic limited liability companies and domestic limited partnerships.
