Benefits Offer Enhanced Tax Exclusions and Eligibility for Founders, Early Employees, and Investors
The recently enacted One Big Beautiful Bill Act makes several taxpayer-friendly revisions to the rules governing Qualified Small Business Stock (QSBS) under Section 1202 of the Internal Revenue Code.
The revisions include -
- Shorter holding period to receive exclusion of gains on QSBS
- Increased amount of gain that can be excluded
- Increase in the eligibility to be a “qualified small business”
For QSBS issued after July 4, 2025, the law introduces a new tiered exclusion system: taxpayers may exclude 50% of gain after three (3) years, 75% after four (4) years, and 100% after five (5) years, versus the prior requirement of holding for five years to qualify for full exclusion. This change from an all-or-nothing five-year rule to a phased schedule creates more flexibility and earlier tax benefits for founders, early employees, and investors. The new law also increases the per-issuer gain exclusion cap from $10 million to $15 million, and this cap will be indexed for inflation beginning after 2026.
By way of background, QSBS refers to stock in a C corporation that (i) was originally issued after August 10, 1993, (ii) when the corporation’s gross assets were not more than $50 million (now increased to $75 million under the new law), and (iii) where the company is engaged in a “qualified trade or business.” Excluded categories include most service businesses (such as law, health, and consulting), financial services, hospitality, and real estate. The corporation must also be a domestic C corporation and meet active business requirements during substantially all of the holding period.
The changes resulting from the One Big Beautiful Bill Act will affect choice-of-entity decisions for start-ups. The improved flexibility and higher exclusion thresholds make C corporation status even more attractive, especially when combined with other benefits such as access to venture capital and equity incentive plans. Founders deciding between LLC vs. C corp structures should carefully evaluate the long-term tax impact of QSBS eligibility under the new rules.
The new rules also affect M&A strategy, especially with respect to rollover equity, in transactions where QSBS holders exchange their stock for equity in a buyer entity. Under the law, when QSBS is exchanged for stock in a tax-free reorganization, the original holding period for QSBS may tack onto the new stock—meaning the time held before the transaction would count toward the tiered exclusion thresholds. For example, if a founder acquired stock after July 4, 2025 and held the QSBS for two years before a sale of their business, then the acquirer-stock received as rollover equity would only have to be held for one additional year to reach the three-year, 50% exclusion threshold. This continuity of the holding period provides greater certainty and flexibility in structuring tax-deferred M&A transactions, and may increase the appeal of rollover equity.
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