On July 4, 2025, President Trump signed the One Big Beautiful Bill Act (the OBBBA) into law, enacting extensions of the Tax Cuts and Jobs Act of 2017, as well as a broad set of tax reforms. Among the OBBBA’s key changes is a substantial expansion of Section 1202 of the Internal Revenue Code, a provision that allows certain investors and founders to exclude gains on the sale of qualified small business stock (QSBS).
The OBBBA significantly enhances Section 1202 by raising eligibility thresholds, increasing the gain exclusion cap, and modifying the required holding periods. These amendments further increase the reach and utility of Section 1202. This alert provides an overview of the Section 1202 framework, its historical development, and the important changes made by the OBBBA.
Section 1202: Historical Context and Policy Purpose
Section 1202 was originally enacted in 1993 to spur investment in small businesses by offering favorable tax treatment for certain equity investments. The provision allows non-corporate taxpayers to exclude up to 100% of gains from the sale of QSBS held for at least five years and acquired after September 27, 2010, subject to certain limitations and qualifications. Combined with a lowered 21% corporate federal income tax rate, the provision has been a useful tool for promoting investment in small and start-up businesses.
Overview of Section 1202 (Prior Law)
Under the pre-2025 rules, in order to qualify as QSBS, the stock had to meet certain requirements:
- Original Issuance: The stock must be acquired directly from a domestic C corporation at original issuance (e.g., through purchase or in exchange for services).
- Gross Assets Test: The issuing corporation’s gross assets (the amount of cash and the aggregate adjusted tax bases of other property) must not exceed $50 million before or immediately after the stock issuance.
- Qualified Trade or Business: The company must be engaged in an active U.S. trade or business during substantially all a shareholder’s holding period (excluding certain industries such as law, accounting, health, finance, and hospitality).
- Holding Period: The stock must be held for more than five years to qualify for the exclusion.
- Exclusion Cap: The exclusion is limited to the greater of $10 million or 10 times the taxpayer’s basis in the stock.
In addition, excluded gains are not subject to the alternative minimum tax (AMT) or the net investment income tax (NIIT)—a distinction that further enhances the effective tax savings.
These rules are still applicable for stock acquired after September 27, 2010 and on or before July 4, 2025.
Key Enhancements in the OBBBA
The OBBBA expands the utility of Section 1202 in several material ways.
1. Staggered Holding Period Exclusions
The OBBBA replaces the five-year holding period with a staggered exclusion for stock acquired after July 4, 2025. QSBS held for at least three years will be eligible for a 50% gain exclusion. QSBS held for at least four years will be eligible for a 75% gain exclusion. QSBS held for 5 years or more will be eligible for 100% gain exclusion.
2. Increased Gross Asset Threshold
The OBBBA increases the asset ceiling for qualified small businesses from $50 million to $75 million, measured immediately before and after stock issuance.
3. Higher Exclusion Cap
The maximum exclusion has been raised to the greater of $15 million (up from $10 million) or 10 times the taxpayer’s basis.
4. Inflation Adjustments
Both the gross asset test and the $15 million gain exclusion limit will now be indexed annually for inflation beginning in 2026.
The changes to the gross asset threshold apply to QSBS issued after July 4, 2025. The other changes apply to taxable years beginning after July 4, 2025.
Conclusion
We encourage investors, founders, and business owners to assess how the new rules may impact their tax position, structuring, and estate planning.
