President Donald Trump on July 4, 2025, signed into law H.R. 1, commonly referred to as the One Big Beautiful Bill Act (OBBB). (For a detailed analysis of the bill, see Holland & Knight's previous alert, "Trump Signs the One Big Beautiful Bill Act," July 3, 2025.) OBBB contains comprehensive changes to federal law, including in particular numerous modifications to the U.S. Internal Revenue Code (the Code). These changes include an expansion of the popular and taxpayer-friendly qualified small business stock (QSBS) rules that provide certain taxpayers with an exemption from capital gains upon a disposition of stock in qualified C corporations.
The expansion of the QSBS regime in the OBBB follows from the introduction of similar legislation in February 2025 by Republican legislators in the U.S. House of Representatives and U.S. Senate titled the Small Business Investment Act of 2025.
Summary of Preexisting QSBS Rules
Code Section 1202 generally allows a noncorporate taxpayer (e.g., an individual or trust) to exclude from taxable income capital gains attributable to the disposition of QSBS that is held for more than five years (including capital gains realized indirectly through a pass-through entity such as a partnership or S corporation, provided certain requirements are met). QSBS is defined as capital stock (common or preferred) of a domestic C corporation, which has "aggregate gross assets" (itself a defined term that can be calculated by reference to tax basis) that did not exceed $50 million at any time after Aug. 10, 1993, through the issuance of the QSBS.1 To qualify as QSBS, the stock also must be acquired at original issuance in exchange for nonstock property or as compensation for performance of services. Certain types of businesses are disqualified from issuing QSBS, including companies engaged in providing professional services (e.g., health, law, accounting, banking, leasing, farming, mineral extraction, and hotel and restaurant services), among others.2
The amount of capital gain that may be excluded under Code Section 1202 is subject to a cap. Depending on the original issuance date, for QSBS acquired after Aug. 10, 1993, but prior to the effective date of OBBB, a taxpayer may exclude 50 percent, 75 percent or 100 percent of the capital gain realized from the disposition of QSBS in a given issuer up to the greater of $10 million (taking into account all dispositions of QSBS by the taxpayer in the same issuer) or 10 times the adjusted basis of the taxpayer in the disposed QSBS.3
For a significant period of time after its initial enactment in 1993, the QSBS rules allowed for only a 50 percent exclusion of gain from disposition of such stock. In 2009, this exclusion increased to 75 percent before increasing again in 2010 to 100 percent pursuant to the Small Business Jobs Act of 2010.
Key Changes
There are three key changes to the QSBS rules under OBBB. First, the required holding period to begin to be eligible for tax benefits from a disposition of QSBS has been shortened from five years to three years, with a phased-in exclusion amount if the holding period is between three and five years. Second, the size of corporations eligible to issue QSBS to investors has been materially expanded from $50 million of gross asset value to $75 million of gross asset value, with a new inflation adjustment to increase that amount each year. Third, the flat cap on the maximum amount of capital gain excludable from the QSBS of a single issuer has been increased from $10 million to $15 million, again with an inflation adjustment. The alternative cap calculated by reference to 10 times the adjusted basis in the QSBS stock continues to remain available and is unchanged by OBBB.
Shortened Holding Period
Shortening the required holding period offers investors in qualifying corporations the ability to seek earlier liquidity opportunities to avail themselves of the favorable QSBS rules. The shortened holding period will make QSBS investments materially more attractive to independent sponsors, private equity sponsors and other types of opportunistic investors, as it provides greater flexibility in choosing an exit at a time when market conditions allow for higher valuations while still allowing such investors to realize a return in the nature of tax benefits.
When QSBS shares acquired after the effective date of OBBB are disposed of at least three years but less than four years after initial issuance, 50 percent (i.e., instead of 100 percent) of the capital gain recognized, up to the relevant cap, is now eligible to be excluded.4 When QSBS shares are disposed of at least four years but less than five years after initial issuance, 75 percent of the capital gain recognized, up to the relevant cap, is eligible to be excluded. QSBS stock held for at least five years is eligible for a 100 percent exclusion of the capital gain recognized, up to the relevant cap, similar to the preexisting rules applicable to QSBS acquired after 2010 and held for more than five years.
The shortened holding period requirement applies to stock acquired after the date of enactment of OBBB (July 4, 2025). Thus, QSBS that was already issued on or prior to July 4, 2025, will still need to satisfy the preexisting five-year holding period requirement to be eligible for the exemption. For purposes of determining when such stock is acquired by a taxpayer, any tacked holding period under Code Section 1223 is taken into account.
Increase in Gross Asset Value Limitation
The second key change to the QSBS rules enacted by OBBB is to increase the limit on the size of businesses eligible to issue QSBS to $75 million of gross asset value. This will significantly expand the universe of companies that can be treated as a "small business" under Code Section 1202 and thus able to issue QSBS. The gross asset value limitation generally is tested and applied at all times prior to and immediately after the issuance of QSBS. Specifically, for newly issued shares to be QSBS, an issuer must not have "aggregate gross assets" in excess of $75 million at any time after Aug. 10, 1993, through immediately after a tested stock issuance.
As noted above, this limitation is no longer a static limit. Rather, the $75 million gross asset value cap will be increased annually by an inflation adjustment, allowing businesses that are of greater value in future years to issue QSBS. The increase in the gross asset value limitation is effective for stock issued after the date of enactment of OBBB.
Increase in Per-Issuer Flat Cap on Capital Gains
The third key change to the QSBS rules enacted by OBBB is to increase the per-issuer flat cap on capital gains subject to exclusion. As described above, for any tax years beginning prior to the effective date of OBBB, eligible taxpayers are permitted to exclude capital gains with respect to a single issuer up to the greater of $10 million (taking into account all prior dispositions of QSBS by the taxpayer in the same issuer) or 10 times the adjusted basis of the taxpayer in the QSBS stock. After enactment of OBBB, eligible taxpayers are permitted to exclude capital gains with respect to a single issuer up to the greater of $15 million (again taking into account all prior dispositions of QSBS by the taxpayer in the same issuer) or 10 times the adjusted basis of the taxpayer in the QSBS stock. The flat cap on capital gains was accordingly materially increased by OBBB while still preserving the alternative cap by reference to adjusted basis (e.g., for an investment of $30 million by a single eligible taxpayer, the limitation on excluded capital gains could be as high as $300 million both before and after the enactment of OBBB).
Increasing the flat cap on gains that are eligible for the exclusion should materially increase the value of QSBS planning for eligible taxpayers by significantly increasing the amount of gain that is sheltered and not subject to tax. This increase will most significantly impact relatively smaller investors who would not otherwise be relying on the 10 times basis cap (i.e., investors who are investing $1 million or less in a single issuer of QSBS).
Like the increase in the gross asset value limitation, the flat cap on capital gains subject to exclusion is no longer static. Rather, it will be increased annually going forward by a cost of living inflation adjustment. Once a taxpayer excludes the maximum amount in effect in a given year, however, subsequent increases in the cap on account of inflation adjustments do not provide additional exclusion amounts in future years.
The increased cap on capital gains subject to exclusion is applicable in the same manner as the shortened holding period requirements. Specifically, the increased cap is applicable to stock acquired after the date of enactment of July 4, 2025, taking into account the tacked holding period rules of Code Section 1223.
Areas Not Changed and Tax Rates
Many areas of the QSBS rules remain unchanged following the enactment of OBBB. Specifically, the types of business activities that may be treated as a "qualified trade or business" remain unchanged (i.e., excluding certain services businesses such as health, engineering, architecture, law, hotels, farming, banking and consulting). The types of reorganization transactions that may be undertaken while maintaining favorable QSBS status also has not been amended by OBBB. The provisions that apply to dispositions of QSBS through a pass-through entity – such as an entity taxed as a partnership – further remain unchanged subsequent to enactment of OBBB. Accordingly, though all of the QSBS changes in OBBB are positive and taxpayer-friendly, significant areas of uncertainty and illogical gaps in certain QSBS provisions remain.
It is possible that the new QSBS provisions in OBBB will spur the IRS to provide more robust guidance, including through regulations. To date, the regulations that have been issued by the IRS under Code Section 1202 generally have been limited to certain guidance to estate and trust beneficiaries and guidance on rules that disqualify QSBS issued near in time to certain redemption transactions. No comprehensive regulations specific to Code Section 1202 have yet been issued on the business activity requirements (e.g., the precise contours of what constitutes "health services"), reorganization rules or recognition of QSBS gain through a pass-through entity.
The new tiered exclusion amounts also bring back into play the 28 percent capital gains tax rate for the portion of the maximum gain taken into account under Code Section 1202 that is not actually excluded.5 For example, assume a taxpayer acquires stock on Jan. 1, 2026, in exchange for services (at a value of zero for ease of illustration) and sells the stock for $20 million on Jan. 1, 2029. The taxpayer will 1) be able to exclude $7.5 million of gain (50 percent of $15 million), 2) pay a 28 percent capital gains tax on $7.5 million (the remainder of the gain taken into account under Code Section 1202 that is not actually excluded) and 3) pay a 20 percent capital gains tax on the remaining $5 million.
Key Takeaways
The changes to Code Section 1202 enacted under OBBB are a significant expansion of the QSBS tax benefits made available to investors, company founders and other eligible taxpayers acquiring stock of qualifying C corporations. To summarize, the three significant taxpayer favorable changes in this area made by OBBB are:
- a reduction in the minimum holding period requirement from five to three years, with a phased-in exclusion percentage of 50 percent (for a three-year holding period), 75 percent (for a four-year holding period) and 100 percent (for a holding period of five or more years)
- an increase in the maximum aggregate gross asset value for a qualifying C corporation issuer from $50 million to $75 million, indexed for inflation going forward
- an increase in the single issuer flat cap on capital gains subject to exemption from $10 million to $15 million, indexed for inflation going forward
These changes materially increase the value to investors and emerging company founders in considering QSBS qualification early on in the process of forming and operating a company. Issues such as entity choice, capital structure, equity compensation planning, and add-on and exit transactions should all be viewed through the lens of QSBS qualification. The tax benefits under the QSBS rules have always been significant for those who are patient and careful enough to pursue them. OBBB will now expand and increase these benefits.
If you have any questions about these QSBS issues, please contact the authors or any member of Holland & Knight's Tax Practice.
Notes
1 Corporations with excessive nonworking capital, non-subsidiary stock or securities in other corporations, or passive real estate holdings will also not qualify for the exclusion. Code Sections 1202(e)(5), (e)(6) and (e)(7).
2 The list of business activities that do not meet the "qualified trade or business" requirement for QSBS stock is codified at Code Section 1202(e)(3).
3 Code Section 1202(b)(1).
4 Example: If a taxpayer acquires QSBS on Jan. 1, 2026, for $1 and then sells the QSBS three years later on Jan. 1, 2029, for $20 million, the taxpayer will be able to exclude $7.5 million of the gain (50 percent of the $15 million cap).
5 See Code Section 1(h)(7).
