The One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, made a number of changes to the Internal Revenue Code of 1986, as amended (the Code), including certain notable changes to the provisions of Code Section 1202 for “qualified small business stock” (QSBS). As described in more detail below, Section 1202, as updated by the OBBBA, provides new and expanded opportunities for investors and small business owners to avail of QSBS benefits.
Pre-OBBBA Section 1202
Section 1202 of the Code provides noncorporate investors with an exclusion from gross income of up to 100% of gain realized from the sale or exchange of QSBS held for more than five years. For QSBS issued prior to the enactment of the OBBBA, the total amount of gain from the sale or exchange of QSBS of a single issuer that may be excludable from gross income by an investor may not exceed the greater of (i) $10 million or (ii) 10 times the investor’s aggregate adjusted basis (as determined under the QSBS rules) in the QSBS issued by the corporation.
For stock to qualify as QSBS, (i) the issuing corporation must be a domestic “C” corporation, (ii) the stock of the corporation must be acquired by the investor at original issuance, (iii) the aggregate gross assets of the issuing corporation must not exceed $50 million at any time prior to or immediately after such issuance, (iv) the corporation must satisfy an active business requirement for substantially all of the investor’s holding period in the stock, and (v) the corporation must not run afoul of certain redemption restrictions.
OBBBA Amendments to Section 1202
The OBBBA updated Code Section 1202 by introducing a tiered exclusion regime, increasing the cap on the gain exclusion and increasing the gross asset limitation.
Reduced Holding Period for Partial Gain Exclusion
For QSBS issued after the date of enactment of the OBBBA, the OBBBA provides a tiered gain exclusion structure for eligible QSBS gain based on the taxpayer’s holding period in the QSBS:
- 50% exclusion for QSBS held for at least three years (but less than four years).
- 75% exclusion for QSBS held for at least four years (but less than five years).
- 100% exclusion for QSBS held for five years or more (remains unchanged by OBBBA).
Prior to the OBBBA, an investor was not eligible to exclude any gain realized on the disposition of QSBS if such QSBS was held for less than five years. This change in law provides expanded opportunities for investors to effectuate an earlier exit from a potential QSBS investment and still benefit (at least in part) from the Code Section 1202 gain exclusion, potentially increasing a business’s ability to attract private capital investors.
Increased Cap on Gain Exclusion
The OBBBA increased the maximum excludible gain per taxpayer, per issuer from the greater of (i) $10 million (or $5 million for married individuals filing separately) or (ii) 10 times the aggregate adjusted basis of the QSBS disposed of during the tax year, to the greater of (x) $15 million (or $7.5 million for married filing separately) or (y) 10 times such basis. In addition, the new $15 million threshold will be increased for inflation for taxable years beginning after 2026. The increased cap on the gain exclusion applies only to QSBS issued after July 4, 2025 (the prior gain exclusion cap applies to QSBS issued before this change in law).
Increased Aggregate Gross Asset Threshold
The OBBBA also increased the “aggregate gross asset” threshold for an issuing corporation to be treated as a “qualified small business” from $50 million to $75 million. For this purpose, “aggregate gross assets” generally includes cash and the aggregate adjusted basis of all other property held by the corporation. As a result, for stock issued after the date of the enactment of the OBBBA to qualify as QSBS, the “aggregate gross assets” of the issuing corporation may not exceed $75 million at any time prior to and immediately after the original issuance of such stock. This new $75 million threshold will also be increased for inflation for taxable years beginning after 2026.
Considerations
Section 1202 historically has offered significant benefits to small business owners. With the increased aggregate gross asset threshold, the increased per-taxpayer exclusion limit, and the modified holding period requirements, it is important for taxpayers to carefully evaluate and document eligibility for Section 1202 treatment.
