Qualified Small Business Stock Tax Benefits Expanded for Early-Stage Companies and Investors

The recently signed One Big Beautiful Bill Act (OBBBA) implements significant changes under Section 1202 of the Internal Revenue Code of 1986 (Code), applicable to qualified small business stock (QSBS) issued on or after July 5, 2025. Specifically, the OBBBA: (i) reduces the minimum holding period of the stock in order to qualify for QSBS tax benefits on the disposition of the stock; (ii) increases the maximum amount of capital gain excludable from the QSBS of a single corporate issuer of stock; and (iii) increases the gross asset cap for corporate issuers eligible to issue QSBS. These changes, which are designed to further encourage investment in U.S.-based earlier-stage companies, provide welcome benefits for a number of private companies and their founders, early employees and investors.

Background of Section 1202

Section 1202 was enacted in 1993 to stimulate investment in U.S. startups. As initially implemented, noncorporate taxpayers selling QSBS were eligible for an exemption from capital gains upon a disposition of the stock. In order to be deemed QSBS, Section 1202 required that the following conditions be met:

• The corporate issuer of the stock is a U.S. domestic C corporation;
• The corporate issuer’s aggregate gross assets, which are comprised of cash and the aggregate adjusted tax bases of the corporation’s other property, do not exceed $50 million as of immediately prior to and immediately after the issuance of the stock;
• The stock is held by the taxpayer for more than five years;
• The stock is acquired at original issuance from the corporate issuer in exchange for nonstock property or as compensation for performance of services; and
• The corporate issuer of the stock is engaged in an active trade or business during substantially all of a stockholder’s holding period and such business is not a disqualified business (e.g., a professional services company).

Depending on the issuance date of the QSBS following the adoption of Section 1202 in 1993 and prior to the enactment of the OBBBA, a taxpayer may exclude 50%, 75% or 100% of the capital gain realized from the disposition of QSBS in a given corporate issuer, subject to a cap.

Summary of Changes Under the OBBBA

Minimum Holding Period

The OBBBA replaces the five-year holding period with a staggered exclusion for stock acquired on or after July 5, 2025, as follows:

• QSBS held for at least three years will be eligible for a 50% capital gain exclusion;
• QSBS held for at least four years will be eligible for a 75% capital gain exclusion; and
• QSBS held for five years or more will be eligible for 100% capital gain exclusion.

Gain Exclusion Caps

Previously, Section 1202 imposed two independent gain exclusion caps:

• A cumulative per-taxpayer, per-issuer $10 million cap ($5 million for married taxpayers filing separately); and
• A cap based on 10 times the aggregate tax basis of QSBS sold by a taxpayer in a tax year (10X Cap).

For stock issued prior to July 5, 2025, eligible taxpayers are permitted to exclude capital gains with respect to a single issuer up to the greater of the foregoing caps. 

Under the OBBBA, the 10X Cap remains in place. However, for stock issued on or after July 5, 2025, the $10 million cap has been increased to $15 million ($7.5 million for married taxpayers filing separately), which is subject to future inflation-adjustment increases on an annual basis beginning in 2027.

Aggregate Gross Assets

The OBBBA increases the aggregate gross assets threshold for the corporate issuers of the stock from $50 million to $75 million, which is subject to future inflation-adjustment increases on an annual basis beginning in 2027. This change is effective for stock issued on or after July 5, 2025.

No Retroactive Effect

The OBBBA changes apply only to stock issued on or after July 5, 2025. Significantly, investors cannot exchange stock issued prior to July 5, 2025, for QSBS and benefit from the amended rules. QSBS that was issued prior to July 5, 2025, will therefore still need to satisfy the preexisting five-year holding period requirement to be eligible for the capital gains exemption.