The Qualified Small Business Stock (QSBS) gain exclusion under Internal Revenue Code Section 1202 is a powerful tax planning tool allowing shareholders to exclude capital gains on the sale of eligible C-corporation stock. With the passage of the OBBBA, Section 1202 is even more valuable for stock issued after July 4, 2025. While the new rules increase the financial upside and expand eligibility, proper planning still requires a careful review of foundational compliance, asset limits, and entity conversions.
Visualizing the OBBBA’s Advantage
Imagine a founder who invests $100,000 to start an eligible C-Corporation in August 2025. Five years later, the company is acquired, and the founder’s shares are sold for $20.1 million, resulting in a $20 million capital gain.
- Without QSBS: A standard 23.8% federal capital gains tax (including the Net Investment Income Tax) results in a $4.76 million tax liability.
- Under Pre-OBBBA Rules: With the historical $10 million cap, the remaining $10 million gain is taxed, resulting in a $2.38 million tax liability.
- Under Post-OBBBA Rules: With the new $15 million cap, only the remaining $5 million gain is taxed, dropping the tax liability to $1.19 million.
The Takeaway: By properly qualifying under the new OBBBA rules, the founder saves over $3.5 million in total federal taxes compared to a standard sale. The OBBBA amendment alone puts an additional $1.19 million in cash directly into the founder’s pocket upon exit compared to the old rules.
(Note: This illustration is simplified and assumes the maximum 20% federal capital gains rate plus the 3.8% Net Investment Income Tax. Actual tax liabilities will vary based on individual tax brackets, state income taxes, and AMT considerations.)
1. Core Eligibility
To qualify for QSBS benefits, both the company and the shareholder must satisfy strict criteria.
A. The Company
- Entity Type: Must be a domestic C corporation. It cannot have previously been an S corporation (see Part 2 of this series for planning details/exceptions), DISC, Section 936 corporation, REIT, REMIC, or cooperative.
- Qualified Business: The corporation must operate a qualified business activity. Excluded businesses generally fall into two categories:
- Service-based businesses: Health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or any trade where the principal asset is the reputation or skill of its employees.
- Specific industries: Banking, insurance, financing, leasing, investing, farming, oil and gas extraction, hotels, restaurants, and certain real estate activities.
- Gross Asset Test: The corporation’s aggregate gross assets must not exceed $50 million before and immediately after the stock issuance. For stock issued after July 4, 2025, this threshold increases to $75 million (with inflation indexing beginning in 2027). Exceeding the threshold later does not disqualify previously issued QSBS, but it prevents future issuances from qualifying.
- Active Business Requirement: At least 80% (by value) of the corporation’s assets must be used in the active conduct of a qualified trade or business for substantially all of the shareholder’s holding period. This test is highly fact-specific; measuring fair market value requires ongoing analysis of internal goodwill, excess cash, non-operating real estate, and portfolio stock.
B. The Shareholder
- Original Issuance: The stock must generally be acquired directly from the company (at original issuance) in exchange for cash, services, or property.
- Eligible Taxpayers: The shareholder cannot be a C corporation. Eligible owners include individuals, trusts, LLCs, partnerships, and S corporations. Pass-through entities face additional limitations based on who owned the entity at the time the QSBS was both acquired and sold.
C. Acquisition Dates & Exclusion Rates
The shareholder’s acquisition date dictates the potential tax benefit. The OBBBA introduced a staggered exclusion concept for newer stock issuances.
| Acquisition Date | Required Holding Period | Exclusion Percentage |
| Before Aug 10, 1993 | N/A | 0% |
| Aug 11, 1993 – Feb 17, 2009 | 5 years | 50% |
| Feb 18, 2009 – Sept 27, 2010 | 5 years | 75% |
| Sept 28, 2010 – July 4, 2025 | 5 years | 100% |
| Post-July 4, 2025 (OBBBA) | 3 years | 50% |
| Post-July 4, 2025 (OBBBA) | 4 years | 75% |
| Post-July 4, 2025 (OBBBA) | 5 years | 100% |
This wraps up Part 1 of our QSBS series. In Part 2, we will dive into advanced structuring strategies, including the tax mechanics and key considerations involved in converting LLCs and S corporations into C corporations to position shareholders for potential eligibility for the Section 1202 gain exclusion.
If you have any questions or are interested in learning more, we are here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
