OBBBA made three significant changes to IRC §1202 Qualified Small Business Stock exclusion - the first material modernization since 2010 when the 100% exclusion was permanently locked in. All three changes apply ONLY to QSBS issued AFTER July 4, 2025. Stock issued on or before July 4, 2025 remains subject to pre-OBBBA rules (binary 5-year holding period, $10M gain cap, $50M aggregate gross asset threshold) regardless of when it is later sold. Three changes for post-OBBBA stock: (1) the binary "more than 5 years" holding period was replaced with a TIERED graduated exclusion - 50% at 3+ years, 75% at 4+ years, 100% at 5+ years; (2) the per-issuer dollar gain cap increased from $10,000,000 to $15,000,000 (inflation-indexed beginning 2027); (3) the aggregate gross asset threshold increased from $50,000,000 to $75,000,000 (also inflation-indexed beginning 2027). The 10× basis alternative cap remains - so on $75M gross assets, theoretical maximum exclusion could approach $750M. CRITICAL TRAP: gain not excluded under the 3-year (50%) or 4-year (75%) partial exclusion is taxed at 28%, NOT the standard 15%/20% long-term capital gain rate. The §1202(i) rule prevents converting pre-OBBBA stock to post-OBBBA treatment through §351 exchanges or §368 reorganizations - the issuance date controls. Section 1045 rollover remains available to defer gain on QSBS held less than 5 years.
Applies to: Stock issued AFTER July 4, 2025. Pre-7/4/2025 stock keeps old rules forever.
Change 1 - Tiered holding period: 50% exclusion at 3+ years; 75% at 4+ years; 100% at 5+ years (was binary 100% at 5+ years).
Change 2 - Gain cap raised: $15M per issuer (was $10M). Inflation-indexed starting 2027.
Change 3 - Gross asset threshold raised: $75M (was $50M). Inflation-indexed starting 2027.
10× basis alternative: Unchanged - greater of dollar cap OR 10× adjusted basis applies.
28% rate trap: Non-excluded portion at 3-year (50% remaining) or 4-year (25% remaining) holding taxed at 28% (not 15%/20%).
§1202(i): Pre-OBBBA stock exchanged in §351 or §368 transaction RETAINS pre-OBBBA treatment - cannot upgrade.
| Requirement | Detail |
|---|---|
| (1) Issuer is domestic C-corporation | NOT S-corporation, NOT LLC, NOT partnership, NOT foreign corporation. Must have been C-corp at time of stock issuance AND must remain C-corp throughout holding period (any S-corp election disqualifies). |
| (2) Original issuance to taxpayer | Stock acquired DIRECTLY from issuing corporation (not secondary market). Acquired in exchange for money, property (other than stock), or services. §1202(c)(1)(B). |
| (3) Aggregate gross asset threshold | Pre-OBBBA: ≤ $50M immediately before AND immediately after stock issuance. Post-OBBBA: ≤ $75M. Gross assets = cash + adjusted basis of other property; FMV used only for contributed property at time of contribution. |
| (4) Active business requirement (80% asset test) | At least 80% of corporation's assets used in qualified trade or business throughout substantially all of taxpayer's holding period. §1202(c)(2)(A); §1202(e). |
| (5) Qualified trade or business | §1202(e)(3) defines by EXCLUSION - health, law, engineering, architecture, accounting, actuarial, performing arts, consulting, athletics, financial services, brokerage services, hospitality (hotels, motels, restaurants), farming, mining, banking, insurance EXCLUDED. |
| (6) Holding period - new tiered for post-OBBBA | Pre-OBBBA: more than 5 years for full 100% exclusion (binary). Post-OBBBA: 3 years (50%) / 4 years (75%) / 5 years (100%). |
| (7) Noncorporate taxpayer (eligible holder) | Individuals, trusts, estates qualify. C-corporations CANNOT claim exclusion. S-corporation and partnership shareholders use look-through. |
| (8) No disqualifying redemptions | Corporation has not redeemed stock from taxpayer or related person within 2 years before/after issuance (significant ownership reduction). Aggregate redemptions ≤ 5% in 1 year before/after issuance. §1202(c)(3). |
| Holding Period | Pre-OBBBA Exclusion (Stock issued ≤ 7/4/2025) | Post-OBBBA Exclusion (Stock issued > 7/4/2025) |
|---|---|---|
| Less than 3 years | 0% | 0% (consider §1045 rollover) |
| 3+ years but less than 4 years | 0% | 50% exclusion |
| 4+ years but less than 5 years | 0% | 75% exclusion |
| 5+ years | 100% (acquired after 9/27/2010); 75% (acquired 2/18/2009-9/27/2010); 50% (acquired before 2/18/2009) | 100% |
Section 1(h)(4) imposes a 28% maximum rate on §1202 gain (the "section 1202 gain" category). The non-excluded portion of the gain (50% at 3-year hold, 25% at 4-year hold) is taxed at 28% federal capital gain rate - NOT the standard 15% or 20% long-term capital gain rates. Compared to a regular long-term capital gain at 20% + 3.8% NIIT = 23.8%, the §1202 partial-exclusion treatment can be effectively WORSE than a plain capital gain for some taxpayers near the top of the 20% LTCG bracket.
Facts: Founder issued QSBS after 7/4/2025. $2,000,000 gain at sale in year 3 (50% exclusion).
Exclusion: $1,000,000 excluded under §1202(a).
Taxable portion: $1,000,000.
Federal capital gain tax at 28%: $280,000.
Plus 3.8% NIIT on taxable portion: $38,000 (assuming income above NIIT threshold).
Total federal tax: $318,000.
Compare - waiting 2 more years for 100% exclusion: $0 federal tax on the $2M gain.
Compare - if this were ordinary LTCG (not §1202): $2M × 23.8% = $476,000. So 3-year §1202 at 50% still beats plain LTCG.
Lesson: Tier 1 (50% exclusion + 28% on remainder) saves taxes vs plain LTCG, but the math strongly favors waiting to year 5 for 100% exclusion when feasible.
| Cap Component | Pre-OBBBA | Post-OBBBA |
|---|---|---|
| Flat dollar cap per issuer | $10,000,000 (reduced by prior year exclusions for same issuer) | $15,000,000 (inflation-indexed 2027+) |
| 10× basis alternative | 10× aggregate adjusted basis of QSBS sold during tax year | Same - 10× basis |
| Greater of | Taxpayer uses the GREATER of flat cap or 10× basis | Same |
| MFS adjustment | $5M MFS (half of $10M) | $7.5M MFS at 5-year hold; $5.625M MFS at 4-year hold; $3.25M MFS at 3-year hold (because the flat cap applies to total exclusion, halved for MFS) |
| Spouse aggregation | Married couples share the per-issuer cap (cannot double) | Same |
| Multi-issuer stacking | Each issuer has its own $10M cap (gift to trusts/family multiplies) | Each issuer has its own $15M cap |
For taxpayers with high basis (large investment), the 10× basis alternative often exceeds the flat $15M cap. With the $75M gross asset threshold, theoretical maximum exclusion per issuer can approach $750M (10× a near-$75M basis stock issuance).
| Investment | 10× Basis Cap | vs $15M Flat Cap | Effective Cap |
|---|---|---|---|
| $100,000 founder stock | $1,000,000 | Use flat cap | $15,000,000 |
| $1,000,000 angel investment | $10,000,000 | Use flat cap | $15,000,000 |
| $2,000,000 investment | $20,000,000 | Use 10× basis | $20,000,000 |
| $10,000,000 investment | $100,000,000 | Use 10× basis | $100,000,000 |
| $50,000,000 investment | $500,000,000 | Use 10× basis | $500,000,000 |
| Aspect | Pre-OBBBA | Post-OBBBA |
|---|---|---|
| Threshold | $50,000,000 | $75,000,000 |
| Test timing | Immediately BEFORE and immediately AFTER stock issuance | Same |
| Computation | Cash + adjusted basis of property + FMV of contributed property at contribution date | Same |
| Inflation indexing | None | Annual inflation indexing beginning tax years after 2026 |
| Effect of OBBBA §174A R&D expensing | R&D capitalized over 5 years could push some startups over $50M threshold | R&D now expensed; reduces capitalized assets; some companies may stay under $75M longer; could re-cross threshold |
| Strategic effect | Many Series A/B companies exceeded $50M | $75M ceiling allows more companies to issue QSBS at later funding rounds |
Taxpayers cannot upgrade pre-OBBBA stock to post-OBBBA treatment via §351 exchange or §368 reorganization. The issuance date is fixed - exchanging old QSBS for new QSBS doesn't reset the rules.
| Scenario | Treatment |
|---|---|
| Pre-7/4/2025 QSBS exchanged in §351 for new corporation stock 2026 | New stock retains pre-OBBBA $10M cap, $50M threshold, 5-year binary holding period |
| Pre-7/4/2025 QSBS in §368 tax-free reorganization 2027 | Successor stock retains pre-OBBBA treatment |
| §1045 rollover of pre-OBBBA QSBS | Replacement QSBS may qualify under POST-OBBBA rules if newly-issued by qualifying small business after 7/4/2025 (separate path, but Treasury guidance pending) |
| Tacking pre-OBBBA holding period to new stock via §1045 | Generally permitted to tack holding period for §1202 purposes |
| §1045 Rollover Mechanic | Detail |
|---|---|
| Election | Taxpayer can elect to defer gain on QSBS held more than 6 months but less than 5 years |
| Reinvestment window | 60 days from sale to invest in replacement QSBS |
| Effect | Gain deferred; holding period tacks from original QSBS to replacement |
| Application post-OBBBA | Taxpayer with pre-OBBBA QSBS sold at year 4 (no exclusion under old rules) can rollover into post-OBBBA QSBS, eventually reach 5-year hold on replacement for 100% exclusion |
| Election mechanics | Made on tax return for year of sale; specific identification of replacement stock |
The per-issuer cap is PER TAXPAYER. Sophisticated planning multiplies exclusion through gifts to family members or non-grantor trusts before sale event.
| Stacking Strategy | Mechanism |
|---|---|
| Gift to spouse before sale | NOT additive - married couples share the per-issuer cap |
| Gift to adult children | Each child gets own $15M cap; potential to multiply exclusion across generations |
| Gift to non-grantor trust | Trust has its own $15M cap if treated as separate taxpayer; trust situs in no-income-tax state (Alaska, Delaware, Nevada, South Dakota, Wyoming) avoids state tax on excluded gain |
| Gift before maturity | Donee tacks donor's holding period under §1202(h); 100% exclusion preserved at 5-year mark for donee |
| Multiple non-grantor trusts | Each trust has its own $15M cap; 5 trusts × $15M = $75M aggregate exclusion vs $15M without stacking |
| Gift tax implications | Gifts use lifetime exemption ($15M under OBBBA effective 2026); careful coordination required |
| State Position | States (verify annually) |
|---|---|
| Full conformity to federal §1202 | Most rolling-conformity states |
| No conformity - full state tax on gain | Alabama, California, Mississippi, New Jersey, Pennsylvania |
| Partial conformity | Hawaii, Massachusetts |
| Partial conformity - other | New York (selective) |
| Trust situs strategy | Non-grantor irrevocable trusts in no-income-tax states (AK, DE, NV, SD, WY) can avoid state tax on QSBS gains even when grantor lives in non-conforming state |
OBBBA §174A restored immediate domestic R&D expensing for tax years beginning after 12/31/2024. This affects the §1202 gross asset calculation - R&D expenses no longer capitalized inflate gross assets.
| Pre-OBBBA (2022-2024) | Post-OBBBA (2025+) |
|---|---|
| R&D capitalized over 5 years under TCJA §174 | R&D fully expensed under §174A (domestic) |
| Capitalized R&D increased gross assets | Lower gross assets after R&D expensing |
| Some companies crossed $50M threshold faster | More companies stay under $75M threshold longer |
| QSBS issuance windows narrower | QSBS issuance windows wider; can re-cross threshold if assets shrink |
Even if other §1202 requirements are met, the active business test fails if the issuer is in a specified service trade or business. The OBBBA did NOT change this list.
| Excluded Business (CANNOT issue QSBS) |
|---|
| Health, law, engineering, architecture, accounting, actuarial science |
| Performing arts, consulting, athletics, financial services, brokerage services |
| Any business whose principal asset is the reputation or skill of one or more employees |
| Banking, insurance, financing, leasing, investing, similar |
| Farming (including raising/harvesting) |
| Production or extraction of products listed in §613 or §613A (mining) |
| Hotels, motels, restaurants, similar (hospitality) |
The most common error: failing to track issuance date by tranche. A founder holding stock issued in 2024 AND 2026 has two different sets of rules. Pre-2025 tranche: $10M cap, $50M threshold, 5-year binary. Post-7/4/2025 tranche: $15M cap, $75M threshold, tiered. Track each tranche separately.
Founders thinking "50% exclusion is great" may sell at 3 years without realizing the non-excluded $1M is at 28% (not 20%). For high-income taxpayers, the math may favor §1045 rollover plus waiting to 5 years for 100% exclusion.
LLC stock does NOT qualify as QSBS. Only stock issued by a C-corporation qualifies. Many startups begin as LLCs for operational flexibility. Convert to C-corp BEFORE significant value accumulates - QSBS clock starts from C-corp stock issuance, not LLC formation.
If the corporation elects S-corp status at any point during the holding period, the §1202 exclusion is lost for all stock previously issued. Counsel clients with QSBS to avoid S-elections.
§1202(c)(3) disqualifies stock if corporation redeemed stock from taxpayer (or related person) within 2 years before OR after issuance (significant ownership reduction). Company buybacks, tender offers, founder share repurchases require QSBS analysis.
§1202 gain (non-excluded portion) is taxed at 28% under §1(h)(4) - NOT the standard 15%/20% LTCG rate. This is a §1202-specific category. Software using default LTCG rate produces incorrect tax.
Pre-OBBBA QSBS exchanged in §351 or §368 transaction does NOT upgrade to post-OBBBA treatment. Practitioners advising on reorganizations need to identify §1202 stock and preserve issuance-date treatment.
Each non-grantor irrevocable trust is a separate taxpayer with its own $15M cap. Sophisticated planning multiplies the exclusion. Carefully structured stacking can convert $15M of exclusion into $75M+ across multiple trusts.
California, New Jersey, Pennsylvania, Alabama, Mississippi do NOT conform to federal §1202. Full state tax owed on gains federally excluded. Trust situs in no-income-tax states (AK, DE, NV, SD, WY) can avoid state tax.
80% of corporate assets must be used in qualified trade or business throughout substantially all of holding period. Excess cash from large funding round can fail the test. Working capital exclusion limited. Monitor periodically.
§1202(e)(3) specified service trades or businesses are excluded. Health-tech, fintech (financial services aspect), law-tech, accounting-tech companies must analyze carefully whether they are excluded SSTBs vs technology companies.
60-day reinvestment window is strict. Practitioners must counsel founders considering exit on §1045 availability BEFORE the sale closes. Post-sale reinvestment beyond 60 days forfeits §1045.
Primary authority: IRC §1202 (Partial exclusion for gain from certain small business stock). §1202(a) (general exclusion - 100% for stock acquired after 9/27/2010 under pre-OBBBA; tiered 50%/75%/100% for stock issued after 7/4/2025 under OBBBA). §1202(a)(1) (general 50% exclusion). §1202(a)(3) (75% exclusion for stock acquired 2/18/2009 - 9/27/2010 pre-OBBBA; 4-year holding tier under OBBBA). §1202(a)(4) (100% exclusion for stock acquired after 9/27/2010 pre-OBBBA; 5-year holding tier under OBBBA). §1202(b) (per-issuer gain limitation). §1202(b)(1) (general limitation - greater of $10M or 10× basis pre-OBBBA). §1202(b)(4) (NEW under OBBBA - $15M flat cap; inflation-indexed beginning 2027). §1202(c) (definition of qualified small business stock). §1202(c)(1)(B) (original issuance requirement). §1202(c)(2)(A) (active business requirement - 80% test). §1202(c)(3) (anti-churning - 2-year redemption lookback/lookforward). §1202(d) (qualified small business definition - $50M gross asset threshold pre-OBBBA; $75M post-OBBBA). §1202(e) (active business requirement detail). §1202(e)(3) (specified service trade or business exclusion - health, law, accounting, performing arts, consulting, athletics, financial services, brokerage, hotels, restaurants, farming, mining, banking, insurance). §1202(h) (treatment of certain transfers - gift recipients tack donor's holding period). §1202(i) (rule for §351 and §368 exchanges - successor stock retains issuance-date treatment; PRE-OBBBA stock cannot upgrade to POST-OBBBA via reorganization). §1202(k) (regulations). §1045 (rollover of gain on QSBS sold within 60 days of replacement QSBS purchase). §1(h)(4) (28% maximum rate on section 1202 gain - applies to non-excluded portion under partial exclusion). §1411 (Net Investment Income Tax 3.8% on non-excluded §1202 gain for high-income taxpayers). §351 (transfers to controlled corporation). §368 (corporate reorganizations). §448(c) ($31M gross receipts test - related to small business taxpayer determinations under OBBBA §174A). §174A (R&D expensing under OBBBA - interacts with §1202 gross asset threshold calculations). One Big Beautiful Bill Act, P.L. 119-21, §70431 (§1202 amendments effective for stock issued after July 4, 2025; pre-7/4/2025 stock retains pre-OBBBA treatment). Form 8949 (sale reporting). Schedule D. Form 1099-B.