This is the third and final installment in our multi-part series exploring the key implications of the One Big Beautiful Bill Act (OBBBA). This follows parts 1 and 2 of this series which discussed the no tax on tips and overtime provisions, SALT deduction, PTET Credit, and the excise tax on compensation for nonprofits. These issues were also discussed in our OBBBA webinar held on July 24, 2025 shortly after the bill went into effect. This article will discuss the expanded qualified small business stock (QSBS) provisions.
Overview of QSBS
To promote investment and innovation, in 1993 Congress enacted section 1202, which allows noncorporate founders and investors an exclusion of their capital gain on the sale of their QSBS in a qualified small business (QSB), as long as the corporation satisfies the QSB requirements and they meet the required holding period. To qualify for the exclusion, the QSBS must be acquired by either (i) an original issuance for money, property, or services provided to the QSB, (ii) by gift or inheritance; (iii) distribution of QSBS from a partnership to a noncorporate taxpayer; or (iv) in a tax deferred transaction from the original holder of the QSBS.[1] A QSB is a domestic C corporation that meets the Gross Asset Test (defined below) at all times leading up the issuance of the QSBS and immediately after the issuance.[2] During the holding period the QSB must have satisfied the Active Business Requirement through using at least 80% (by value) of its assets in the active conduct of a qualifying trade or business.
Section 1202(e)(3) provides that a qualified trade or business is any trade or business other than those involving the performance of services in certain industries, such as health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, farming, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
The OBBBA has made significant expansions to the QSBS rules for stock acquired after July 4, 2025 (the enactment date for the OBBBA). The prior rules are still in effect for QSBS acquired prior to July 4, 2025.
Below is a table that summarizes the changes the OBBBA made to the above rules.
Key Takeaways and Concluding Thoughts
This is a big development for investors, founders, and employees of QSB’s. The OBBBAs revamp of the QSBS rules enables investors to have an earlier liquidity event. Although the amount of capital gain that can be excluded for selling before 5 years is phased down, it is no longer a zero-sum game as it was before. For taxpayers that sell their QSBS at any of the holding periods under the OBBBA, can avoid the gain being an alternative minimum tax (AMT) preference item and thus avoid the AMT burdens. The expansion of the Gross Asset Test and gain limitation are also beneficial for owners of QSBS.
Despite these positive developments, there are still hurdles for taxpayers to meet under the QSBS rules, such as whether the QSB is engaged in a qualified trade or business, satisfying the original issuance requirements, and planning for any redemptions and their effects on the QSBS status. Furthermore, any gains not excluded in connection with sales of QSBS for 3- or 4-year holding periods will be taxed at the 28% capital gains rate rather than the normal 20% rate. As of the time of writing this article, states such as California, New Jersey, and Pennsylvania have not yet conformed to the expanded QSBS rules.
One added benefit is that taxpayers can still utilize a §1045 rollover of the gain on the sale of the QSBS held for 3 and 4 years, provided the proceeds are reinvested in another QSBS within 60 days of the sale. Recordkeeping will be important for substantiating any QSBS gain exclusion reported on the taxpayer’s tax return, in order to reduce risk of audit by the IRS.
[1] IRC §1202(c)(1)(B); IRC §1202(h)(2) and (h)(4).
[2] IRC §1202(d).
[3] For taxpayers that file married filing separate, the applicable cap is $5 million for QSBS acquired before the OBBBA was enacted and $10 million (indexed for inflation) after July 4, 2025 respectively.
[4] Aggregate Gross Assets means the amount of cash and the adjusted tax bases of other property held by the issuing corporation at the time of contribution.
