Qualified Small Business Stock Exclusion Enhanced by Recent Legislation

The recently enacted “One Big Beautiful Bill Act” significantly expanded the benefits of IRC Sec. 1202 and relaxed certain requirements. These changes are not retroactive and are effective for stock acquired after the legislation was enacted. IRC Sec. 1202 generally permits taxpayers to exclude capital gain from the sale of qualified small business stock (QSBS) from federal gross income. 

The changes to IRC Sec. 1202 offer a unique opportunity to leverage tax benefits, enhance investment flexibility, and expand investors’ target acquisition strategies.  Staying informed and consulting with experts will be crucial for maximizing the advantages these changes may bring. 

Specifically, the legislation makes the following changes for stock issued after the date of enactment (that is, after July 4, 2025): 

• Increases the gross asset test from $50 million to $75 million, adjusted annually for inflation starting in 2027.   
  • This expands the reach of IRC Sec. 1202 to more targets.  Any target up to $75 million of gross assets may now qualify.  
    
    
• Increases the lower gain exclusion amount from $10 million to $15 million ($7.5 million per individual if married filing separately), adjusted annually for inflation starting in 2027.   
  • The upper limit of ten times the taxpayer’s tax basis is still available.  
    
    
• Allows taxpayers to claim reduced benefits if the stock is held for less than five years.   
  • Previously, a taxpayer must have held the stock for more than five years before sale to claim benefits under IRC Sec. 1202.  
  • The changes allow taxpayers to claim a 50% exclusion after holding the stock for three years, a 75% exclusion after holding the stock for four years, and the 100% exclusion after holding the stock for five or more years.
    
    • Non-excluded gain is generally subject to the federal income tax at the rate of 28%, as well as the net investment income tax at the rate of 3.8%.   

Planning Opportunities: 

• Targets up to $75 million do not have to engage in right-sizing.
   
• Targets above $75 million can still qualify with properly structured right-sizing.   
  
  
• Relaxed holding period requirements give taxpayers more flexibility regarding timing of QSBS investment exit.   
  
  
• Increase in the lower gain exclusion amount to $15 million enhances the tax savings impact of gifting and intra-family transfers.   
  
  
• IRC Sec. 1045 nonrecognition treatment remains available where sales proceeds do not qualify for an exclusion under IRC Sec. 1202 and are reinvested into a new QSBS, provided the holding period is more than six months. 

In light of these legislative changes, we strongly recommend that you contact one of our IRC Sec. 1202 experts if you are considering acquiring a target with the intention of qualifying for IRC Sec. 1202 benefits or are generally looking at targets around $75 million. Contact us below to see how we can assist.