Article

Changes to section 1202, Qualified Small Business Stock, in the One Big Beautiful Bill Act

July 15, 2025 · Authored by Benjamin M. Willis

On July 4, 2025, President Trump signed the One Big Beautiful Bill Act (the Act[P.L. 119-21]) into law. The Act introduces several changes to IRC section 1202 that broaden the availability of Qualified Small Business Stock (QSBS) benefits to eligible shareholders and expand the amount of gain that can be excluded.

Background

Section 1202 permits eligible shareholders of stock in certain C corporations to potentially exclude from gross income up to 100% of their gain from the sale or exchange of QSBS. To qualify, there are certain shareholder and corporate level requirements that need to be met, including the original issuance requirement, the gross assets test and the active business test, which require careful measurement during the shareholder’s entire holding period, and, in some instances, before the stock is even acquired.

The Act

The Act makes several changes to section 1202 benefiting investors of QSBS acquired after July 4, 2025, including reduced holding period requirements, broadened eligibility thresholds and increases to the per-issuer cap on eligible gains that can be excluded from tax. Below is more detailed information.

Reduction of holding period with graduated benefits

Under prior law, for QSBS acquired on or before July 4, 2025, QSBS was required to be held for more than five years to qualify for gain exclusion. The amount of gain that could be excluded upon selling or exchanging QSBS depended on when the shares were acquired. For shares acquired for cash before Feb. 18, 2009, 50% of the gain could be excluded; 75% could be excluded for shares acquired for cash after Feb. 17, 2009, and before Sept. 28, 2010; and 100% could be excluded for shares acquired after Sept. 27, 2010.

For QSBS acquired after July 4, 2025 (the applicable date), the Act reduces the holding period requirement to three years and introduces a tiered benefit structure:

• QSBS held for three years: 50% exclusion
• QSBS held for four years: 75% exclusion
• QSBS held for five years or more: 100% exclusion

Consider: Taxpayers are no longer required to hold QSBS for more than five years to exclude gains on QSBS acquired after the applicable date, although the benefit is greater if held for five years or more.

Increase in aggregate gross asset test threshold

Under prior law, the aggregate gross assets of a qualified small business cannot exceed $50 million at all times before and immediately after issuance. The term aggregate gross assets means the amount of cash and adjusted basis of other property held by the corporation, except for the adjusted basis of contributed property, which is deemed to be equal to the property’s fair market value.

For stock issued after July 4, 2025, the Act increases the aggregate gross asset threshold to $75 million with annual adjustments for inflation for tax years beginning after 2026.

Consider: Raising the aggregate gross asset threshold by $25 million broadens section 1202 eligibility and will consequently increase the number of corporations that can be considered a qualified small business. See below about how the raised threshold provides opportunities for increased gain exclusion under the 10x basis limitation.

Increases to the per issuer limitation

Under prior law, the aggregate amount of gain that could be excluded under section 1202 could not exceed the greater of (A) $10 million, reduced by any gain excluded by the taxpayer in the same corporation in prior years (the $10 million limitation), or (B) 10 times the taxpayer’s adjusted basis in the stock that was disposed of (the 10x basis limitation).

For QSBS acquired after July 4, 2025, the Act increases the $10 million limitation from $10 million to $15 million, subject to reduction for amounts previously or concurrently excluded under section 1202. For tax years beginning after 2026, the $15 million per issuer limitation will be adjusted annually for inflation.

While the Act did not affect the 10X basis limitation, the expanded aggregate gross asset threshold of $75 million, as discussed in above, consequently increases the gain exclusion to a potential maximum of $750 million.

The Act additionally clarifies that the $10 million limitation for a married individual filing separately is one-half the adjusted limit in effect for the tax year. Thus, for shares acquired on or before July 4, 2025, the limitation is $5 million (same as prior law). For shares acquired after July 4, 2025, and held for three, four or five years, the limitation is $3.25 million, $5.625 million and $7.5 million, respectively.

Consider: For QSBS acquired after the effective date, the Act increases the $10 million limitation referenced above to $15 million, adjusted for inflation for years after 2026.

Furthermore, gain exclusions determined by the 10x basis limitation can be significantly greater due to the expanded aggregate gross asset threshold – potentially, a maximum of $750 million, or 10 times the maximum aggregate tax basis of $75 million in QSBS under the new rule. This is $250 million greater than the $500 million maximum potential exclusion eligible under the prior rules, calculated as 10 times a maximum stock basis limited to $50 million.

Recognition of foreign research expenditures

The active business requirement is broadened to include not only domestic but also foreign research and experimental expenditures. Specifically, qualifying activities now include those treated as foreign research or experimental expenditures under section 174, or domestic research or experimental expenditures under section 174A.

Consider: In addition to increasing the threshold to $75 million, more corporations are expected to meet the aggregate gross asset test because of the Act’s changes that permit the expensing of domestic research and experimentation (R&E) expenditures in lieu of mandatory capitalization. The Act also specifies that both domestic and foreign R&E activities qualify under the active business test.

What’s next?

Notably, the Act did not scale back or otherwise limit existing strategies taxpayers have been using to structure into QSBS eligibility and/or maximize their gain exclusions. On the contrary, the Act’s changes may have created new avenues for proactive and properly executed tax planning.

Due to the decreased tax burden associated with acquiring, holding and disposing of QSBS, it is more important than ever to consult with your tax advisor regarding eligibility and qualification for QSBS benefits. Notably, the Act does not resolve ambiguities in section 1202, and it is still possible to fail one or more requirements and inadvertently disqualify the stock. With more to gain, there is also more to lose.

If you have questions about how this may impact your tax situation, please reach out to your Baker Tilly tax advisor.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.