As the year draws to a close, taxpayers and investors should consider how the One Big Beautiful Bill Act (the Act) (P.L. 119-21) — signed into law July 4, 2025 — may open new opportunities for tax-favored exits and investment strategies under section 1202. The Act’s expanded definitions and thresholds mean that more corporations may now qualify as “qualified small businesses,” and more shareholders may benefit from gain exclusions when selling Qualified Small Business Stock (QSBS).
Year-end is an ideal time to assess eligibility and confirm that corporate capitalization, share issuance and recordkeeping align with the new $75 million gross-asset ceiling and other QSBS requirements. Investors considering late-year capital infusions or founders planning new equity rounds should evaluate whether to structure those issuances to qualify for QSBS treatment beginning in 2026.
Finally, with the reduced holding-period requirements (three, four and five years for 50%, 75% and 100% exclusions, respectively), taxpayers acquiring QSBS before Dec. 31, 2025, can begin their three-year clocks immediately. Taking action before year-end could make a meaningful difference in timing future gain exclusions and optimizing exit strategy planning.
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 but not limited to 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: (1) reduced holding period requirements, (2) broadened eligibility thresholds and (3) increases to the per-issuer cap on eligible gains that can be excluded from tax. Below is more detailed information.
1. Reduction of holding period with graduated benefits
Under prior law, 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.
These rules still apply to QSBS acquired on or before July 4, 2025.
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; and
QSBS held for five years or more: 100% exclusion.
Planning consideration: 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.
2. 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.
These rules still apply to QSBS issued on or before July 4, 2025.
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.
Planning consideration: Raising the aggregate gross asset threshold by $25 million broadens 1202 eligibility and will consequently increase the number of corporations that can be considered a qualified small business. Also, see below about how the raised threshold provides opportunities for increased gain exclusion under the “10X Basis Limitation.”
3. 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).
These rules still apply to QSBS acquired on or before July 4, 2025.
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 section two 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.
Planning consideration: 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.
4. 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.
Planning consideration: 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.
Example of enhanced benefits
Suppose a taxpayer purchases QSBS on April 1, 2026, for cash. The taxpayer sells the stock on Oct. 1, 2030, holding it for four and a half years. The total gain on the sale is $20 million. The taxpayer has not previously used any QSBS exclusion for stock in this corporation. Since the stock was held for at least four years (but less than five years), 75% of the gain may be excluded, or $15 million. Since this amount does not exceed the per issuer limitation of $15 million, the full amount may be excluded, resulting in over $3.5 million in federal income tax savings (assuming a 23.8% federal income tax rate and ignoring state tax impacts).
Note, if the stock instead had been acquired for cash on April 1, 2025, and held for four and a half years, none of the gain would be eligible for exclusion because the stock was not held for at least five years. If the stock was acquired for cash on April 1, 2025, and sold after five years, the taxpayer would only be able to exclude $10 million, because that was the pre-issuer limitation in place for the stock. The changes and exclusion amounts are based on when the stock was acquired, not when it was sold.
Next steps
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 increased tax savings 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 on how the provisions outlined above may impact your tax situation, please contact 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.
