New Tax Legislation Enhances Benefits of Qualified Small Business Stock

Changes to the tax treatment of Qualified Small Business Stock (QSBS) have emerged from recent legislation, enhancing its benefits for investors and startup founders. The new provisions, part of the One Big Beautiful Bill Act (OBBBA) enacted on July 4, 2025, significantly expand the potential exclusions for capital gains on sales of QSBS. This move is designed to stimulate investment in small businesses and support entrepreneurs.

Qualified Small Business Stock, as defined under Section 1202 of the Internal Revenue Code of 1986, allows eligible non-corporate taxpayers to exclude a portion or all of the gain from the sale of shares held for a minimum period. The OBBBA increases the exclusion limit from $10 million to $15 million for stock acquired after the legislation’s enactment, with inflation adjustments planned for 2027.

Key Requirements for QSBS Status

To qualify as QSBS, several criteria must be met. First, the business must be incorporated as a U.S. C corporation. Additionally, the corporation’s aggregate gross assets must not exceed $50 million at any time from August 10, 1993, until just after stock issuance. Under the new legislation, this threshold is raised to $75 million, effective after July 4, 2025.

Moreover, the corporation must utilize at least 80 percent of its assets in a qualified trade or business for most of the holding period. Certain businesses, including professional services and finance, are excluded from this designation. Stockholders must acquire QSBS directly from the corporation at the time of issuance to maintain its status.

The holding period for QSBS has specific requirements. Stock issued on or before July 4, 2025, must be held for at least five years to qualify for the capital gain exclusion. For shares acquired after this date, different percentages of exclusion apply based on the duration of the holding period. For stock held for three years, 50 percent of capital gains can be excluded; for four years, 75 percent; and for five years, 100 percent remains exempt.

Strategies for Estate Planning with QSBS

A significant advantage of QSBS is its transferability, allowing holders to pass on the capital gain exclusion to heirs and trusts. Under Section 1202(h), a transferee of QSBS through gift or death is treated as having acquired the stock in the same manner as the original holder, preserving the advantageous tax treatment.

Strategically gifting QSBS to family members or irrevocable non-grantor trusts can maximize tax exclusion benefits. Each recipient can potentially claim their own capital gain exclusion, effectively multiplying the tax-free gain across multiple family members or trusts. However, caution is necessary; the Internal Revenue Service may view multiple trusts with similar grantors and beneficiaries as a single entity for tax purposes, which could negate the intended tax benefits.

Moreover, transferring QSBS to a partnership may result in the loss of its status. Therefore, care must be taken when structuring such transfers to ensure compliance with QSBS requirements.

Maintaining QSBS status during mergers and acquisitions is also possible with careful planning. In a tax-free reorganization, if the acquiring corporation’s stock qualifies for QSBS and is exchanged for shares of a target corporation, the QSBS status can be preserved. The holding period of the original stock can carry over to the new shares, provided certain conditions are met.

In conclusion, the recent enhancements to QSBS under the OBBBA present valuable opportunities for investors and business owners aiming to maximize their tax benefits. However, the complexities surrounding compliance and transfer rules necessitate thorough consultation with tax and estate planning professionals. Understanding these nuances is essential to navigating the advantages of QSBS while avoiding potential pitfalls.