Section 1202 QSBS Update: Major Tax Savings Opportunities for Entrepreneurs and Investors
- pscdfw
- Aug 11
- 3 min read
Section 1202 of the Internal Revenue Code provides one of the most powerful tax incentives available to entrepreneurs, investors, and business owners. Commonly referred to as the Qualified Small Business Stock (QSBS) exclusion, it allows taxpayers to exclude a significant portion — and in many cases, all — of the gain from the sale of qualifying stock in a C corporation.
When structured correctly, this can mean multi-million-dollar tax savings at the time of exit for founders, early investors, and even employees with stock grants.
What Is QSBS and Who Qualifies?
To qualify for the Section 1202 benefit:
Original issuance – The stock must be issued directly by a domestic C corporation (not purchased from another shareholder).
Small business requirement – The corporation must be a qualified small business, generally with $50 million or less in gross assets at the time of issuance (this threshold increases to $75 million for stock issued on or after July 5, 2025).
Holding period – The stock must be held for the required period (historically 5 years, now reduced for partial exclusions under new rules).
Active business requirement – The corporation must actively operate a qualified trade or business, excluding certain service-based industries like accounting, law, and consulting.
When these requirements are met, gain on the sale of QSBS can be excluded from federal income tax up to the applicable per-taxpayer, per-issuer limit.
New Legislative Changes – One Big Beautiful Bill Act (OBBBA)
Recent changes under the One Big Beautiful Bill Act (OBBBA) have expanded both the value and accessibility of QSBS benefits:
Increased gain exclusion cap – For QSBS issued on or after July 5, 2025, the per-taxpayer, per-issuer exclusion rises from $10 million to $15 million (or 10× basis), with inflation adjustments beginning in 2027.
Expanded issuer eligibility – The aggregate gross asset limit increases from $50 million to $75 million, with inflation adjustments beginning in 2027.
Tiered holding period benefits (applies to QSBS issued on or after July 5, 2025):
Held 3 years – 50% gain exclusion
Held 4 years – 75% gain exclusion
Held 5+ years – 100% gain exclusion
Planning Implications for Clients
These updates present significant new planning opportunities:
Faster access to benefits – Founders and investors can now qualify for partial tax exclusions after just 3 or 4 years, improving liquidity and reinvestment options.
More companies qualify – The higher $75 million asset threshold brings more growth-stage companies into QSBS eligibility.
Bigger potential tax savings – With higher exclusion caps, advanced strategies like “stacking” through trusts or family members can achieve much larger aggregate tax-free gains.
Critical timing considerations – Startups nearing the asset threshold must be careful when issuing new stock to maintain QSBS eligibility.
Conversion Considerations
For businesses considering converting from an LLC or partnership to a C corporation, QSBS eligibility can be tricky:
Built-in gains at conversion may be excluded from QSBS benefits.
Improperly structured conversions could result in lost eligibility.
Timing and valuation must be carefully managed to maximize potential tax savings.
QSBS Rules – Before and After OBBBA
Aspect | Pre-OBBBA (≤ July 4, 2025) | Post-OBBBA (≥ July 5, 2025) |
Gain exclusion cap | $10M or 10× basis | $15M or 10× basis (inflation-adjusted) |
Max corporate assets | $50M | $75M |
Holding period requirement | 5 years for any exclusion | 3 yrs → 50%, 4 yrs → 75%, 5+ yrs → 100% |
The recent changes to Section 1202 QSBS create a rare window for massive tax savings in the right situations. If you own or plan to invest in a qualifying C corporation, now is the time to review your eligibility and structure your ownership for maximum benefit.