Tax Byte

The One, Big, Beautiful Bill Act Revolutionizes Section 1202

Sharon Kreider, CPA & Karen Brosi, CFP, EA

The fireworks weren’t the only thing lighting up the sky on July 4th, 2025. President Trump’s signature on the One Big Beautiful Bill Act (OBBBA) sent cheers through the tax planning community, delivering a significant overhaul to §1202. For those of us who’ve spent years navigating the rigid confines of the qualified small business stock (QSBS) provisions, this legislation is a special gift.

The Pre-OBBBA Landscape

The old §1202 had you hold QSBS for more than five years to get the full 100% exclusion, with no relief for earlier exits. Meanwhile, the $10 million per-issuer cap on gain exclusion simply wasn’t enough to eliminate tax entirely on total gains. Finally, the $50 million aggregate gross assets threshold meant that many growing companies quickly outgrew their QSBS eligibility, leaving founders and early investors to watch their potential tax benefits evaporate.

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The OBBBA’S Three Game-Changing Modifications

The OBBBA introduces three primary modifications to §1202, effective for QSBS acquired on or after July 4, 2025.

The Graduated Exclusion Schedule

The legislation creates a tiered exclusion system for QSBS:

50% exclusion for QSBS held for at least three years
75% exclusion for four years
100% exclusion for five years or more

This graduated approach acknowledges what practitioners have always known—the market doesn’t wait for tax optimization. The new structure allows for partial exclusions and earlier exits while still rewarding long-term investment. For the first time, there can be meaningful conversations with clients about exit strategies that don’t revolve entirely around an arbitrary five-year cliff.

Consider the founder who’s been approached with an acquisition offer in year three. Previously, this was a binary choice between significant tax liability or potentially missing a strategic opportunity. Now, that founder can exclude half their gain while still capturing the business opportunity.

The $15 Million Cap

The per-issuer limitation increases from $10 million to $15 million for QSBS acquired after July 4, 2025. Beginning in 2027, this $15 million cap will be indexed for inflation.

For our clients, this translates to an additional $1.19 million in federal tax savings at current capital gains and net investment income tax rates. This provides significant breathing room for companies experiencing rapid growth. The difference between a $10 million and $15 million exclusion could mean the difference between full QSBS benefits and partial benefits for many successful investors and sellers.

The $75 Million Asset Threshold

Perhaps the most practical change for day-to-day planning is the increase in the aggregate gross assets threshold from $50 million to $75 million. Similar to the gain exclusion cap, this $75 million threshold will also be indexed for inflation starting in 2027.

The OBBBA now enables taxpayers to deduct domestic research or experimental expenditures in the year they are paid or incurred rather than capitalizing and amortizing such expenditures as was the case under prior law. This change, combined with the increase to the $75 million asset threshold, is expected to permit more corporate issuers to remain under the aggregate gross asset cap, even if they have raised an aggregate amount of capital in excess of the aggregate gross asset cap.

Planning Implications

Practitioners should note an important limitation: the changes to §1202 under the OBBBA only apply to QSBS issued after the July 4, 2025, date of enactment. QSBS issued on or before July 4, 2025, continues to be subject to the preexisting rules. This creates a potential planning opportunity for companies considering issuing new stock.

State Conformity

State conformity is, as always, an issue. As of July 2025, Alabama, California, Mississippi, and Pennsylvania do not conform to the federal QSBS exclusion, meaning gain is fully taxable under state income tax law, while Hawaii and Massachusetts partially conform. New Jersey conforms to federal law for sales beginning in 2026.

For clients in non-conforming states, the federal benefits will be diminished by state tax liability. One planning strategy gaining traction is the use of non-grantor irrevocable trusts located in no-income-tax jurisdictions. While this adds complexity, when properly formed and administered by an experienced tax attorney, these trusts can own QSBS and potentially avoid both federal and state capital gains tax, assuming all §1202 requirements are met.

The Road Ahead

There will be forthcoming guidance from the IRS and/or Treasury regarding provisions of the OBBBA, including changes to §1202. Practitioners should stay tuned for regulations that clarify implementation details, particularly around the interaction between old and new rules for companies with mixed stock issuance dates.