Higher Capital Gains Exclusions, Partial Exclusions for Shorter Holding Periods, and More Eligible Small Businesses
Signed into law on July 4, 2025, the One Big Beautiful Bill (OBBB) created many changes to Qualified Small Business Stocks (QSBS). The tax code updates expand which businesses can issue QSBS, increase capital gains exclusions for investors, and bring in a partial capital gain exclusion for shorter holding periods.
Startup founders, venture capitalists, and investors should all pay close attention to the changes to ensure compliance and optimize tax planning. At Wiggam Law, we are always ready to help clients deal with the newest manifestations of the tax code, regardless of how complex they are. To get guidance on your tax concerns, contact us today.
Key takeaways
- The OBBB increased the asset cap for C-corporations that want to issue QSBS from $50 million to $75 million.
- The OBBB also reduced the minimum holding period from five to three years and added tiered capital gain exclusions for QSBS held for more than three but fewer than five years.
- The OBBB increased the capital gains exclusion on qualifying QSBS dispositions from $10 million to $15 million, while preserving the cap of 10 times basis.
What Is Qualified Small Business Stock?
QSBS is stock issued by qualifying small businesses. It must be acquired at original issuance, with limited exceptions, in exchange for non-stock property or as compensation for services.
If investors hold QSBS for a certain period of time, they can exclude some or all of the capital gains, helping to significantly reduce their tax liability. Designed to encourage investment in startups and growth-stage businesses, QSBS tax incentives have been around for decades, and the OBBB made these stocks even more attractive to investors.
Key QSBS Changes Under the OBBB
The OBBB established the following new rules regarding corporations’ eligibility to issue QSBS and the tax benefits investors receive when selling the stock.
Higher Asset Caps
C-corporations can only issue QSBS if their assets at the time of issuance and immediately thereafter are under $75 million. Under the OBBB, the asset cap increases annually with inflation. Prior to the OBBB, only C corporations with assets of under $50 million as of August 10, 1993, and through the issuance date could issue QSBS.
The OBBB did not change the rules about which type of assets the corporation must hold. At least 80% of the business’s assets must be in active operation for the business – a rule designed to prevent passive real estate investments from qualifying for preferential tax treatment.
Additionally, although the stocks must be issued by a C-corporation, they can be held by a partnership or S-corporation. In those cases, investors can claim the capital gains exclusion as long as they meet the holding requirements and any other criteria.
Shorter Holding Period Requirements
Prior to the OBBB, investors had to hold QSBS for at least five years to claim the capital gains exclusion. The OBBB preserves the full exclusion after five years and allows a partial exclusion for assets held at least three years:
- Three to four years: 50% capital gains exclusion, up to the cap.
- Four to five years: 75% capital gains exclusion, up to the cap.
- Five or more years: 100% capital gain exclusion, up to the cap.
The new rules apply to QSBS acquired after July 4, 2025, not to any stocks issued before this date. To illustrate, imagine that a C-corp issued QSBS to an investor on July 1, 2025. Because that was prior to the date the OBBB was signed into law, the investor must hold the stock for at least five years to claim the capital gains exclusion. In contrast, an investor who purchased QSBS just a few days later, on July 5, 2025, qualifies for a 50% capital gains exclusion after three years, a 75% exclusion after four years, and, as usual, a 100% exclusion after five years.
The tiered exclusion levels also bring the 28% capital gains tax rate back into the mix – any QSBS gains not excluded under the shorter holding terms are subject to this rate.
For example, say that an investor sells QSBS acquired after July 4, 2025, for a $15 million gain, after holding it for 3.5 years. Their basis in the stock was only $1 million, which means they’re subject to the $15 million cap rather than the cap of 10 times basis. They get an exclusion of $7.5 million in capital gains, but the remaining $7.5 million is subject to capital gains tax at 28%.
Or, consider an investor with a $10 million basis who’s held the QSBS (acquired after July 4, 2025) for over five years. They qualify for a capital gains exclusion of $100 million. That’s 10 times their basis in the stock and a 100% capital gains exclusion because they meet the holding period requirements.
Increase to the Capital Gain Exclusion’s Flat Cap
The OBBB increased the flat cap for the capital gain exclusion to $15 million, but the law retained the previous exclusion of 10 times basis. As long as they meet the holding requirements, investors can exclude the higher of these two numbers.
For example, say an investor has a $5 million basis and generates a $20 million gain when they dispose of QSBS that they’ve held for over five years. The gain exceeds the $15 million cap, but thanks to their $5 million basis, they can claim an exclusion of up to $50 million (basis times 10), meaning that their entire $20 million gain is excluded from capital gains.
Prior to the OBBB, the flat cap was $10 million, but investors could alternatively calculate the exclusion as 10 times their adjusted basis. The higher exclusion rates only apply to QSBS acquired after July 4, 2025.
To explain, imagine QSBS acquired after July 4, 2025. The investor enjoys a phased-in exclusion of:
- 50% after three years, meaning they can exclude up to $7.5 million based on the $15 million flat cap or up to five times their adjusted basis if higher.
- 75% after four years, which works out to $11.25 million or 7.5 times basis.
- 100% after five years, the greater of $15 million or 10 times basis.
The exclusion applies to all stock from a single issuer, and previous sales from that issuer will be considered. For instance, if an investor previously excluded $3 million in gains from that QSBS issuer, they’re limited to a $12 million capital gains exclusion or a limit as calculated based on their adjusted basis.
Protecting QSBS Tax Incentives
Whether you’re issuing QSBS, transferring stock, reorganizing the issuing company, or disposing of QSBS, you need to protect these valuable benefits. Consider these tips and always consult with an experienced tax professional:
- When issuing QSBS, have detailed records about the entity’s assets on the date of issuance and prior. Also, keep detailed records about each asset’s operational role.
- Issue stock strategically before growth to ensure the corporation meets the asset cap requirements.
- Track investor consideration for QSBS shares to ensure you meet the requirements for original issuance based on the contribution of non-stock property or as compensation for services.
- Generate statements related to the investor basis.
- Remember that only original issuance stocks are eligible for the QSBS capital gains exclusion. Once sold or transferred from the original owner, the stocks no longer qualify for capital gains exclusion at disposition, but there are limited exceptions.
- Work with a tax professional to secure documentation that proves QSBS transferred by gift, due to death, or from a partnership to a partner, continues to qualify as QSBS.
- If dealing with Section 351 contributions and Section 368 reorganizations, work with an experienced tax professional to ensure the stock maintains its QSBS status.
As of 2025, investors should consider the new holding period rules and work with a tax planner to ensure they dispose of QSBS strategically to maximize their exclusions.
Contact Wiggam Law for Help With QSBS Tax Disputes
At Wiggam Law, our experienced attorneys are ready to guide investors and small business owners who face tax problems related to QSBS, whether they’re subject to the new OBBB rules or earlier legislation. We don’t believe in cookie-cutter solutions, and we work closely with all of our clients to ensure that we find resolution options that meet their needs.
The OBBB is new – but our attorneys are ready. We can also help if you’re facing an audit related to the overtime tax deduction, the OBBB’s limitation on deducting gambling losses, the implications of the OBBB for 1099 workers, or recent updates to investments in Opportunity Zones.
FAQs
What types of businesses now qualify for QSBS after the OBBB?
The OBBB increased the asset cap, allowing businesses to have up to $75 million in assets when issuing QSBS. However, the OBBB did not change the limitations on services – businesses in industries such as health, law, accounting, banking, farming, hotels and restaurants, and consulting cannot issue QSBS.
How long must investors hold QSBS to claim the 100% exclusion?
To receive the full 100% exclusion, up to the cap, investors must hold QSBS for at least five years. The OBBB did not change this part of the tax code. However, the legislation did introduce a phased-in exclusion of 50% or 75% after a three-year or four-year holding period, respectively, but only for QSBS issued after July 4, 2025.
Can LLCs or S corporations qualify under the new rules?
The OBBB did not change rules related to QSBS eligibility for S corporations or LLCs. S corporations and LLCs cannot issue QSBS directly. However, they are permitted to be shareholders in a C-corporation that issues QSBS. If structured correctly, the capital gains exclusion can flow through to the S-corporation shareholders or LLC members, provided all other QSBS requirements are met.
Can an S-corporation change its stock to QSBS by becoming a C-corp?
S-corporation stock issued prior to an S-corp becoming a C-corp is not eligible to become QSBS. However, if an S-corp becomes a C-corp, the C-corp can issue QSBS, provided it meets the other requirements. These terms were not changed by the OBBB.
Do the OBBB’s new rules apply retroactively to older stock?
No, the new rules do not apply to any stocks that were acquired or issued prior to July 4, 2025, the date the OBBB was signed into law. QSBS issued prior to that date are subject to the $50 corporate asset cap and the $10 capital gains exclusion flat cap, and they are not eligible for the phased-in exclusions after three years.
How can investors confirm that their shares qualify as QSBS under the OBBB changes?
Only QSBS issued after July 4, 2025, is subject to the new rules created by the OBBB. All QSBS issued before this date are subject to the five-year holding period and the $10 million flat cap (or 10 times adjusted basis).
Did the OBBB Change the AMT treatment of QSBS?
QSBS sales are not treated as an Alternative Minimum Tax (AMT) preference item. The OBBB specified that gains excluded under the new three or four-year tiered system are also immune from AMT.