The "One Big Beautiful Bill Act" (OBBBA), signed into law on July 4, 2025, has dramatically reshaped the landscape for Qualified Small Business Stock (QSBS). This legislation significantly enhances the already powerful tax incentives for founders, early employees, and investors in qualifying U.S. C-corporations. If you're involved in a startup, these changes are critical for maximizing your financial upside.
What's New and Why It Matters
For QSBS acquired after July 4, 2025, OBBBA introduces three key improvements:
- Higher Capital Gains Exclusion Cap: The lifetime federal tax exclusion limit has jumped from $10 million to $15 million (or 10 times the stock's adjusted basis, whichever is greater). This means substantially more tax-free profit from a successful exit.
- Increased Gross Asset Threshold for Eligibility: More companies can now qualify. The previous limit of $50 million in gross assets at the time of stock issuance has been raised to $75 million. This is a game-changer for larger startups or those in capital-intensive industries, allowing their stock to qualify.
- New Tiered Exclusion for Holding Periods: This is perhaps the most impactful change for flexibility. While a 100% exclusion still requires holding QSBS for over five years, OBBBA introduces a phased-in benefit:
- 50% exclusion for stock held 3 to 4 years.
- 75% exclusion for stock held 4 to 5 years.
- 100% exclusion for stock held 5+ years. This eliminates the "all or nothing" five-year cliff, offering significant tax relief even for earlier liquidity events.
The excluded gains also remain exempt from the Alternative Minimum Tax (AMT) and the Net Investment Income Tax (NIIT).
Who Benefits and Key Requirements
QSBS primarily benefits non-corporate individuals (founders, early employees, individual investors) holding stock in a qualifying C-corporation. While partnerships, S-corps, and trusts can, under specific rules, pass through these benefits, corporations themselves are not eligible.
To qualify for QSBS, crucial requirements apply at various stages:
At Stock Issuance:
- C-Corporation Status: The company must be a U.S. C-corporation when the stock is issued.
- Gross Asset Limit: The company's total gross assets must not exceed the new $75 million threshold (for stock acquired post-July 4, 2025) immediately before and after stock issuance.
- Qualified Business: The business must be engaged in an "active qualified trade or business." Certain service industries (e.g., law, finance, healthcare, consulting, hospitality) and others (e.g., farming, mining) are excluded.
- Original Issuance: You must acquire the stock directly from the corporation (not from another shareholder) in exchange for cash, property, or services.
During the Holding Period:
- Active Business Test: The company must continue to use at least 80% of its assets in a qualified active trade or business.
- Holding Period: The new tiered exclusion applies based on how long you hold the stock (3, 4, or 5+ years for stock acquired post-July 4, 2025).
Strategic Implications for Founders and Investors
The OBBBA makes QSBS an even more attractive proposition. For startups, ensuring your C-Corp structure is QSBS-compliant from day one is paramount. For investors, understanding these enhanced benefits can significantly impact your post-exit returns.
Given the nuances of these rules—especially the different effective dates for old vs. new QSBS—proactive legal and tax planning is essential. Consulting with advisors can help you navigate these complexities, ensure compliance, and maximize the tax-free potential of your startup equity. Don't miss out on these powerful new benefits!
This summary provides general information about Qualified Small Business Stock. It is not intended as legal or financial advice. Small businesses should consult with qualified professionals for advice tailored to their specific circumstances. This is a general memo and may not address all aspects of U.S. tax laws or laws generally, or their implications for your specific business.
If you have any questions about this Alert, please contact Richard Devlin, Sharda Balaji, any of the attorneys in our Corporate and Commercial Law Advisory Group, or the attorney in the firm with whom you are regularly in contact.
