Qualified Small Business Stock After the 2025 Tax Law: What Founders and Early Employees Should Know

Mike Germain, CFA

Sep 9

4 min read

Section 1202 was already one of the most valuable provisions in the tax code for startup equity. The One Big Beautiful Bill Act made it more generous for stock issued after July 4, 2025.

For founders, early employees, and angel investors in the Bay Area, few tax provisions matter as much as Section 1202 of the Internal Revenue Code, better known as the qualified small business stock (QSBS) exclusion. When the requirements are met, a substantial portion of the gain on the sale of eligible stock can be excluded from federal income tax. The One Big Beautiful Bill Act (OBBBA), enacted as Public Law 119-21 (H.R. 1, 119th Congress) and signed into law on July 4, 2025, expanded the provision in three important ways through Section 70431 of the Act, which amended Section 1202 of the Internal Revenue Code.

What changed

According to Holland & Knight's analysis of the QSBS changes, the law introduced the following for stock acquired after the date of enactment:

A tiered holding period. Previously, stock had to be held for more than five years to qualify for any exclusion. Now, stock held for at least three years qualifies for a 50% exclusion, four years for 75%, and five years or more for the full 100% exclusion. (IRC § 1202(a)(5), as added by OBBBA § 70431)
A higher per-issuer cap. The maximum excludable gain per issuer rose from $10 million to $15 million, with inflation adjustments going forward. The alternative cap of ten times the adjusted basis in the stock remains available. (IRC § 1202(b)(4)–(5), as amended)
A larger company size threshold. The gross asset test that a corporation must meet at the time of issuance increased from $50 million to $75 million, also indexed for inflation. (IRC § 1202(d)(1), as amended)

Stock issued before July 4, 2025, continues to be governed by the prior rules, including the five-year holding period and the $10 million cap. That means many people will hold two categories of QSBS from the same company, each with different rules.

The basic requirements still apply

The expansion did not eliminate the underlying tests. To qualify, the stock generally must be issued by a domestic C corporation, acquired at original issuance (not purchased from another shareholder), and the corporation must satisfy an active business requirement, with at least 80% of assets used in a qualified trade or business. Certain industries, including most professional services, finance, and hospitality, are excluded. Options and RSUs are not QSBS until they are exercised or settled into actual shares, and the holding period generally begins at that point.

Documentation matters. Many companies now provide QSBS attestation letters, and it is wise to retain capitalization records, stock certificates or ledger entries, and evidence of the company's gross assets at the time of issuance.

California does not conform

An important caveat for Silicon Valley residents: California does not conform to the federal Section 1202 exclusion. Gains excluded federally are generally fully taxable in California as ordinary income, at rates that reach 13.3% for the highest earners as noted in NerdWallet's California tax guide. This does not make QSBS less valuable at the federal level, but it does affect the total after-tax result and should factor into any decision about timing or residency.

Planning ideas people are discussing

Tracking lots by acquisition date. Because pre- and post-enactment stock have different rules, keeping clean lot-level records can be essential.
Early exercise. Employees with options at qualifying companies sometimes exercise early to start the QSBS holding period, often paired with a Section 83(b) election. This carries real financial risk if the company does not succeed.
Gifting and stacking. QSBS can be transferred by gift, and the recipient generally inherits the holding period. Some families use trusts to multiply the per-issuer cap across multiple taxpayers. These strategies are complex and subject to scrutiny.
Section 1045 rollovers. If stock is sold before the holding period is met, gain may be deferred by reinvesting in other QSBS within 60 days.

Cautions

QSBS is a powerful but technical provision. Eligibility can be lost through corporate actions such as redemptions, and the rules for trusts, partnerships, and gifted shares have their own traps. This article is educational only and is not tax or legal advice. Consult a qualified tax adviser or attorney before relying on Section 1202 in any transaction.

Important Disclosures

Important Disclosures: Propulsion Capital Management is an investment adviser registered with the State of California Department of Financial Protection and Innovation. Registration does not imply a certain level of skill or training. This article is provided for general informational and educational purposes only and does not constitute investment, tax, legal, or accounting advice, nor an offer or solicitation to buy or sell any security or to adopt any particular investment strategy. The information is believed to be accurate as of the date of publication but is subject to change without notice; tax laws and regulations change frequently and their application depends on individual facts and circumstances. Nothing herein should be relied upon as a substitute for personalized advice from a qualified professional. Investing involves risk, including the possible loss of principal, and past performance is no guarantee of future results. Diversification does not ensure a profit or protect against loss. Any examples are hypothetical, are for illustrative purposes only, and do not reflect the experience of any client. Links to third-party websites are provided for convenience; Propulsion Capital Management does not endorse, and is not responsible for, the content of third-party sites. Propulsion Capital Management does not provide tax or legal advice; please consult your tax adviser or attorney regarding your specific situation.