Navigating Qualified Small Business Stock

Qualified small business stock (QSBS) isn’t new. It’s been in the tax code for more than 30 years. But this powerful tax break, which allows investors or business owners to exclude 100% of their gain on sales of eligible stock, received a substantial upgrade under last year’s One Big Beautiful Bill Act (OBBBA).

Key improvements include expanding the definition of “qualified small business” to larger companies, allowing partial exclusions for shorter holding periods and increasing the per-issuer lifetime limit on QSBS exclusions. Here's a summary of QSBS rules and requirements.

Who’s Eligible?

Under Section 1202 of the Internal Revenue Code, individuals and other noncorporate taxpayers, including U.S. trusts and estates, generally can exclude up to 100% of capital gains on the sale of eligible stock in a qualified small business (QSB). QSBs are domestic C corporations engaged in “active” trades or businesses whose aggregate gross assets (including the assets of more-than-50%-owned subsidiaries) didn't exceed $50 million before or immediately after the stock was issued. Note that professional services, finance, farming, mineral production, and hospitality C corporations don’t qualify. (This list of industries isn’t exhaustive.)

Under the OBBBA, the gross asset threshold was increased from $50 to $75 million for QSBS acquired after July 4, 2025. It’ll be indexed for inflation after 2026. To qualify for the 100% exclusion:

• An investor must acquire stock through an original issuance directly from the corporation in exchange for money, property (other than stock), or services,
• The investor must hold the stock for at least five years, and
• The stock must have been issued after September 27, 2010.

For QSBS acquired after July 4, 2025, investors may claim a 50% exclusion for stock held at least three years and a 75% exclusion for stock held at least four years. The taxable portion of the gain will be taxed at 28%. That means gain eligible for the 75% exclusion will be taxed at an effective rate of 7% and gain eligible for the 50% exclusion will be taxed at an effective rate of 14%.

What’s the Lifetime Limit?

Sec. 1202 places a lifetime cap on the amount of gain that can be excluded on sales of a particular issuer’s stock of $10 million (or, if greater, 10 times the investor’s adjusted basis in the stock). The OBBBA increased the cap to $15 million for QSBS acquired after July 4, 2025. This cap is indexed for inflation after 2026.

Keep in mind that the cap is per issuer. So, for example, an investor who acquires QSBS in two QSBs could exclude up to $15 million in gain per company, for a total of $30 million.

How Can It Be Used for Estate Planning?

The original issuance requirement doesn’t apply to QSBS received by gift or inheritance. So investors who gift QSBS to family members also transfer the ability to exclude up to 100% of the gain. This is an enormous advantage over ordinary gifts of appreciated stock, which are subject to capital gains tax when sold. Plus, the donor’s holding period is tacked on to the recipient’s for purposes of the holding requirement.
In addition, donors can use a technique called “stacking” to maximize the tax benefits of QSBS. Dividing gifts of QSBS among several family members may enable you to multiply the per-issuer cap, shielding more capital gains from tax.

Suppose, for example, that you own $36 million worth of QSBS (acquired pre-OBBBA) with a basis of $6 million. If you sell the stock, the lifetime cap would limit your exclusion to $10 million in gain. If, instead, you gifted $12 million in stock to each of your two children before the sale (either outright or through a carefully designed trust), you’d each enjoy a $10 million cap, allowing you to exclude the entire $30 million gain.

Is It Right for You?

QSBS offers extraordinary tax-planning opportunities for investors and business owners alike, and the benefits are even more attractive under the OBBBA. However, these investments aren’t right for everyone. Business owners, in particular, need to weigh the advantages of tax-free capital gains against the potential costs (including double taxation of dividends) of operating as a C corporation. Talk to a professional tax advisor about potential tax mitigation strategies.

Keep Your Estate Plan Limber

Last year’s One Big Beautiful Bill Act made the $15 million gift, estate, and generation-skipping transfer (GST) tax exemptions “permanent” (meaning there’s no expiration date, though the amount will be annually indexed for inflation). For now, this provides greater certainty in estate planning. However, because Congress could change the exemption in the future, you might want to take steps to improve your estate plan’s flexibility.

One potential option is to use an irrevocable trust that removes assets from your estate but gives your trustee (or a “trust protector”) the authority to take actions that would bring the assets back into your estate. Why? Your trustee might determine that it would yield a better tax outcome. Other potential tools for improving estate plan flexibility include special power of appointment trusts, limited powers of appointment, and disclaimer trusts.

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