Qualified Small Business Stock (“QSBS”) has long been a powerful tax incentive for investors and entrepreneurs in the startup and small business ecosystems. Designed to encourage investment in early-stage companies, QSBS offers significant federal tax benefits for gains on qualifying stock.
But as part of the recent waves of tax reform — particularly the changes introduced and proposed under legislation colloquially referred to by lawmakers and analysts as the “One Beautiful Bill” (a nod to broader reform efforts like the Inflation Reduction Act of 2022 and other Biden-era tax proposals), which was signed into law on July 4, 2025 — the QSBS landscape has undergone material shifts. These changes carry profound implications and greater opportunities for founders, investors, and startup advisors.
QSBS: A Quick Refresher
What is QSBS?
QSBS refers to stock that qualifies for Section 1202 of the Internal Revenue Code. This provision allows exclusion of capital gains on the sale of certain stock issued by a Qualified Small Business (“QSB”), if specific criteria are met.
QSBS Eligibility Criteria (Pre-Reform)
To qualify as QSBS under Section 1202, the stock had to meet several conditions:
- Qualified Issuer: The stock must be issued by a United States C corporation.
- Qualified Small Business: The corporation must have gross assets under $50 million at the time of stock issuance and immediately thereafter.
- Active Business Requirement: At least 80% of the corporation’s assets must be used in an active trade or business (non-investment businesses). So service companies (law firms, engineering, accounting firms, etc..), farms, hotels, and restaurants do not qualify.
- Original Issuance: The investor must acquire the stock directly from the company (not via secondary markets or from an existing shareholder).
- Holding Period: The investor must hold the stock for at least five years to benefit from the capital gain exclusion.
- Stockholder: The taxpayer must be an individual or a trust, and not another legal entity.
The QSBS Gain Exclusion (Before the Changes)
Depending on the date of stock acquisition, different percentages of gain were eligible for exclusion:
- 50% exclusion for stock acquired between August 10, 1993 and February 17, 2009.
- 75% exclusion for stock acquired between February 18, 2009 and September 27, 2010.
- 100% exclusion for stock acquired on or after September 28, 2010.
The maximum gain exclusion was capped at the greater of $10 million or 10 times the adjusted basis of the stock.
Importantly, QSBS excluded gains were also not subject to the 3.8% Net Investment Income Tax (“NIIT”) under the 100% exclusion rule, making it an especially favorable provision for early-stage investors.
The ‘One Beautiful Bill’: What Changed?
The “One Beautiful Bill” introduced or set the stage for sweeping changes in the tax code.
QSBS, despite its small-business intent, came under scrutiny for being overused by high-net-worth investors and hedge funds to shelter millions in capital gains.
Key Changes to QSBS in Recent Legislation & Proposals
1. Creation of a tiered-gain exclusion.
For QSBS acquired after July 4, 2025:
- QSBS held for atleast three years but less than four years: 50% exclusion
- QSBS held for atleast four years but less than five years: 75% exclusion
- QSBS held for atleast 5 years: 100% exclusion
- QSBS acquired prior to July 4, 2025 will remain subject to the previously existing rules.
2. The gross assets threshold for the QSB has been increased.
The corporation must have gross assets under $75 million (up from $50 million) at the time of stock issuance and immediately thereafter, adjusted for inflation beginning in 2027.
3. The per-user cap has been increased.
For QSBS acquired after July 4, 2025, the maximum gain exclusion is capped at the greater of $15 million (up from $10 million) or 10 times the adjusted basis of the stock, adjusted for inflation beginning in 2027.
4. Reinstatement of AMT and NIIT on QSBS Gains
Previously, the alternative minimum tax (AMT) did not apply to gains excluded under the 100% rule. Likewise, those gains were exempt from the 3.8% NIIT.
Under the new framework:
For taxpayers using the less than 100% exclusion, AMT applies to the taxable portion.
The remaining gain (i.e., the portion of the gain not excluded) is now subject to NIIT, increasing the effective tax burden significantly.
Real-World Implications
1. Changed Tax Bills for Founders and Investors
Investors planning for a tax-free windfall are now facing the possibility of higher effective capital gains tax rates.
2. Disruption to Exit Planning
Many M&A deals factored QSBS into their valuation models, especially where founders or seed investors held large equity positions. With a lower exclusion, the after-tax proceeds from a sale are reduced, which may:
- Impact deal terms.
- Prompt renegotiations on earnouts or equity swaps.
3. Reconsideration of Entity Structure
The rules apply only to C corporations, and some founders may now consider whether the double-taxation risk is still worth it, especially with:
- Possibly a reduced benefit from QSBS.
- Flat 21% corporate tax rate possibly increasing in future reforms.
4. Estate and Trust Planning Impact
Trusts that previously doubled or tripled QSBS exclusions by leveraging multiple grantor trusts are now under scrutiny. The Treasury has begun cracking down on this practice by:
Limiting aggregation benefits.
Increasing audits on high-net-worth individuals.
Planning Considerations and Strategies
Despite the reduced benefits, QSBS still provides material tax advantages compared to ordinary capital gains treatment. Here are some planning tips:
1. Staggered Sales to Stay Below AGI Threshold
Taxpayers can potentially structure their exits to try to preserve the tax benefits a given tax year.
2. Rollover of QSBS Gains (Section 1045)
If the five-year holding period hasn’t been met, gains from QSBS can be rolled into another QSBS investment within 60 days of sale under Section 1045, deferring recognition.
3. Timing Exit Based on Legislation
Founders may delay or accelerate exits based on the political climate and potential reversal or moderation of these QSBS rules in future tax bills.
The Future of QSBS
With the 2024 and 2026 legislative agendas potentially ushering in more tax changes, QSBS may either:
Be further curtailed as part of progressive tax reform, or
Be reinstated to its full benefit in a business-friendly administration.
The sunsetting of some of the portions of the Tax Cuts and Jobs Act (“TCJA”) in 2026 may serve as a flashpoint for revisiting QSBS, especially given its role in startup financing and innovation.
Conclusion
QSBS has evolved from a niche tax perk to a mainstream wealth-building strategy for founders and early investors. With the passage of the “One Beautiful Bill” and related reforms, it may become an even more useful strategy to minimize taxes.
The provision remains valuable — albeit in a potentially more favorable format to some. Investors and founders must now rethink timing, entity structure, and tax strategy with a clear understanding of the new QSBS landscape.
In an environment where tax policy is increasingly dynamic, staying informed and proactive is no longer optional — it’s essential. The attorneys at Rapp & Krock, PC are happy to discuss or assist with the structuring of the QSBS or an exit from the QSBS.
ABOUT THE AUTHOR: Bradley Rapp is a Shareholder at Rapp & Krock, PC in the Business Transactions group and routinely advises businesses concerning non-compete agreements.
Rapp & Krock, PC presents the information in this article for general education purposes only. Although this article discusses legal issues, it is not legal advice. The law and the content of any linked website may have changed since this article was written, and Rapp & Krock, PC makes no warranty or guarantee about the continuing accuracy of the information presented. Use of this article does not create an attorney-client relationship, and Rapp & Krock, PC does not represent you unless and until we are expressly retained in writing.
Copyright © 2025 by Rapp & Krock, PC. All rights reserved.