The One Big Beautiful Bill Act Brings Major Changes to Section 1202 Capital Gains Exclusion

Introduction

On July 4, 2025, the One Big Beautiful Bill Act (OBBBA) was signed into law, ushering in sweeping changes to the U.S. tax code. Among its most significant reforms are the enhancements to Section 1202 of the Internal Revenue Code, which governs the exclusion of capital gains from the sale of qualified small business stock (QSBS). These changes are poised to reshape the landscape for founders, investors, and small businesses, making the QSBS regime more accessible and attractive than ever before. This article explores the key modifications, their legal underpinnings, and the practical implications for taxpayers.

Background: Section 1202 Before OBBBA

Section 1202 was originally enacted in 1993 to encourage investment in small businesses by allowing noncorporate taxpayers to exclude a portion of the gain realized on the sale of QSBS. To qualify, the stock had to be acquired at original issuance from a domestic C corporation with aggregate gross assets not exceeding $50 million before and immediately after the issuance. The corporation also had to be engaged in a qualified trade or business, and at least 80% of its assets had to be used in active business operations.

The exclusion percentage varied based on the acquisition date of the stock: 50% for stock acquired before February 18, 2009; 75% for stock acquired between February 18, 2009, and September 27, 2010; and 100% for stock acquired after September 27, 2010. The gain eligible for exclusion was capped at the greater of $10 million or 10 times the taxpayer’s basis in the stock. The holding period requirement was a strict five years, and the exclusion was not available to corporate taxpayers or for stock acquired on the secondary market.

Key Changes Under the OBBBA

The OBBBA introduces three transformative changes to Section 1202, all of which apply to QSBS acquired after July 4, 2025:

Tiered Gain Exclusion Based on Holding Period

The most notable change is the introduction of a tiered exclusion system. For QSBS acquired after the effective date, taxpayers no longer need to wait five years to benefit from the exclusion. Instead:

A 50% exclusion applies if the stock is held for at least three years.
A 75% exclusion applies if the stock is held for at least four years.
The full 100% exclusion remains available for stock held for at least five years.

This tiered approach provides greater flexibility for investors and founders, particularly in industries where earlier exits are common. It also aligns the QSBS regime more closely with the three-year holding period for carried interests under Section 1061, potentially broadening its appeal to private equity and venture capital investors.

Increased Per-Issuer Gain Exclusion Cap

The OBBBA raises the per-issuer cap on excludable gain from $10 million to $15 million for QSBS acquired after July 4, 2025. This cap will be indexed for inflation beginning in 2027. The alternative cap—10 times the taxpayer’s basis in the disposed QSBS—remains unchanged. Importantly, once a taxpayer reaches the $15 million cap for a particular issuer, future inflation adjustments do not provide additional exclusion for that issuer.

Higher Aggregate Gross Asset Threshold for Issuers

The maximum aggregate gross assets a corporation can have to issue QSBS is increased from $50 million to $75 million, also indexed for inflation after 2026. This expansion allows more companies—especially those in capital-intensive sectors like technology, life sciences, and manufacturing—to qualify as small businesses for QSBS purposes. The asset test continues to be applied at all times before and immediately after the stock issuance, and includes cash plus the adjusted basis of other property, with contributed property valued at its fair market value at the time of contribution.

Legal Details and Statutory Language

The statutory amendments are codified in Section 70431 of the OBBBA. The new law amends Section 1202(a) to provide the tiered exclusion percentages and defines the “applicable date” as July 4, 2025. The per-issuer cap is addressed in Section 1202(b)(4), which now provides for a $15 million limit (indexed for inflation), reduced by prior exclusions for the same issuer. The gross asset test is amended in Section 1202(d)(1) to reflect the $75 million threshold, also subject to inflation adjustments.

The law also clarifies that the holding period for QSBS acquired in certain tax-free reorganizations or by gift is determined by tacking under Section 1223, and that the new exclusion percentages and caps apply only to stock acquired after the OBBBA’s enactment date.

Practical Implications and Planning Considerations

The OBBBA’s changes to Section 1202 have several important implications:

Earlier Liquidity Opportunities: Investors and founders can now realize significant tax benefits after only three or four years, rather than waiting the full five years. This is particularly valuable in industries with shorter investment cycles.
Expanded Eligibility: The higher asset threshold allows more companies to issue QSBS, making the regime relevant to a broader range of startups and growth companies.
Larger Exclusion Amounts: The increased per-issuer cap means that more gain can be excluded from income, especially for founders and early investors with substantial equity stakes.
Entity Choice: The enhanced benefits may prompt more businesses to organize as C corporations to take advantage of QSBS treatment, especially given the permanence of the 21% corporate tax rate and the ability to immediately expense research and business property under other OBBBA provisions.
Due Diligence and Documentation: Investors should carefully document acquisition dates, basis, and compliance with the QSBS requirements, as the new rules create multiple “batches” of QSBS with different exclusion percentages and caps depending on the acquisition date.

Unchanged Requirements and Limitations

Despite these enhancements, several core requirements remain unchanged:

The stock must be acquired at original issuance (not on the secondary market).
The issuing corporation must be a domestic C corporation engaged in a qualified trade or business.
The 80% active business asset test and the list of disqualified businesses (e.g., health, law, financial services, hospitality) are unchanged.
The exclusion is not available to corporate taxpayers.
The alternative 10x basis cap remains in place.

Conclusion

The OBBBA’s expansion of Section 1202 represents a significant win for small business owners, founders, and investors. By introducing a tiered exclusion, raising the per-issuer cap, and increasing the asset threshold, Congress has made the QSBS regime more flexible and accessible. These changes are likely to spur greater investment in small businesses and provide substantial tax savings for those who plan carefully and comply with the statutory requirements. As always, taxpayers should consult with qualified tax advisors to navigate the complexities of the new law and maximize the benefits available under Section 1202.

External Links

1. Grant Thornton – Explaining enhanced Section 1202 benefits

2. McDermott Will & Emery – One Big Beautiful Bill Act brings major changes to Section 1202 capital gains exclusion

3. Aprio – OBBB Expands QSBS: What §1202 Means for Founders & Investors

4. Official Legislative Text – P.L. 119-21 (H.R. 1, One Big Beautiful Bill Act, OBBBA)

If you have questions about the OBBBA, Section 1202, or how these changes may impact your tax planning, please contact us for further assistance.