The final budget reconciliation bill (H.R. 1, the Act), signed into law on July 4, 2025, expands the Qualified Small Business Stock (QSBS) exclusion provided by IRC Section 1202.

Prior law

IRC Section 1202 permits a non-corporate shareholder to exclude gain from the sale of QSBS that is held for more than five years. The exclusion is 100% for stock acquired after September 27, 2010, and either 50% or 75% for stock acquired in earlier periods.

The gain excluded under IRC Section 1202 is not treated as a preference item for purposes of the alternative minimum tax (AMT) under IRC Section 57(a)(7) for post-2010 acquisitions. The exclusion is subject to a per-issuer cap, which is generally the greater of $10 million or 10 times a taxpayer's basis in the subject stock. The exclusion does not apply if a corporation's aggregate gross assets exceed $50 million at any time from the corporation's date of formation through the moment immediately after the stock is originally issued to the taxpayer.

New law

The Act introduces a tiered gain exclusion for QSBS; 50% for QSBS held for at least three years, 75% for QSBS held for at least four years, and 100% for QSBS held for at least five years. This change applies only to stock originally issued on or after July 4, 2025. The gain excluded under the three- and four-year rules will not be treated as a preference item for purposes of the alternative minimum tax (AMT) under IRC Section 57(a)(7) if the stock was acquired after September 27, 2010.

The per-issuer cumulative exclusion limitation increases from $10 million to $15 million, subject to an annual inflation-adjustment increase. Taxpayers fully utilizing the inflation-adjusted per-issuer limitation in any tax year will no longer be eligible for additional inflation adjustments. The Act also makes conforming amendments to ensure married-filing-separately taxpayers can benefit from the inflation-adjusted per-issuer limitation.

Finally, the Act increases the "aggregate gross asset" calculation under IRC Section 1202(d) to $75 million from $50 million, which will also be subject to an annual inflation adjustment.

Effective dates

Amendments made by the Act are generally effective for stock issued or acquired, and to tax years beginning after the date of enactment (i.e. July 4, 2025) unless otherwise indicated.

Implications

Portions of the Act affecting IRC Section 1202 represent a significant expansion of the QSBS incentive and make much-needed changes relative to the incentive's original purpose of encouraging Americans to make high-risk, long-term, growth-oriented investments.¹ On this point, high-risk but successful investments will benefit greatly from the changes.

First, increasing the per-issuer limitation to $15 million from $10 million increases the cash-tax benefit of the 100% exclusion to $3.57 million (compared to the prior law benefit of $2.38 million).² For investments made after the date of enactment, where the AMT preference does not apply, the 50% exclusion under the new three-year holding period and the 75% exclusion under the four-year holding period result in cash-tax benefits of as much as $1.19 million and $2.38 million, respectively.³ Note, however, that these figures represent just the floor of the cash-tax benefit, given that the per-issuer limitation will be inflation-adjusted over time. Investments made in otherwise eligible QSBS before July 4, 2025, will still only benefit from the current per-issuer limitation of $10 million under IRC Section 1202(b)(1)(A) (even if sold after July 4, 2025).

Second, increasing the computation of "aggregate gross assets" to $75 million (subject to future inflation-adjustments) provides a much-needed update to the $50 million threshold, which has remained the same since the statutes' original enactment in 1993.⁴ The increased dollar figure coupled with (1) full expensing for business property and (2) full expensing of domestic research and experimental expenditures will likely benefit many start-ups. Those start-ups would likely satisfy the "qualified small business" requirement for a longer period compared to current law because the accelerated deductions described previously will act to lower their "aggregate gross asset" computation.⁵

The changes to IRC Section 1202 under the Act represent a watershed moment for future founders, investors, and employees of eligible businesses to take advantage of the expanded exclusion. To achieve the exclusion, however, it is important to remember the lessons learned from the United States Federal Court of Claims' holding in Tongzhong Ju and Yanxia Li v. United States⁶. (See Tax Alert 2024-0755). Specifically, taxpayers wishing to receive favorable qualified small-business stock treatment must maintain clear and contemporaneous evidence that all of the requirements to benefit from the exclusion have been satisfied.