Written by Jason Tholen
The One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, significantly expanded the tax
benefits available under Internal Revenue Code Section 1202, which governs qualified small
business stock (QSBS).
Qualified Small Business Stock (QSBS) can offer significant tax benefits for founders, investors, and owners of closely held businesses. When the requirements of Internal Revenue Code Section 1202 are satisfied, eligible taxpayers may exclude a substantial portion or, in certain circumstances, all of the gain realized on the sale of qualifying stock. Because eligibility is dependent on specific criteria, including entity structure, business activity, asset limitations, and holding period, proactive planning is essential to preserve and maximize available tax benefits.
In addition to meeting initial qualification requirements, ongoing structuring, documentation, and transaction planning throughout the lifecycle of a business can significantly affect the amount of gain eligible for exclusion. The following overview summarizes key QSBS eligibility rules, potential tax benefits, and important limitations, as well as strategic considerations—including planning opportunities that may allow multiple taxpayers to access separate exclusion amounts. Early evaluation of ownership structure, capitalization history, and anticipated liquidity events can help ensure these valuable tax advantages are not inadvertently lost.
BACKGROUND AND OBJECTIVES:
QSBS Eligibility Criteria
- Issuer Must Be a C Corporation. The stock must be issued by a domestic C
corporation; interests in S corporations, LLCs, or partnerships do not qualify;
provided, however, that an LLC which elects to be taxed as a C corporation does
qualify for QSBS exclusion. Corporate status must apply at the time of issuance
and generally during the required holding period. - Original Issuance Requirement. The taxpayer must acquire the stock at its
original issuance, directly from the corporation, in exchange for money, property
(other than stock), or services. Purchases from existing shareholders do not
qualify. - Qualified Trade or Business. The corporation must engage in a qualified trade
or business. Certain service businesses and other excluded activities do not
qualify. A facts-and-circumstances review is required for industry classification.
Businesses involving certain services, finance, investing, leasing, hospitality, and
resource extraction are generally excluded. Classification hinges on the
corporation’s actual activities and revenue mix. - Gross Assets Limitation. The corporation’s aggregate gross assets must not
exceed $75,000,000 at all times before and immediately after the issuance.
Asset values are generally measured by adjusted tax basis with special rules for
certain contributions. - Active Business Requirement. At least 80 percent (by value) of the
corporation’s assets must be used in the active conduct of one or more qualified
trades or businesses during substantially all of the taxpayer’s holding period. - Holding Period. The taxpayer must hold the stock for 3 years to claim a 50%
exclusion for capital gains, 4 years to claim 75% exclusion from capital gains and
more than five years to claim 100% exclusion from capital gains. - Eligible Taxpayer. Individuals, certain trusts, and estates may claim the
exclusion. There is no requirement that the taxpayer be a citizen to claim
exclusion under Section 1202; however, C corporations (as the owner of QSBS)
cannot claim the Section 1202 exclusion.
Tax Benefits
- Gain exclusion. Subject to limitations, gain from the sale of QSBS on stock
issued after July 4, 2025, may be excluded from federal income tax, up to the
greater of (a) $15,000,000 reduced by prior QSBS exclusions for the same
issuer, or (b) 10 times the taxpayer’s adjusted basis in the stock. The applicable
exclusion percentage depends on the date the QSBS was acquired. - AMT and NIIT considerations. Excluded gain is not subject to regular federal
income tax. Certain rules may affect alternative minimum tax and the 3.8 percent
net investment income tax; coordination rules should be reviewed based on
acquisition date and taxpayer status. - Basis and state conformity. Basis and state tax treatment vary. Some states do
not conform to Section 1202 or conform only in part. Utah is a “Rolling
Conformity” state with respect to the federal individual income tax, standard
deduction and personal exemption, and corporate income tax. “Rolling
Conformity” is a statutory default that automatically conforms Utah tax law with
federal tax law. Although not all Utah tax law is Rolling Conformity with federal
tax law, IRC section 1202 does fall under those tax laws which do. Where stock
qualifies as Qualified Small Business Stock under federal tax law and thus
qualifies for exclusion from income taxation, Utah mirrors the federal treatment. If
stock qualifies for 1202 exclusion treatment at the federal level, it also will be
excluded from Utah taxation.
Limitations and Conditions
- Redemptions and related-party rules. Certain redemptions by the corporation
around the time of issuance or acquisitions from related parties can disqualify
stock. - Corporate Conversions and Reorganizations. Conversions to C corporation
status, tax-free reorganizations, and recapitalizations require careful structuring
to preserve QSBS eligibility, original-issuance status, and holding periods. - Multiple issuances and per-issuer caps. The $15,000,000/10x basis limitation
applies per issuer, per taxpayer. Family attribution, community property, grantor
trust, and entity considerations can affect limit calculations. - Documentation. Contemporaneous records are essential, including
capitalization tables, board approvals, subscription documents, valuation support
for the $75,000,000 asset test, and evidence of trade or business activities.
Multiple Exclusions Using Non-Grantor Trusts
Because the QSBS exclusion is calculated on a per-taxpayer, per-issuer basis, it may
be possible to increase the total excluded gain by having multiple taxpayers each
qualify for their own exclusion amount with respect to the same issuer. Properly
structured non-grantor trusts can serve as separate taxpayers for this purpose. Key
points include:
- Concept. A non-grantor trust that is a separate taxpayer may claim its own
Section 1202 exclusion on the sale of QSBS it holds, subject to meeting all
QSBS requirements. Multiple non-grantor trusts, each a separate taxpayer, may
each access a separate exclusion amount with respect to the same issuer’s
stock, provided each trust independently satisfies Section 1202’s requirements. - Timing and Acquisition. To qualify, the trust must acquire QSBS at original
issuance (or by permitted acquisition such as certain tax-free transfers) and hold
the stock for the required holding period. Stock assignments or transfers must be
structured carefully to preserve original-issuance requirements and holding
periods. - Trust Design and Administration. Trusts intended to be separate taxpayers
must be structured as non-grantor trusts under Subchapter J. This generally
requires: (a) Avoiding retained powers or interests that would cause grantor trust
status. (b) Using independent trustees and maintaining fiduciary independence.
(c) Observing separate taxpayer formalities, including separate tax returns and
records. - Allocation Among Beneficiaries and Trusts. Where appropriate, multiple non-
grantor trusts with distinct beneficiaries and separate economic interests may
each qualify as separate taxpayers. Care must be taken to avoid structures that
could be recharacterized as a single taxpayer or disregarded for tax purposes.
Coordination with gifting strategies, valuation, and gift tax exemption usage is
essential. - Considerations and Risks. Any transfer of QSBS must be considered a “gift”
for federal tax purposes, otherwise the transfer of stock can disqualify the stock
from 1202 exclusion. Additionally, the timing of the transfer must avoid the
anticipatory assignment of income doctrine which would treat the stock as owned
by the transfer and would allow for only one QSBS exclusion rather than multiple
(one $15,000,000 exclusion amount).
Jason Tholen
Jason Tholen practices estate planning, trust administration, business formation, and taxation. His estate planning practice includes the drafting of basic wills and revocable trusts, as well as the utilization of more sophisticated estate planning techniques such as dynasty/legacy trusts, irrevocable life insurance trusts, defective grantor trusts, and asset protection trusts and handles estate and gift tax returns. He has extensive experience in business formation and restructuring focused on multi-generational ownership and management. Mr. Tholen is skilled in drafting prenuptial agreements, handling trust litigation, and preparing settlement agreements as alternatives to litigation.