For entrepreneurs, investors, and early employees in small businesses, one of the most powerful tax incentives in the tax code is the Qualified Small Business Stock (QSBS) gain exclusion under Section 1202. This rule allows eligible taxpayers to exclude a significant portion (or even all) of the capital gains from selling stock in certain C corporations. With recent updates through the One Big Beautiful Bill Act (OBBBA), the potential benefits have become even more valuable.
What Is QSBS?
Let’s break down how QSBS works, what the limits are, and some strategies that may help to maximize the exclusion.
How QSBS Works
So, what exactly is QSBS and why should it matter to you? QSBS refers to stock in a domestic (U.S.) C corporation that meets certain requirements under Section 1202 of the tax code. When you sell this stock after having held it for more than five years, you can exclude a portion (if not all) of the capital gains of the sale from federal income tax.
Congress designed this incentive to encourage investment in small businesses. For qualifying taxpayers, it can translate into millions in potential tax savings.
QSBS Exclusion Limits
However, the amount of gain that is eligible for exclusion by a taxpayer is subject to an annual limitation equal to the greater of either:
The $10 Million / $15 Million Cap
- For QSBS issued before July 5, 2025, taxpayers can exclude up to $10 million of gain per company.
- For QSBS issued after July 4, 2025, the OBBBA increased the cap to $15 million per company.
The 10X Basis Cap
- Taxpayers may exclude up to 10 times their tax basis in the stock.
- For example, if you invested $2 million in a qualifying company, you could potentially exclude up to $20 million in gains.
Strategies to Maximize QSBS Benefits
Because the QSBS exclusion is determined on a per-taxpayer, per-company basis, there are planning opportunities to increase the total tax-free amount. Below are a few examples of these strategies:
Staggering Sales Over Multiple Years:
Selling different blocks of QSBS in different years can help you take advantage of both the standard caps and the 10X basis cap.
- Splitting Ownership Among Multiple Taxpayers: Since each taxpayer has their own exclusion, dividing ownership among family members, trusts, or other entities can multiply the benefit.
- Trust and Estate Planning: Using non-grantor trusts may create additional “taxpayers,” each with their own exclusion cap, while also supporting estate and asset protection planning.
- Strategic Gifting: Gifting QSBS to family members, trusts, or even non-U.S. persons can allow each recipient to use their own exclusion cap.
- Section 1045 Rollovers: If QSBS is sold before meeting the five-year holding requirement (or if the gains exceed the cap) taxpayers can reinvest proceeds into new QSBS under Section 1045 to defer taxes.
- Basis “Packing”: By contributing property or services in exchange for QSBS, taxpayers may increase their stock’s basis, which can expand the 10X cap.
Important Considerations
While this tax benefit sounds like a great way to potentially reduce large capital gains from the sale of small business stock, there are some additional factors you should take into consideration before diving headfirst into this strategy.
- First, the current law is a little ambiguous on the treatment of married couples – meaning, it’s not 100% clear whether each spouse gets a separate exclusion or if they are combined together.
- Secondly, not all states follow the federal QSBS rules, so state tax treatment may vary.
- Lastly, these strategies often overlap with estate planning, wealth transfer, and business structuring, so careful coordination between all of those pieces is essential.
Final Thoughts
The QSBS exclusion under Section 1202 is one of the most generous tax benefits available to entrepreneurs and investors, but maximizing its value requires careful planning. Timing of sales, ownership structure, and proactive estate and trust strategies can make the difference between a standard exclusion and potentially tens of millions of dollars in additional tax savings.
If you’re holding (or planning to invest in) qualified small business stock, now is the time to explore your options. Be sure to speak with your advisor so they can help you design a game plan that fits your financial goals and minimizes your tax burden.
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