News

On June 16, 2025, the Senate Finance Committee released its initial amendments to the  “One Big Beautiful Bill” initially passed by the U.S. House of Representatives on May 22, 2025 (the “Reconciliation Bill”).[1] In addition to addressing pending lapses of certain provisions of the 2017 Tax Cuts and Jobs Act, the Senate Finance Committee draft also expands several provisions of the Qualified Small Business Stock (“QSBS”) gain exclusion found in Section 1202 of the Internal Revenue Code of 1986 (as amended, the “Code”). 

Current QSBS Exclusion

At present, the QSBS exclusion generally allows individuals and other non-corporate taxpayers to exclude from income up to[2] the greater of $10 million ($5 million if married filing separately)[3] or 10 times the aggregate adjusted bases of the taxpayer in the QSBS sold during a year.[4]  To qualify for the exclusion, a number of shareholder- and corporate-level requirements must be met. For example, in order for any gain to be eligible for exclusion, the taxpayer must receive stock at original issue after August 10, 1993 in exchange for property or services (but not stock) and have held the QSBS for more than five years at the time of the sale.[5]  In addition, the entity into which the investment is made must be a domestic C corporation, and such C corporation (and any of its predecessors) must not have had, at any time from August 10, 1993 through immediately after the issuance of the stock, aggregate gross assets in excess of $50 million.[6] Further, during substantially all of the taxpayer’s holding period for the stock, 80% or more of the assets (by value) of the C corporation must be used in the active conduct of one or more qualified trades or businesses (i.e., a business that is not a professional service firm, bank, farm, hotel, etc.).[7] Note that the above is a brief summary of certain QSBS requirements and should not be viewed as a fulsome discussion of all QSBS requirements. In addition, there are restrictions on redemptions, transfers, and corporate restructurings which can also impact QSBS status, discussion of which is beyond the scope of this alert.

Proposed QSBS Exclusion Expansion

The Senate Finance Committee’s initial amendments to the Reconciliation Bill would significantly expand the QSBS exclusion for stock originally issued after the bill’s enactment. 

• First, the amendments would modify the five-year holding period requirement by introducing a phase-in system.[8]  For stock acquired after enactment of the bill, a taxpayer could exclude 50% of gain after a three-year holding period, 75% after a four-year holding period, and 100% after a five-year holding period.[9]  The phase-in therefore would enable holders of stock that would not have previously qualified for QSBS status to partially benefit from the exclusion. In addition, the excluded portion of any gain from QSBS held for more than 3 years but not more than 5 years would expressly not be treated as an AMT preference item.[10]
• Second, the amendments also would increase the exclusion ceiling to the greater of $15 million ($7.5 million if married filing separately)[11] or 10 times the aggregate adjusted basis in the QSBS.[12] This means that stock issued after the date of enactment and held for more than 3 but not more than 4 years could potentially be taxed at a maximum rate of 15.9% (50% * (28% unexcluded 1202 gain rate under Section 1(h)(4)(A)(ii) + 3.8% net investment income tax)), while stock issued after the date of enactment and held for more than 4 but not more than 5 years would be taxed at a maximum rate of 7.95% (25% * (28% unexcluded 1202 gain rate under Section 1(h)(4)(A)(ii) + 3.8% net investment income tax)). Further, the exclusion ceiling would benefit from cost-of-living adjustments starting in 2027.[13] 
• Third, the aggregate gross assets limit of the business would also increase from $50 million to $75 million, which would also benefit from cost-of-living adjustments starting in 2027.[14] 

These changes would greatly increase the number of taxpayers eligible to exclude gain, the potential amount of gain eligible for exclusion, and the number of businesses that can issue QSBS in the first instance. In addition, taxpayers considering an incorporation transaction (including a partnership or LLC conversion) may be well advised to wait until after finalization of the bill given the more favorable rules referenced above.

For more information or assistance regarding Section 1202, the proposed changes provided in the One Big Beautiful Bill, or other tax issues, please contact a member of the Michael Best tax team.