Understanding QSBS: A valuable tax break for business owners just got better

A little-known provision in the tax code, Qualified Small Business Stock (Section 1202), allows certain business owners to avoid capital gains on the sale of closely held business shares. What was a significant tax benefit historically is further enhanced after the passage of the One Big Beautiful Bill Act (OBBBA) in 2025. If specific requirements are met, an owner of business shares may be able to exclude up to $15 million (or more in certain cases) of appreciation in the stock from federal capital gains taxes.

This provision is considered one of the most complex areas of the tax code requiring in-depth analysis from a qualified tax professional.

What is Qualified Small Business Stock (QSBS)?

When stock shares meeting the definition as QSBS are sold, up to $15 million of capital gains or 10 times the original cost basis of the stock—whichever is greater—can be excluded from capital gains treatment. To benefit from this massive tax break, the shares being sold must meet specific qualifications. First, this tax treatment only applies to a business organized as a domestic C-corporation (or an LLC that elects to be taxed as a corporation). Companies structured as pass-through entities for purposes of taxation are not eligible. These would include sole proprietors, partnerships, most LLCs and S-corporations.

Here are some additional requirements to meet the definition of QSBS:

• The company must meet an aggregate gross assets test to determine if shares may be considered QSBS. Currently, if gross assets exceed $75 million at the time the shares are issued, QSBS treatment is not available.
• The stock must generally be acquired directly from the company through an initial issuance, which means that shares purchased from another corporate shareholder are not eligible for this special tax treatment. However, QSBS acquired from an original issue and subsequently gifted to another person may be eligible for the capital gains exclusion.
• The corporation must use at least 80% of its assets in a “qualified trade or business” which generally excludes professional service-related firms (law, accounting, finance, banking, etc.). Other types of businesses operating in the areas of hospitality, natural resources and farming are excluded as well. Additionally, the company must not hold more than 10% of its assets in securities.

How the OBBBA expands the tax benefits of QSBS

The OBBBA expands QSBS tax treatment for shares issued after the signing of the law on July 4, 2025.

Planning considerations for business owners

• When establishing a smaller business that may have significant growth potential and meet the requirements of being considered a qualified small business under Section 1202, weigh the benefits of structuring the entity as a C-corporation instead of a pass-through entity like an LLC or S-corporation. This may allow for capital gains exclusion in the future when the shares are disposed. A decision like this must be made in consultation with the appropriate tax and legal experts, performing a thorough analysis of the type of business entity making the most sense based on particular circumstances.
• S-corporation business owners may consider converting the firm to a C-corporation to “start the clock” on reaching the holding period necessary to benefit from QSBS tax treatment when shares are sold. This can be a complicated process requiring thorough analysis and consultation with qualified professionals.
• Gift shares of QSBS to other family members. When QSBS is gifted, the holding period for the shares generally carries over to the recipient for purposes of meeting the five-year requirement for capital gains exclusion (or the three- or four-year period to benefit from partial exclusion). Additionally, the tax benefit of QSBS in some cases may be “stacked” when shares are gifted to other beneficiaries, since each recipient may benefit from the maximum capital gains exclusion based on their gifted shares (up to $15 million or ten times the cost basis, whichever is greater).

Seek professional guidance

As noted, this is one of the most complex areas of the federal tax code. In addition to the requirements highlighted, there are more nuanced areas of Section 1202 that may need to be addressed. Consulting with a tax and legal professional with working knowledge and expertise around this area of the tax code is needed. Lastly, since some states may not recognize this special tax treatment, there may be state income tax ramifications when QSBS is sold.