QSBS Just Got a Makeover: What the New Law Means for Founders and Investors

If you're a founder, investor, or startup executive, chances are you've heard of Qualified Small Business Stock (QSBS). For years, this powerful section of the Internal Revenue Code (§1202) has allowed qualifying shareholders to exclude up to 100% of capital gains when selling stock in a qualified small business, provided they held it for at least five years.

Now, thanks to the One Big Beautiful Bill Act (OBBBA), signed into law by President Trump on July 4, 2025, the QSBS rules have been significantly updated. These changes bring new flexibility and new complexity. Here's what you need to know.

What Changed Under the New Law?

The new QSBS rules apply to stock acquired on or after July 4, 2025. The three key updates include:

1. Tiered Capital Gains Exclusion

Under the old rules, you had to hold QSBS for five years to receive any tax benefit. Now, earlier exits get partial exclusions:

• 50% exclusion if held for 3 years

• 75% exclusion if held for 4 years

• 100% exclusion still applies after 5 years

  
  

This is a major win for shareholders facing liquidity events before the five-year mark.

2. Higher Exclusion Cap

The lifetime exclusion cap per issuer has been increased from $10 million to $15 million, or 10x basis, whichever is greater. This adjustment means even larger exits can qualify for significant tax savings. Beginning in 2027, this amount will also be indexed for inflation.

3. Expanded Eligibility

The definition of a “qualified small business” has expanded. Previously, companies needed to have less than $50 million in gross assets at the time of stock issuance. That threshold is now $75 million, opening the door for more growing businesses to qualify.

Why This Matters: Key Benefits

The changes represent a significant expansion of QSBS benefits. Here’s what founders and investors stand to gain:

• Earlier Exits Are Less Punitive. In the past, exiting before five years meant losing the entire QSBS exclusion. Now, even a three- or four-year holding period offers meaningful tax relief—potentially making M&A deals or secondary sales more attractive.

• More Companies Qualify. The higher asset threshold means high-growth startups that quickly scale up are less likely to age out of QSBS eligibility before issuing equity.

• Larger Gains Can Be Shielded. With the exclusion cap increased to $15 million (plus inflation indexing), QSBS becomes even more powerful for those with substantial equity positions.

• Still One of the Best Tax Breaks in the Code. Even with partial exclusions, the tax savings under QSBS far exceed those under standard long-term capital gains rates—particularly when paired with strategic estate planning.

  
  

What to Watch Out For: Potential Drawbacks

Of course, no tax law change comes without caveats. While the OBBBA expands QSBS in many ways, it also introduces some new considerations.

• Partial Exclusions Still Mean Partial Taxes. For stock sold before the five-year mark, any gain not excluded is taxed at a 28% rate, plus the 3.8% Net Investment Income Tax (NIIT)—a higher effective rate (31.8%) than the usual long-term capital gains rate of 20%. So while earlier exits are now more tax-efficient, they’re not tax-free.

• More Complexity for Planning. Deciding whether to sell at year 4 (75% exclusion) or wait another year (100%) now involves more nuanced tax planning. And stacking strategies (e.g., gifting shares to trusts) may be impacted by the new exclusion cap mechanics.

• Two Sets of Rules Now Apply. Stock acquired before July 4, 2025, remains subject to the original rules. Stock acquired on or after follows the new structure. That means founders with multiple equity grants or rollover stock must carefully track eligibility and timelines to ensure accurate tax treatment.

• Lack of Guidance in Key Areas. Some key questions remain unresolved—for example, how these rules apply to shares acquired via SAFE notes or option exercises. Until the IRS issues clarifying guidance, some gray areas will persist.

• States May Not Conform. Many states don’t recognize QSBS exclusions at all. Even if you qualify for a federal exclusion, you may still owe state capital gains tax—especially in high-tax states like California or New York.

  
  

Navigating the New Landscape

Understanding the new QSBS rules is crucial for anyone involved in startups. The changes can significantly impact your financial strategy. Here are some steps to consider:

1. Consult a Tax Advisor. With the new complexities, it’s wise to get professional advice. A tax advisor can help you navigate the nuances and maximize your benefits.

2. Keep Accurate Records. Documenting acquisition dates and holding periods is more important than ever. This will ensure you can prove your eligibility for the appropriate exclusions.

3. Plan Your Exit Strategy. Think carefully about when to sell. Weigh the benefits of partial exclusions against the potential for full exclusions after five years.

   
   

Final Thoughts

The QSBS updates in the One Big Beautiful Bill Act are, on the whole, a win for founders and investors. The ability to receive partial exclusions for earlier exits introduces flexibility that reflects today’s fast-moving startup environment. Meanwhile, the expanded exclusion caps and broader eligibility make the benefit more accessible and more valuable than ever.

But with greater flexibility comes greater complexity. Investors, founders, and tax advisors will need to be especially careful to document acquisition dates, verify eligibility under both the old and new rules, and think strategically about exit timing.

In conclusion, the QSBS changes are a game-changer. They present new opportunities for tax savings, but they also require careful planning and consideration. Embrace these changes, and you can position your business for greater success.