The One Big Beautiful Bill Act (OBBBA) introduced major updates to Qualified Small Business Stock (QSBS) under Internal Revenue Code Section 1202. If you hold or expect to receive startup equity, understanding how Sections 1202, 1045, and 83b work together can help you plan a tax-efficient exit strategy and preserve eligibility for some of the most generous capital gain exclusions in the tax code. Here is a quick summary:
Key QSBS Changes Under the OBBBA (Section 1202)
| Provision | Old Rule | New Rule (Effective for Stock Acquired After July 4, 2025) | Why It Matters |
|---|---|---|---|
| Holding Period for Exclusion | 5 years required for 100% exclusion | 3 years = 50% exclusion 4 years = 75% exclusion 5 years or more = 100% exclusion | Shorter holding periods now qualify for partial QSBS treatment |
| Exclusion Cap | $10 million or 10 times basis | $15 million or 10 times basis, adjusted annually for inflation | Greater potential for tax-free capital gain |
| Aggregate Gross Assets Limit | $50 million | $75 million | Startups can grow more before disqualifying under Section 1202 |
What It Means for You
If you sell your shares before reaching the full 5-year holding period, you can now exclude 50% of the gain at 3 years, or 75% at 4 years, instead of receiving no tax benefit. This change aligns better with the reality of early exits, M&A activity, and funding timelines in the startup world.
The increase in the exclusion cap to $15 million (indexed for inflation) allows for even more tax-free upside for successful exits. And the increase in the aggregate gross assets test to $75 million gives startups additional runway before they need to worry about losing QSBS eligibility.
Bonus: Gain Deferral with IRC Section 1045
If you sell QSBS before meeting the five-year holding period under Section 1202, you may be able to defer the gain by reinvesting the proceeds into another QSBS within 60 days of sale. This strategy is authorized under Internal Revenue Code Section 1045.
Section 1045 Highlights:
- Applies to QSBS held for more than 6 months
- Requires reinvestment into new QSBS within 60 days
- Only applies to non-corporate taxpayers
- The original holding period tacks on to the new stock
- If the replacement stock is held long enough, you may still achieve full or partial gain exclusion under Section 1202
This is a powerful planning tool if you want liquidity but still aim to preserve QSBS treatment in the future. Timing is critical, so reinvestment windows and documentation must be carefully tracked.
Structure Your Equity the Right Way to Maximize QSBS Benefits
If you are a founder, early employee, or investor, your equity could qualify for tax-free gains under Section 1202, but only if it is structured correctly.
It is important to get it right from the start, so you do not miss out on millions in potential savings.
How We Help:
- LLC to C Corp Planning: We help you understand the tax implications of starting as an LLC and identify the optimal timing to convert to a C Corporation to preserve QSBS eligibility.
- QSBS Eligibility Analysis: We work with your legal and corporate team to ensure your equity compensation and stock structure align with Section 1202 and 1045 requirements.
- Entity and Tax Compliance Support: We assist with documentation, valuation reviews, and tracking relevant QSBS criteria, including gross asset thresholds, stock grant timing, and original issuance.
Start the QSBS Clock Early with Section 83b and Early Exercise
Want to start the QSBS holding period sooner? If you are planning to issue or receive stock options or restricted stock, we provide guidance on:
- Understanding the tax impact of early exercising stock options
- Coordinating with your legal team to ensure timely and accurate Section 83b elections
- Modeling potential exit timelines to align with the 3, 4, or 5-year QSBS exclusion windows
Final Thoughts
The combination of Sections 1202, 1045, and 83b creates one of the most powerful tax planning opportunities in the startup world. The OBBBA has made QSBS more flexible and more accessible, but only if your company and your equity are structured properly.
To qualify and maximize these benefits, you must:
- Operate as a C corporation
- Stay under the $75 million asset threshold
- Issue original stock
- Time your equity grants and elections strategically
- Consider rollover opportunities if exiting early
At TS CPA, we speak the language of equity, and we build tax strategies that work with your startup timeline, not against it.