The ability for non-corporate taxpayers to exclude all or a portion of capital gains tax from the sale of qualified small business stock (QSBS) has been expanded in the One Big Beautiful Bill Act (OBBBA) signed into law on July 4, 2025. The article below provides an overview of the rules and requirements that apply to QSBS for further discussion with an experienced CPA or Attorney if applicable to your personal financial situation.
The federal exclusion for QSBS encourages investment in small businesses by providing substantial tax benefits on eligible stock sales. While taxpayers may be unaware of this powerful incentive for shareholders of qualifying C corporation stock, it is important to understand the rules and requirements for qualification and be able to substantiate eligibility to claim the exclusion.
C Corporation is Required: To qualify as QSBS, the stock must have been issued by a domestic C corporation and acquired directly from the C corporation at its original issue. Only domestic C corporations are eligible to issue QSBS. Pass-through entities such as an S corporation or partnership are not eligible to issue QSBS and shares acquired through the secondary market are not eligible. Exceptions to the original issuance requirement include QSBS transferred at death or as a gift. Individuals and certain trusts are eligible owners of QSBS.
Holding Period Requirement: For stock issued after July 4, 2025, the OBBBA has created a tiered holding period which provides a 50% capital gain exclusion for stock held for at least three years, a 75% exclusion for stock held at least 4 years, and a 100% exclusion for stock held at least 5 years. For stock issued before July 4, 2025, taxpayers may exclude up to 100% of qualifying gains if the stock was held for more than five years. The lowering of the holding period to qualify for a partial capital gain exclusion may potentially benefit more investors who are able to realize tax benefits more quickly.
Total Gross Asset Limit: To qualify to issue QSBS, the issuer must not have more than $75 million in gross assets for stock issued after July 4, 2025 (or $50 million for stock issued before July 4, 2025). This increased asset threshold allows larger companies to qualify.
Active Business Test: The active business test requires that an eligible corporation uses at least 80% of its assets in the active conduct of a qualifying trade or business.
Qualifying Trade or Business: To qualify as QSBS, a company must meet the active business requirements and must not operate in certain excluded industries such as professional services (including accounting, law, consulting, brokerage services), banking, insurance, finance, leasing, investing, farming, hospitality (including hotels and restaurants), mining and natural resource extraction.
Cap on Federal QSBS Capital Gains Tax Exclusion: The OBBBA increased the cap on QSBS federal capital gains tax exclusion, per issuer, to the greater of $15 million (from $10 million) or ten times the adjusted basis. Capital gains that are qualified to be excluded are exempt from federal capital gains tax and from the net investment income tax. Gains that are not excluded may be subject to either:
- a 28% federal capital gains tax rate on the portion of QSBS gain that qualifies but is not excluded under the applicable percentage (e.g., under the new 3-, 4-, or 5-year holding tiers), or
- the regular long-term capital gains tax rate (generally 20%) on any gain above the per-issuer cap
In both cases, the 3.8% net investment income tax may also apply if income thresholds are met.
State Tax Rules: Each state has its own state tax rules for QSBS capital gains tax exclusion at the state income tax level. In general, with some exceptions, states without individual income tax do not charge state capital gains taxes. California treats all capital gains as ordinary income, has the highest state capital gains tax with a top marginal tax rate of 13.3%, and does not provide a state tax exclusion for capital gains on the sale of QSBS. Other states fully conform to federal QSBS rules at the state level. As such, individual state tax rules will have a variety of implications for individual investors.
Investing through an IRA: Investing in QSBS through an IRA is not tax efficient as the IRA would not pay capital gains taxes when it sells QSBS (and would not pay capital gains on sale of stock that was not QSBS) but would pay tax on any distributions from the IRA at ordinary income tax rates.
For small business owners and investors, the expanded QSBS exclusion offers possible new opportunities for greater after-tax returns. Vantage Wealth cannot give tax advice and recommends that inquiries regarding qualification for capital gains tax exclusion from the sale of QSBS be discussed with a qualified CPA or Attorney. Please let us know if you would like a referral to a trusted expert or if we can be of further assistance.
Sources: IRS.gov, taxexpertnow.com, law.cornell.edu