Changes to Section 1202 of the Internal Revenue Code have increased the tax benefits available to investors in small businesses and startups. The changes are part of the One Big Beautiful Bill Act (OBBBA) signed into law on July 4, 2025. They expand the qualified small business stock rules, which provide capital gain exclusions for shareholders.
Investors – including founders and early-stage executives – should review their tax planning strategies and consider how investments in small businesses might now be more appealing. We explain how below:
Section 1202
Section 1202 was enacted to encourage investments in small businesses and startups that are C corporations. It permits noncorporate taxpayers to exclude up to 100% of capital gains from the sale of qualified small business stock if certain requirements are met.
Changes for Qualified Small Business Stock Acquired After July 4, 2025
Prior to OBBBA, a shareholder needed to hold qualified small business stock for five years in order to qualify for a capital gain exclusion. The new legislation creates a tiered system of shortened holding periods. Now, the capital gain exclusions are:
- 50% for qualified small business stock held for three years
- 75% for qualified small business stock held for at least four years
- 100% for qualified small business stock held for at least five years
Additionally, the capital gain exclusion cap increases. Now, the capital gain exclusion is subject to a per-issuer limitation of $15 million for qualified small business stock, which is an increase from $10 million under prior law.
The issuing corporation is required to meet a gross asset threshold at any time prior to or immediately after an issuance of qualified small business stock. The gross asset threshold increases from $50 million to $75 million for stock issued after July 4, 2025.
Key Takeaways for Investors
Here are four key takeaways from the changes to Section 1202:
- An investor can hold qualified small business stock for as little as three years and still benefit from a 50% capital gain exclusion, assuming all of the Section 1202 requirements are met.
- Investors should track issuance dates of qualified small business stock to take advantage of the holding periods and capital gain exclusions for stock issued both pre- and post-OBBBA.
- The increase in the gross asset threshold allows for investments in larger and more mature businesses that may have been previously excluded under the lower threshold. The increased threshold may have an impact if and when a business converts to a C corporation to take advantage of the capital gain exclusions under Section 1202.
- The retention of the look-through rule to the ultimate investor under Section 1202 allows an investor to hold their qualified small business stock through multiple layers of pass-through entities and benefit from the capital gain exclusion under Section 1202.
Now is the time to assess opportunities with qualified small business stock under Section 1202. Contact your Much attorney to discuss tax planning strategies.