QSBS Benefits Enhanced and Eligibility Requirements More Relaxed for Stock Issued After 2025 Reconciliation Act

On July 4, 2025, President Donald Trump signed into law “[a]n Act to provide for reconciliation pursuant to title II of H. Con. Res. 14.” (formerly known as the One Big Beautiful Bill Act, referred to herein as the “Act”), an all-encompassing reconciliation bill including sweeping domestic policy changes championed by the president that are expected to impact virtually every industry, business, and household of America. As discussed below, the Act has made the tax code’s treatment of QSBS (as defined below) even more favorable by loosening certain requirements and increasing the cap on potential benefits.

Summary

The changes as a result of the Act discussed below can be summarized as follows: 

Background

The US tax code provides significant benefits to stockholders in early stage companies if the stock meets the requirements to be “qualified small business stock” or “QSBS”.¹ Under current law, if stock qualifies as QSBS and the shareholder holds that QSBS for more than 5 years, the shareholder would generally be entitled to entirely exclude from its federal income any gain up to certain thresholds.² These rules were first enacted in 1993 and have been made more favorable in the ensuing years; in particular, the gain exclusion was limited to 50% when first enacted before ultimately increasing to 100% in 2010. 

Current Law

Taxpayers eligible for QSBS benefits are generally limited to US resident individuals, including certain individuals that own an interest in a partnership or S corporation that subsequently acquires QSBS.

A taxpayer that disposes of QSBS more than 5 years after issuance can exclude at least 50% of the gain recognized, 75% of the gain recognized for stock acquired after February 17, 2009 and on or before September 27, 2010 and 100% of the gain recognized with respect to stock issued thereafter.

In order for stock to qualify as QSBS (among a few other technical requirements): 

• The issuer of the stock must be a “C” corporation.
• The shareholder must have acquired the stock at initial issuance from the corporation itself rather than purchasing or otherwise receiving the stock from another shareholder.³
• The issuer must be engaged in an “active business” (other than certain non-qualified trades or businesses)⁴ for substantially all of the shareholder’s holding period in the stock.
• The issuer may not redeem other stock above certain de minimis thresholds and within certain time frames before and after the issuance of the intended QSBS.
• The issuer’s “aggregate gross assets” cannot have exceeded $50M at any time from formation until immediately after the stock was issued (the “Gross Asset Test”).⁵

Taxpayers are limited to excluding gain up to the greater of $10 million (or $5 million per married individual filing separately) or 10 times their tax basis in the QSBS, in each case with respect to any single issuer.

Changes Under the Act

The Act has made substantial favorable changes for holders of QSBS.

Exclusion Percentage. In addition to the 100% exclusion with respect to QSBS held for at least 5 years, shareholders will now be able to exclude 50% of their gain for QSBS held at least 3 years and 75% if held at least 4 years. This change partially eliminates the effect of the “cliff” that currently incentivizes shareholders to defer an exit transaction until the 5 year holding period has been satisfied and reduces the misalignment in an exit transaction among shareholders that acquired their shares between 3 and 5 years ago and other shareholders that acquired their shares more than 5 years ago.

Gain Limitation. The per-issuer cap for gain exclusion has increased from $10 million to $15 million (if less than 10x the shareholder’s tax basis in the QSBS). In addition, that cap will be subject to an annual inflation adjustment starting after 2026. This is a welcome revision given that the $10 million cap has not changed since the rules were first introduced in 1993 despite substantial inflation since that time.

Gross Asset Test. The Gross Asset Test has similarly been unchanged since 1993. Under the Act, however, it has been revised to require that a company’s aggregate gross assets have not exceeded $75 million immediately after issuing stock intended to qualify as QSBS, up from $50 million. That $75 million cap will also be subject to an ongoing inflation adjustment.

Effective Date. The above changes apply to stock issued after July 4, 2025, the date of the Act’s enactment.

*    *    *

Clients should carefully consider the timing of both stock issuances and potential exit transactions. Issuing or acquiring QSBS after the Act’s enactment date may enable shareholders to benefit from higher exclusion percentages, increased per-issuer gain caps and expanded gross asset thresholds.

If you have any questions regarding the Act or how it may affect you, please contact the authors of this alert or your O’Melveny advisor.

¹IRC Section 1202.
²Note that not all states recognize QSBS benefits (including California), so gain may not be excluded for state income tax purposes.
³Certain transfers are permitted while still maintaining QSBS benefits including, subject to limitations, (i) gifts, (ii) distributions by pass-through entities and (iii) certain non-recognition transactions.
⁴Non-qualifying trades or businesses include professional services (e.g., health, law, engineering, accounting, etc.), fossil fuel production, hotels, restaurants and similar businesses and farming.
⁵Aggregate gross assets are generally calculated based on the tax basis of the issuer’s assets other than assets contributed to the corporation by a shareholder.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Robert Fisher, an O'Melveny partner licensed to practice law in California; Billy Abbott, an O'Melveny partner licensed to practice law in California and New York; Alexander Anderson, an O'Melveny partner licensed to practice law in New York; Will Becker, an O'Melveny partner licensed to practice law in Texas; Eleanor Gilbert Dunn, an O'Melveny associate licensed to practice law in Texas; and Arsalan Memon, an O'Melveny associate licensed to practice law in California, New Jersey, and New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

© 2025 O’Melveny & Myers LLP. All Rights Reserved. Portions of this communication may contain attorney advertising. Prior results do not guarantee a similar outcome. Please direct all inquiries regarding New York’s Rules of Professional Conduct to O’Melveny & Myers LLP, 1301 Avenue of the Americas, Suite 1700, New York, NY, 10019, T: +1 212 326 2000.