New tax law makes a significant tax benefit even better

Qualified small business stock
New tax law makes a significant tax benefit even better

Qualified small business stock (QSBS) isn’t new — it’s been in the tax code for more than 30 years. But this tax provision, which allows investors or business owners to exclude 100% of their gain on sales of eligible stock, was expanded under last year’s One Big Beautiful Bill Act (OBBBA).

Key improvements include expanding the definition of “qualified small business” to larger companies, allowing partial exclusions for shorter holding periods and increasing the per-issuer lifetime limit on QSBS exclusions. Here's a summary of QSBS rules and requirements.

Who’s eligible?

Under Section 1202 of the Internal Revenue Code, individuals and other noncorporate taxpayers — including U.S. trusts and estates — may be eligible to exclude up to 100% of capital gains on the sale of qualified small business stock (QSBS), subject to meeting applicable requirements. Qualified small businesses (QSBs) are domestic C corporations engaged in “active” trades or businesses whose aggregate gross assets (including the assets of more-than-50%-owned subsidiaries) didn't exceed $50 million before or immediately after the stock was issued. Note that professional services, finance, farming, mineral production and hospitality C corporations don’t qualify. (This list of industries isn’t exhaustive.)

Under the OBBBA, the gross asset threshold was increased from $50 to $75 million for QSBS acquired after July 4, 2025. It’ll be indexed for inflation after 2026. To qualify for the 100% exclusion:

• An investor must acquire stock through an original issuance directly from the corporation in exchange for money, property (other than stock) or services,
• The investor must hold the stock for at least five years, and,
• The stock must have been issued after September 27, 2010.

For QSBS acquired after July 4, 2025, investors may claim a 50% exclusion for stock held at least three years and a 75% exclusion for stock held at least four years. The taxable portion of the gain is generally subject to a 28% federal capital gains rate. For illustrative purposes, assuming the 28% rate applies, gain eligible for the 75% exclusion would result in an effective federal rate of approximately 7%, and gain eligible for the 50% exclusion would result in an effective rate of approximately 14%. Actual tax results will depend on applicable federal rates and an investor’s individual circumstances.

What’s the lifetime limit?

Sec. 1202 places a lifetime cap on the amount of gain that can be excluded on sales of a particular issuer’s stock of $10 million (or, if greater, 10 times the investor’s adjusted basis in the stock). The OBBBA increased the cap to $15 million for QSBS acquired after July 4, 2025. This cap is indexed for inflation after 2026. Keep in mind that the cap is per issuer. So, for example, an investor who acquires QSBS in two QSBs could exclude up to $15 million in gain per company, for a total of $30 million.

How can it be used for estate planning?

The original issuance requirement doesn’t apply to QSBS received by gift or inheritance. So investors who gift QSBS to family members also transfer the ability to exclude up to 100% of the gain. This may provide potential tax advantages compared to ordinary gifts of appreciated stock, depending on individual circumstances. Plus, the donor’s holding period is tacked on to the recipient’s for purposes of the holding requirement. In addition, donors can use a technique called “stacking” to maximize the tax benefits of QSBS. Dividing gifts of QSBS among several family members may enable you to multiply the per-issuer cap, potentially increasing the amount of gain eligible for exclusion.

For illustrative purposes only, suppose that you own $36 million worth of QSBS (acquired pre-OBBBA) with a basis of $6 million. If you sell the stock, the lifetime cap would limit your exclusion to $10 million in gain. If, instead, you gifted $12 million in stock to each of your two children before the sale (either outright or through a carefully designed trust), you’d each enjoy a $10 million cap — allowing you to exclude the entire $30 million gain.

Is it right for you?

QSBS may provide meaningful tax-planning considerations for certain investors and business owners, particularly in light of recent changes under the OBBBA, which modified certain exclusion percentages and holding period provisions. However, these investments aren’t right for everyone. Business owners, in particular, should carefully evaluate the advantages of tax-free capital gains against the potential costs (including double taxation of dividends) of operating as a C corporation. Consider consulting with a qualified tax professional to discuss your specific situation and potential tax mitigation strategies.

Sidebar: Keep your estate plan limber

Last year’s One Big Beautiful Bill Act made the $15 million gift, estate and generation-skipping transfer (GST) tax exemptions permanent under current law, subject to potential future legislative changes and annual inflation adjustments. For now, this provides greater certainty in estate planning. However, because Congress could change the exemption in the future, you might want to take steps to improve your estate plan’s flexibility. One potential option is to use an irrevocable trust that removes assets from your estate but gives your trustee (or a “trust protector”) the authority to take actions that would bring the assets back into your estate. Why? Your trustee might determine that doing so would be more tax-efficient under the circumstances. Other potential tools for improving estate plan flexibility include special power of appointment trusts, limited powers of appointment and disclaimer trusts.

Important Disclosures

Investment advisory services offered through Planned Financial Services, LLC, dba Return on Life Wealth Partners, an SEC-registered investment adviser. Registration does not imply a certain level of skill or training.

The views expressed are current as of the date of publication and are subject to change without notice. The strategies and concepts discussed are provided for informational purposes only and may not be suitable for all individuals. This material is not intended as specific investment, tax, or legal advice. Individuals should consult their tax and legal professionals regarding their specific circumstances. Federal and state tax laws are subject to change and may affect the applicability or impact of the strategies discussed.

For more information about our services and regulatory disclosures, please see our Form ADV at www.returnonlifewealth.com/additional-disclosures.