Breaking down the OBBBA: How Section 1202 creates opportunity for existing businesses

Section 1202 of the Internal Revenue Code is an increasingly powerful tax incentive for founders, investors and established businesses seeking to start, acquire or sell a business. The One Big Beautiful Bill Act (OBBBA), effective July 4, 2025, expanded these benefits. Now, company leaders should assess whether a C corporation (C corp) structure – and the ability to issue qualified small business stock (QSBS) – meets their long-term growth and exit planning goals.

This article outlines QSBS fundamentals, explains how the OBBBA changed them, and offers strategic C corp guidance for both existing and new businesses.

What QSBS is and why it matters

QSBS is stock issued by a C corp that meets specific requirements under Section 1202, effective on or after July 4, 2025:

• Company size: The company’s assets can’t exceed $75 million in value any time before or immediately after stock issuance.
• Active business: At least 80% of assets must be used in an eligible trade or business, such as manufacturing, R&D or e-commerce. Most personal services, financial services, farming and hospitality businesses don’t qualify. 
• Original issue: The stock must be acquired directly from the company in exchange for cash, property (other than stock) or services.

Who can own QSBS

QSBS eligibility rules are key to planning, especially for companies considering conversion or owners evaluating succession strategies involving gifts or trusts. To qualify for the Section 1202 gain exclusion, the stock must be acquired at original issuance by an eligible shareholder. Eligible shareholders include U.S. citizens or resident individuals, as well as certain pass‑through entities — such as partnerships, LLCs taxed as partnerships, S corps, and trusts — as long as the company directly issues the stock and any gain flows to individual taxpayers. C corps and tax‑exempt entities are not eligible shareholders.

Why QSBS matters for existing businesses

The main benefit of QSBS is the eligibility to avoid capital gains tax on a qualifying stock sale, up to the greater of $15 million or 10 times the shareholder’s basis. For example, excluding $15 million of gain at a 20% long-term capital gain rate yields at least $3 million in federal tax savings. There is additional potential state tax savings if the state conforms to federal treatment of QSBS or Net Investment Income Tax (NIIT), depending on the taxpayer’s income level.

Since the exclusion limit applies on a per-company, per-taxpayer basis, owners anticipating gains over this limit may consider gifting QSBS shares to family members or eligible trusts. This can expand the exclusion and multiply its limit.

Even businesses currently structured as partnerships, S corps or LLCs may benefit from converting to a C corp to start the QSBS holding period. While conversion requires careful planning, restructuring now allows future value appreciation to qualify for the Section 1202 exclusion upon QSBS sale or redemption.

How the OBBBA changed QSBS

The OBBBA created two separate QSBS regimes based on the date of stock issuance. These regimes are not interchangeable. QSBS issued before July 4, 2025 is subject to the original Section 1202 rules, but QSBS issued on or after this date follows the new OBBBA rules.

• Pre-OBBBA QSBS: 
  • $50 million gross asset threshold
  • $10 million gain exclusion cap
  • Five‑year holding period requirement
• Post-OBBBA QSBS: 
  • $75 million gross asset threshold
  • $15 million gain exclusion cap
  • New graduated exclusion schedule

These new provisions are discussed in further detail below.

Less restrictive gross asset threshold

The OBBBA raised the gross asset threshold from $50 million to $75 million for QSBS issued on or after July 4, 2025, with inflation adjustments starting in 2027. The tax basis of assets on the balance sheet determines the threshold. Fully or partially depreciated assets may help a company stay below this limit. Contributed assets must be valued at their contribution-date value, including any built-in gain.

Growing companies anticipating significant appreciation should evaluate how this expanded threshold may make a C corp more attractive, especially given its current 21% federal corporate tax rate.

Higher caps on tax-free gain

The OBBBA increased the exclusion cap on the sale of QSBS to $15 million, up from $10 million, for stock issued on or after July 4, 2025. Indexing for inflation will begin in 2027. Most U.S. states practice “rolling conformity,” meaning they adopt federal policies at the state level, including QSBS tax exclusion treatment.

The 10-times basis limitation remains unchanged. Shareholders with basis above $1.5 million may be able to exclude more than the $15 million exclusion cap.

Graduated exclusion schedule

The OBBBA created a new graduated exclusion schedule for gains on the sale of QSBS. Under the pre-OBBBA rules, stock issued prior to July 4, 2025 was subject to a five-year “cliff” holding period – with no exclusion applied if the stock was held for less than five years. The new exclusion schedule for QSBS acquired after July 4, 2025 is based on the following holding periods:

• 3 years: 50% gain exclusion
• 4 years: 75% gain exclusion
• 5 years: 100% gain exclusion

While these holding periods define the gain portion fully excluded from taxation, there may also be opportunities to defer recognition of non-excluded gain on the sale of QSBS. This potential deferral is subject to specific reinvestment rules under Section 1045, which are outside of this article’s scope.

Strategic considerations for businesses

Existing businesses

• Evaluate entity structure: Consider whether converting to a C corp aligns with your succession or exit strategy. This strategic planning should account for value appreciation, ownership succession and cash needs that may require careful tax planning.
• Model scenarios: Compare potential Section 1202 tax savings with the costs and implications of conversion, including the impact on annual operating income taxes.
• Document continued eligibility: Maintain detailed records of asset values, stock-issuance dates and stock certificates to substantiate QSBS status. Companies must also meet working-capital and active-business requirements for shareholders to qualify for the exclusion.

New businesses

Review your business plan, expected value trajectory and tax factors to determine whether forming as a C Corp – and positioning your company as QSBS-eligible from the start – supports long-term goals. In some cases, operating as a pass-through entity may be more beneficial initially, with a planned future conversion strategy.

Next steps

Connect with a Sikich professional to assess the benefits and trade-offs of converting to a C corp. Our team can help you model scenarios, evaluate potential tax savings and ensure QSBS rules compliance — giving you the insight for informed, long-term business planning decisions. Our experts can also guide you through business succession planning.

More OBBBA analysis can be found on our OBBBA resource hub.

About our authors

Dan Leffler, CPA, has over 16 years of experience supporting privately-held and family-owned organizations. His specializations include guiding owners through succession planning, protecting their legacy, maximizing value and enhancing the tax efficiency of transactions.

Joseph Chadbourne, CPA, has worked extensively in tax research since 2017. He specialized in partnership and C corp tax law, with particular focus on major IRS policy changes and their implications for clients’ tax planning.