H.R. 1 Expands QSBS Exclusions: Key Updates to Section 1202

The Reconciliation Bill -H.R. 1 - has introduced transformative changes to Section 1202 of the Internal Revenue Code which covers the exclusion of gain from the sale or exchange of Qualified Small Business Stock (QSBS). These updates significantly broaden eligibility, raise cap limits, and introduce a tiered gain exclusion, providing more flexibility and tax-saving opportunities for investors.

The QSBS gain exclusion allows non-corporate taxpayers to exclude a portion of capital gains from the sale of stock in a qualified C corporation if the stock is held for a certain amount of time. Prior law, which still applies to stock acquired on or before July 4,2025, required a 5-year holding period and limited the exclusion to the greater of $10 million or 10 times the adjusted basis. For qualifying stock acquired after July 4, 2025, the new rules divide gain exclusions into three tiers based on the holding period: 50% exclusion for QSBS held for at least 3 years, 75% exclusion for QSBS held for at least 4 years, and 100% exclusion for QSBS held for at least 5 years. The maximum gain exclusion is increased to the greater of $15million or 10 times the adjusted basis for QSBS acquired after July 4, 2025.

QSBS remains defined by several key criteria, which also changed under H.R. 1. Under previous tax law, the issuing corporation must be a domestic C corporation with tax basis in its gross assets not exceeding $50 million at all times before and immediately after the stock is issued. Under H.R. 1, this was raised to $75 million. Previous law and new law both require at least 80% of the corporation’s assets to be used in an active trade or business and excludes specific sectors like law, healthcare, finance, engineering and hospitality.

As an example, a qualifying taxpayer acquired QSBS on July 5^th, 2025 for $5 million, held it for 4.5 years, and then sold it for $45 million, realizing a gain of $40million. Since the holding period was at least 4 years but less than 5 years, the taxpayer can exclude up to 75% of the gain - subject to the limitation of the greater of $15 million or 10 times the basis. The greater of the two parameters is $50million (ten times the original basis of $5 million). In this example, the taxable gain would be $10 million – the original gain of $40 million is reduced by 75% ($30 million) to arrive at $10 million. Because the exclusion of $30million does not exclude the limitation of $50 million mentioned above, the taxpayer can exclude the entire $30 million.

Section 1202 of the tax code provides significant tax saving opportunities to qualified investors and H.R. 1 expands these. If you are interested in investing in QSBS or implementing changes to your business to qualify, our tax advisors are ready to help.