If a small business owner needs a quick cash infusion to a keep a struggling operation afloat or funds for expansion, they may reach into their own pockets. Little-known tax benefit: The owner, or another investor, is eligible for a special tax break if they acquire “qualified small business stock” (QSBS) issued by the company. In short, any gain from a future sale of the tax could be 100% tax-free.
What’s more, this tax benefit was recently preserved and enhanced by the One Big Beautiful Bill Act (OBBBA). Now business owners have even more flexibility than before.
Starting point: The tax break for QSBS has gone through several iterations. Under prior law, the tax-free payoff was available to 50% of the gain from the sale of QSBS held at least five years. Among other requirements, the stock had to have been issued directly to the owner or provided by the original recipient of the shares.
After several law changes under Section 1202 of the tax code, the exclusion was permanently increased to 100%, subject to certain restrictions. For instance, the amount of gain allowed on a sale of QSBS acquired before enactment of the OBBBA is limited to $10 million. Similarly, the gain can’t exceed ten times the basis of QSBS stock sold during the year.
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Nonetheless, the tax savings for QSBS purchased before the OBBBA can be sizeable.
Example: Inez invested $1 million in QBSB in her company on July 1, 2022. If she holds the stock for at least five years—until July 2, 2027—she can sell it for up to $10 million without paying a penny of capital gains tax. As a result, Inez may realize a $9 million capital gain completely free of tax. Assuming a 20% tax rate on long-term capital gain, she can effectively save $1.8 million (20% of $9 million)!
The following requirements must be met to claim the 100% tax exclusion for QSBS:
- The stock must have been issued after August 10, 1993.
- The stock can’t be acquired in exchange for other stock.
- The issuing corporation must be a C corporation.
- At least 80% of the corporation’s assets must be used in the active conduct of a qualified trade or business.
- Certain businesses, such as those involving real estate or personal services (e.g., law, health, financial services, etc.), are excluded.
- The corporation can’t have more than $50 million in assets at the time the stock is issued.
Even better: The OBBBA provides additional tax benefits for QSSB issued after July 4, 2025. The three main provisions are as follows.
- 1. A partial tax exclusion may be claimed for QSBS owned for less than five years. The partial exclusion is 50% for stock held at least three years and 75% for stock held at least four years. It remains 100% for QSBS held at least five years.
- 2. Prior to the OBBBA, the limit on QSBS was the greater of $10 million or ten times the basis of the stock, as discussed above. The new law increases the dollar cap to $15 million.
- 3. The threshold used to qualify as a “small business” for purposes of the QSBS exclusion jumps from $50 million to $75 million.
Fall-back position: Finally, be aware of another potential tax break for investors in QSBS. No current tax is due on a gain from a sale of QSBS if the proceeds are rolled over into new QSBS within 60 days. Keep this tax break in your hip pocket.
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Tags: business stock, obbba, QSBS, Small Business, tax benefits, Taxes
