New QSBS Holding Periods

We have previously written about qualified small business stock (QSBS) changes

proposed, and then enacted, in what is commonly referred to as the One Big Beautiful Bill Act (OBBBA).

The OBBBA made four, big taxpayer-friendly changes to QSBS, specifically (1)

shortening the time a taxpayer must hold QSBS to qualify for a gain exclusion from five to three years, (2) making it so that a corporation can still be considered “small” even if it has had more than $50M worth of assets, so long as asset value (as determined for QSBS purposes) hasn’t exceeded $75M prior to or immediately following the applicable stock issuance, (3) increasing the baseline exclusion amount from $10M to $15M, and (4) indexing the $75M and $15M amounts for inflation, so that they can increase each year.

This post focuses on the effects of the new QSBS holding periods.

To get the benefit of the new rules, the QSBS must be issued after July 4, 2025. QSBS issued before July 5, 2025, still must be held more than five years to potentially get exclusion benefits in a cash sale.

How do the rules work for stock issued after July 4? Generally,

• for QSBS held for at least three years but less than four, a seller can exclude up to 50% of gain on sale from income;

• for QSBS held for at least four years but less than five, a seller can exclude up to 75% of gain on sale from income; and

• for QSBS held for at least five years, a seller can exclude up to 100% of gain on sale from income.

  
  

But the change in law isn’t quite as good as it first appears.

When QSBS doesn’t apply, the highest federal income tax rate that applies to a sale of stock held for more than one year is 23.8%. When QSBS does apply, but the exclusion percentage is less than 100%, the gain that is not eligible for exclusion is taxed as high as 31.8% — made up of the 28% rate that also applies to “collectibles” and the 3.8% rate on net investment income.

In other words, if I can get a full 50% exclusion on gain, my effective federal tax rate may be half of the 31.8%, or 15.9%. Compare this to 23.8% if no benefit applied. The 15.9% is not as good as 11.9% (which is half of 23.8%), but still an improvement.

The other point of confusion we are seeing is what the 50% and 75% percentages apply to. Some think this means that they get to take 50% or 75% of

their gain limitation. For example, the baseline gain limitation for stock issued after July 4 is $15M. If at three years the stock is sold for $7M, in an ideal world the $7M would be fully excludible, since 50% of $15M (ignoring indexing) is $7.5M.

But that is not the case. Only 50% of the overall gain of $7M can be excluded, or

$3.5M.

Additionally, the cap is applied before the 50% or 75% calculation. Say that QSBS is sold for $30M gain at three years. If the 50% applied first, that would result in $15M of excludible gain, such that only the remaining $15M would be taxed for federal purposes.

But since the cap applies before the 50%, the $30M gain is first reduced to the $15M cap (ignoring inflation adjustments), such that only $7.5M, 50% of $15M, is excluded from income.

Maybe you or your company is experiencing FOMO, but taking the time to generally understand what the new version of QSBS offers may be important before choosing to upgrade.

Questions about how these changes might impact your business or investment? Contact Oak Ridge Tax Law Partners Chase Manderino or Martin de Jong to discuss.