Qualified Small Business Stock under Sections 1202 and 1045.

Section 1202 provides that non-corporate taxpayers may exclude gain from the sale of Qualified Small Business Stock from federal income tax. For stock issued after July 4, 2025, the exclusion is capped per issuer at the greater of $15 million or 10 times the investor's adjusted basis in the stock. Stock issued on or before that date remains subject to the prior $10 million cap.

Under the 10x basis alternative, an investor with a $5 million basis in qualifying stock may, if the exclusion is otherwise available, exclude gain of up to $50 million. Gain excluded under Section 1202 is also excluded from the 3.8% net investment income tax.

State tax treatment varies. Some states conform to the federal exclusion, while others, including California, do not. New York generally conforms. State treatment should be confirmed with a qualified advisor.

Section 1202 imposes four principal requirements, each of which generally must be satisfied for stock to qualify.

First, the issuer must be a domestic C corporation; stock in S corporations, LLCs taxed as partnerships, and foreign entities does not qualify. Second, the stock must generally be acquired at original issuance, directly from the issuing corporation in exchange for money, property, or services, rather than purchased from another shareholder. Third, the corporation's aggregate gross assets must not exceed the statutory ceiling immediately before and immediately after issuance: $75 million for stock issued after July 4, 2025, and $50 million for stock issued on or before that date. Fourth, the corporation must use at least 80% of its assets in the active conduct of a qualified trade or business.

The qualified trade or business requirement excludes certain service businesses, including those in health, law, financial services, consulting, and hospitality, as well as banking, farming, and extraction activities. Technology, manufacturing, Medtech device companies, and most product-based businesses generally qualify. Tech-enabled services companies require careful, fact-specific analysis to determine eligibility.

The One Big Beautiful Bill Act (OBBBA) enacted the most significant amendments to Section 1202 since 2010. These amendments apply only to stock issued after July 4, 2025. Stock issued on or before that date remains subject to the prior rules. Investors holding stock issued both before and after that date hold two distinct categories of Qualified Small Business Stock, which must be tracked separately for purposes of applying the applicable exclusion rules.

The OBBBA made three principal changes. The per-issuer exclusion cap increased from $10 million to $15 million, subject to inflation indexing after 2026. The gross asset ceiling increased from $50 million to $75 million, also subject to indexing, extending eligibility to a broader range of later-stage companies. In addition, the prior five-year holding period requirement was replaced with a tiered exclusion schedule based on holding period.

Under current law, the portion of gain not excluded at the 50% and 75% tiers is subject to a 28% federal tax rate, plus the 3.8% net investment income tax, resulting in the effective rates set forth above. Stock issued on or before July 4, 2025 generally requires a five-year holding period for any exclusion to apply.

Section 1045 provides that a taxpayer who sells Qualified Small Business Stock held for more than six months, but who has not reached a desired holding period tier, may defer recognition of gain by reinvesting the proceeds in other Qualified Small Business Stock within 60 days of the sale. Under Section 1045, the holding period of the original stock generally tacks onto the replacement stock, so that the holding period continues to run toward the applicable exclusion tier.

The requirements of Section 1045 are strictly construed. The 60-day period runs from the date of sale, not from the date proceeds are received. The full amount of proceeds, not merely the gain, generally must be reinvested to defer the entire gain. The election is made on the taxpayer's return for the year of sale. The replacement stock must itself qualify as Qualified Small Business Stock at issuance, which requires identifying a qualifying C corporation able to complete a closing within the 60-day period.

Satisfying this requirement depends on identifying an issuer prepared to close within the applicable window. Investors reinvesting under Section 1045 should confirm directly with the issuer whether it can complete a closing inside the 60-day period.