New and improved Section 1202: How could you benefit?

By Derek Bostrom, CPA, MBT, and Matt Ringwelski, CPA

The Section 1202 Qualified Small Business Stock (QSBS) exclusion has provided tax incentives for sellers of qualifying C corporations for decades. Now, recently enhanced by the One Big Beautiful Bill Act (OBBB), it’s getting more attention than ever.

 

Here’s what you should know about it.

 

What is the Section 1202 QSBS exclusion?

 

The Section 1202 QSBS exclusion was enacted in the early 1990s to encourage investment in small businesses. Under the new OBBB rules, it allows owners of qualifying C corporations to exclude whichever is greater on the sale of QSBS: up to of $15 million of gain or 10x their basis in the stock.

 

How do you qualify for the Section 1202 QSBS exclusion?

 

Qualifying for the QSBS exclusion is rarely black and white. A business’s ability to qualify will depend on several factors, including these five criteria:

 

Gross asset limitation: The company’s aggregate gross assets must not exceed $75 million immediately before and after the stock issuance. Per the OBBB, this threshold will be adjusted annually for inflation beginning in 2027.

 

Original issuance: For C corporation stock to be considered for QSBS exclusion, it must have been acquired at original issuance in exchange for money, property, or as compensation for services.

 

Holding period: Previously, QSBS was eligible for the gain exclusion only if it had been held for longer than 5 years. Now, the sale of QSBS issued after July 4, 2025, is eligible for the following gain exclusions:

 

• Up to 50% if held for longer than 3 years
• Up to 75% if held for longer than 4 years
• Up to 100% if held for longer than 5 years

 

This presents a significant opportunity for business owners, especially for owners of startups.

 

Active business requirement: At least 80% of the corporation’s assets must be used in the active conduct of a qualified trade or business.

 

Qualified trade or business: The Internal Revenue Code does not provide a specific definition for a qualified trade or business under Section 1202. It does, however, provide examples of activities that do not qualify:

 

• Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services
• Any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees
• Any banking, insurance, financing, leasing, investing, or similar business
• Any farming business (including the business of raising or harvesting trees)
• Any business involving mining or the production or extraction of oil and gas
• Any business of operating a hotel, motel, restaurant, or similar business

 

Does Section 1202 apply to established businesses?

 

If your business was started prior to the OBBB, it could still be eligible for Section 1202; however, the rules would be slightly different. The Section 1202 enhancements related to the OBBB apply only to C corporations established on or after July 4, 2025.

 

Can you transition your company to a C corporation so you can qualify?

 

The short answer: It depends. Regardless, changing your entity structure can be a complicated process that has both tax and legal consequences. It’s important to consult with your tax and legal advisors to see if an entity change would make sense for you.

 

Could you benefit from Section 1202?

 

Structuring your business as a C corporation has its downsides, but the Section 1202 QSBS exclusion offers a potential benefit that you shouldn’t ignore. If you think your business could qualify, it’s important to contact your tax advisor as soon as possible.

 

At Abdo, we’re here to shine a light on the benefits and dynamics of your entity structure and the eligibility criteria for Section 1202. We can guide you through the process of structuring your company in a way that maximizes your ability to qualify for Section 1202 and other tax benefits. We can also assist in evaluating your existing business’s eligibility for Section 1202 and advise on next steps.

 

To learn more about how Abdo can empower your business, contact us today.