The One Big Beautiful Bill Act Expands Favorable QSBS Treatment

On July 4, 2025, President Trump signed into law the One Big Beautiful Bill Act (the “Act”), after it was passed by Congress on July 3, 2025. Notably, the Act made significant and welcome changes from the perspective of startup company stockholders and venture capital investors to the qualified small business stock (“QSBS”) rules set forth in Internal Revenue Code (“Code”) Section 1202. In a nutshell, the changes modernize (by adjusting for inflation) and expand the already favorable tax treatment for QSBS under Code Section 1202. The Act also permanently reinstates elective expensing for qualifying domestic research and experimental expenditures that will likely help more startups in research and capital intensive sectors qualify for favorable QSBS treatment.

Overview of Pre-Act QSBS Rules

Under pre-Act Code Section 1202, taxpayers could exclude from gross income gain from the sale of QSBS. Generally, stock may qualify as QSBS if the following requirements are met:

• The stock is issued after August 10, 1993;
• The corporation issuing the stock is a domestic C corporation with aggregate gross assets that do not exceed $50 million;
• The issuing corporation is actively engaged in a qualified trade or business; and
• The stock is issued to the taxpayer at its original issuance either in exchange for property or money, or as compensation for services.

To claim the Code Section 1202 exclusion under pre-Act law, the QSBS holder must have held the QSBS for more than 5 years. The gain exclusion is 100% for QSBS acquired after September 27, 2010; 75% for QSBS acquired after February 17, 2009, and on or before September 27, 2010; and 50% for QSBS acquired on or before February 17, 2009.

Per taxpayer, the maximum amount of eligible gain with respect to the stock of a single issuer that may be taken into account under Code Section 1202(a) and therefore be subject to an exclusion is the greater of:

• $10,000,000 reduced by the aggregate amount of eligible gain taken into account by the taxpayer under Code Section 1202 in prior taxable years with respect to stock of the same issuer; or
• 10 times the aggregate adjusted bases of QSBS of that issuer disposed of by the taxpayer during the taxable year.

The rules described above still apply for QSBS issued prior to July 5, 2025.

Key Takeaways and Changes from the Act

The Act changes Code Section 1202 in three significant ways:

1. Aggregate Gross Asset Requirement

• • Under the Act, the aggregate gross asset requirement (“Gross Assets Test”) was increased from $50 million to $75 million, adjusted for inflation following the 2026 taxable year.

2. Per-Issuer Limitation

• • The per-issuer limitation was increased from the greater of $10 million or 10 times the adjusted bases of the QSBS to $15 million or 10 times the adjusted bases of the QSBS. The $15 million limitation will be adjusted for inflation following the 2026 taxable year.

3. Holding Period and Accompanying Exclusions

• • Under prior law, QSBS must be held for more than 5 years to receive exclusion treatment. The Act reduced the requisite holding period to at least 3 years for QSBS acquired after the date of enactment.
  • The Act provides a tiered approach that increases the exclusion percentage for eligible gain on QSBS acquired after the enactment of the Act, based on the holding period of the QSBS as follows:
    • Eligible gain from QSBS acquired after enactment and held for 3 years would receive a 50% exclusion.
    • QSBS acquired after enactment and held for 4 years would receive a 75% exclusion.
    • QSBS acquired after enactment and held for 5 years would receive a 100% exclusion.
  • The Act does not change the treatment of eligible gain from the disposition of QSBS which was acquired on or before enactment.
  • Further, the new rules do not generally apply to tax-free exchanges of QSBS or replacement transactions for QSBS pursuant to Code Section 1045.

Research and Experimental Expenditures (Code Sections 174 and 174A)

Under prior law enacted as part of the Tax Cuts and Jobs Act (“TCJA”), for tax years beginning after December 31, 2021, taxpayers were required to capitalize and amortize (instead of being able to immediately take a tax deduction with respect to) expenditures related to research and experimentation (“R&E Expenditures”). Capitalization and amortization of R&E Expenditures were required ratably over a five-year or 15-year period depending on whether the research and experimentation activity was domestic or foreign performed. Among other negative impacts, these TCJA changes contributed to many companies failing to satisfy the QSBS Gross Assets Test.

The Act reverses the R&E Expenditures regime enacted by the TCJA for domestically performed R&E Expenditures and allows immediate expensing and deductions of such for tax years beginning after December 31, 2024. Further, the Act permits certain eligible companies (generally having annual gross receipts not in excess of $31,000,000) to retroactively expense and deduct R&E Expenditures for domestic activity for taxable years beginning after December 31, 2021, by filing amended tax returns. Companies that are currently amortizing R&E Expenditures may also elect to accelerate the remaining unamortized amounts of such expenditures generally over a one- or two-year period. Foreign performed activity is still subject to a 15-year capitalization and amortization regime. 

The Act’s changes to Section 174 are especially favorable for early- and late-stage companies in research and capital intensive sectors like biotech and aerospace and defense, and should make it easier for such companies to meet the Gross Assets Test (which generally looks to adjusted tax basis for value determinations) particularly when considering the increase in the Gross Asset Test threshold from $50 million to $75 million.

What’s Next

We anticipate that the Act’s changes to the QSBS rules will allow an increasing number of venture-backed companies and their stockholders to qualify for favorable QSBS treatment, and that this change may provide tailwinds for tight financing markets in certain research intensive industries like biotech, aerospace, energy, transportation, and heavy industry.

The IRS and Treasury have yet to issue guidance on the Act, including addressing whether the retroactive changes to expense and deductions will permit previously ineligible companies to now qualify for QSBS treatment solely as a result of the new Section 174 rules. Companies on the cusp of the Gross Assets Test for prior taxable years nevertheless might consider revisiting their QSBS analysis in light of the Act’s recent changes and consider whether filing amended tax returns and taking immediate deductions (instead of capitalizing and amortizing) with respect to R&E Expenditures could be favorable in connection with issuances of stock in the last few years. Moreover, given the asymmetric approach to domestic and offshore research, companies with substantial offshore expenditures should evaluate whether onshoring certain research activities could further optimize their tax planning and QSBS eligibility.

Changes to Code Section 1202 will begin implementation for QSBS issued after July 4, 2025. QSBS issued prior to July 5, 2025, will still fall under the old rules in Code Section 1202. QSBS holders should consider planning with respect to sales of pre- and post-Act QSBS to maximize potential exclusions, particularly considering the increase in the gain exclusion cap from $10 million to $15 million. Our team would be pleased to continue the discussion and work with your team on understanding the new legislation and impacts.