Qualified Small Business Stock (QSBS) has existed for over 30 years. Launched under the auspices of Internal Revenue Code Section 1202, QSBS helps support the growth of small businesses by providing tax incentives for accredited investors and funds. Meanwhile, the Tax Cuts and Jobs Act (TCJA) of 2017 encouraged small businesses to change their legal structures so they could take advantage of corporate tax rate reductions and QSBS eligibility.
However, 2025 will be the year of tax reforms, especially with certain provisions of the TCJA set to expire. The question is whether these changes will impact the issuance, ownership, and sale of Qualified Small Business Stock.
QSBS Tax Issues: The Current Status
Before discussing future tax ramifications, let’s take a look at the current QSBS tax situation.
Section 1202—Tax Exclusions
Section 1202 of the Internal Revenue Code was enacted in 1993 to encourage investments in small businesses. Today, investors benefit from capital gains tax exclusions when they sell their QSBS stock—as long as they hold it for at least five years.
Here’s how this breaks down:
The exclusions are limited to whichever is greater:
- Stock valued at $10 million OR
- 10 times the stock’s aggregate adjusted basis when issued
Going further, investors receive these exclusions as long as the QSBS entity:
- Operates within a qualified trade or business under Section 1202 rules
- Doesn’t exceed $50 million in aggregate gross assets
- Is an active business entity
- Is structured as a C Corporation
TCJA—Cutting Corporate Taxes
The TCJA generated tax changes for businesses in areas including depreciation, credits, expensing, and deductions. One compelling shift focused on reducing the corporate income tax rate for C corporations from 35% to 21%. This incentivized smaller businesses to move from pass-through entity setups (like S Corporations or Limited Liability Companies) into C Corp status.
According to the U.S. Chamber of Commerce (USCC), 1.4 million small businesses were structured as C Corps in 2021. The USCC went on to say that most C Corps are small businesses. And these C Corps can issue QSBS as long as they meet the requirements listed under Section 1202.
The QSBS Crystal Ball: Possible Reforms?
Right now, the 2025 tax reforms mentioned don’t target QSBS. But changes have been made to the QSBS exclusions in the past. For instance, the exclusion amount was adjusted from 50% when Section 1202 was enacted to 75% in 2009. A year later, the exclusion amount increased to 100%, where it stands today.
However, the Build Back Better Act of 2021 included a reduction in the QSBS exclusion rate to 50% for:
- Taxpayers with adjusted gross income equal to or higher than $400,000
- Trusts and estates at all income levels
The House of Representatives passed Build Back Better. But the Senate failed to pass the bill in its then-current form. A year later, both the House and Senate passed a slimmed-down version of Build Back Better. The bill, the Inflation Reduction Act of 2022, didn’t include changes to the QSBS exclusions mentioned in Build Back Better.
Moving on, one question is what will happen as Congress targets the TCJA’s expiring provisions next year. Changes impacting corporations could include expensing, foreign-derived intangible income, and deduction limitations based on EBIT. The corporate income tax rate isn’t expected to change—when passed in 2017, it was considered permanent. But, as seen with Build Back Better, everything could be examined, including QSBS exclusions and corporate tax rates.
Will changes to Section 1202 also be on the table? Probably not. However, investors should keep in mind that if 1202 is targeted, tax reform actions could impact the following:
- Capital gain tax exclusion limits
- Changes in the gross assets threshold
Stay Up-to-Date
One thing we know for sure is that tax reform is on the table for Congress in 2025. What we don’t know right now is what those reforms will include.
Because of this, investors, business owners, funds, and other entities should closely monitor business and tax trends. One good way to do so is to follow CapGains and the QSBS Expert website for the latest updates on the 2025 tax reform and its potential impact on QSBS. Investors who stay informed are better prepared to handle possible tax changes while focusing on the best QSBS strategies.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.