Section 1202 Under the OBBBA – Pale Ale to IPA

For craft beer drinkers, IPA (i.e., India Pale Ale^[1]) has seemed the preferred style for some time.  IPA is really just a standard pale ale that has been modified by adding more barley to increase the alcohol content, and more hops to increase the hoppy flavor and bitterness.

And so it is with Internal Revenue Code Section 1202 under the One Big Beautiful Bill Act (OBBBA), passed on July 4, 2025.  Section 1202 has been around for decades and allows shareholders holding Qualified Small Business Stock (QSB Stock) to exclude capital gain on the sale of their stock.  As we first discussed in a Tax Blog post from 12/11/2020,^[2] shareholders in qualifying corporations can use Section 1202 to greatly reduce their tax liability when they sell their company.  As pale ale is modified to produce IPA, the OBBBA has modified the provisions of Section 1202 to make it more potent.

Pre-OBBBA Section 1202

Section 1202, originally enacted in 1993, has allowed shareholders of certain C corporations to exclude 100% of capital gain recognition upon the sale of their stock (with lesser percentages for stock issued during certain periods prior to 2010).  As we pointed out in our previous Tax Blog post, pass-through entities such as LLCs and S corporations have grown increasing popular.  But if the exit strategy of a business is taken into consideration, it might be worth considering a C corporation because of the advantages offered to the shareholders by Section 1202.

The modifications to Section 1202 brought on by the OBBBA apply only to stock issued after July 4, 2025.  For all other QSB Stock, the following provisions of Section 1202 continue to apply:

• QSB Stock is stock that the shareholder received in an original issuance by a C corporation which qualifies as a Qualified Small Business (QSB).
• For a corporation to qualify as a QSB:
  • the value of the “aggregate gross assets” of the corporation (i.e., the amount of cash and the aggregate adjusted bases of other property held by the corporation) cannot exceed $50,000,000 at any time before, and immediately after, the issuance of the QSB Stock; and
  • at least 80% by value of the corporation’s assets must be used in a “qualifying trade or business” (i.e., a trade or business other than providing professional services, and excluding certain other business listed in Section 1202).
• To qualify as QSB Stock, the shares must be held for more than 5 years by the shareholder.
• The maximum amount of gain excluded is the greater of: (i) $10,000,000, reduced by prior exclusions with respect to the same corporation, and (ii) 10 times the shareholder’s basis in QSB Stock disposed of in the same year.

OBBBA Modifications to Section 1202

Holding Period Phase-In.  Prior to the OBBBA, a shareholder of QSB Stock was required to hold such stock for more than 5 years in order to exclude any gain from the sale of such QSB Stock.  For QSB Stock issued after July 4, 2025, the shareholder is required to hold such stock for a minimum of 3 years to exclude 50% of the gain, 4 years to exclude 75% of the gain, or 5 or more years to exclude 100% of the gain from the sale of such QSB Stock.  This “phased-in” holding period requirement alleviates the all-or-nothing nature of the 5-year holding period.

Increase in the Size of a QSB.  Prior to the OBBBA, to qualify as a QSB, a corporation’s aggregate gross assets could not exceed $50,000,000 at any time before and immediately after the issuance of the QSB Stock. For QSB Stock issued after July 4, 2025, this number has been increased to $75,000,000, subject to an inflation adjustment for taxable years beginning after 2026.  This increase in size for eligible corporations will allow shareholders from more “middle-market” companies to take advantage of Section 1202.

Increase in the Amount of the Gain Exclusion.  Prior to the OBBBA, the maximum amount of gain exclusion under Section 1202 was the greater of $10,000,000 and 10 times the adjusted tax basis of the sold QSB Stock. For QSB Stock issued after July 4, 2025, the first prong of the calculation was modified—the QSB Stock gain exclusion is increased to $15,000,000, subject to an inflation adjustment for taxable years beginning after 2026. The “10 times the adjusted tax basis” prong of the calculation remains unchanged and may still be useful in some situations.

The Bottom Line

The OBBBA has modified the gain exclusion provisions of Section 1202 for QSB Stock to make the provisions available to more corporations, and to provide increased benefits to shareholders.

[1]  The designation “India Pale Ale” comes from the 19^th century, when India was a British colony.  The British troops in India wanted their pale ale from England.  In order to preserve the pale ale during its long voyage to India around the Cape of Good Hope, the brewers in England added more hops and increased the alcohol content, both of which acted as preservatives.

[2]  Section 1202 Qualified Small Business Stock Benefits Revisited – Boutin Jones Inc.