Senate Would Expand the Qualified Small Business Stock Exemption

On June 16, 2025, the Senate Finance Committee (SFC) released legislative text for a bill that it proposed in response to the previous House bill named the One Big Beautiful Bill (BBB). The full Senate appears on track to consider changes to the BBB by the week of June 23, 2025. Withum previously summarized the key business and individual tax provisions of the BBB. Notably, the BBB did not include any provisions affecting section 1202, the section of the Internal Revenue Code dealing with qualified small business stock (QSBS). The SFC proposal would expand QSBS in many ways that are favorable for taxpayers. This is significant because proposals released by Congress in prior years would have reduced QSBS benefits rather than expand them.

Section 1202 provides a full or partial exclusion of capital gain realized on the sale of QSBS that is held for more than five years. There are various requirements in order for stock to constitute QSBS – there are some that apply to the Company that issued the QSBS (company-specific requirements), and there are some that apply to the shareholder that is selling the QSBS (shareholder-specific requirements). If all the requirements are met, then a selling shareholder can exclude from gross income capital gain in an amount equal to the greater of (i) a cumulative per-issuer amount of $10 million or (ii) an annual exclusion of 10 times the basis in the stock sold (for an exclusion amount up to $500 million). There are also specific tax strategies, like stacking and packing, that enable shareholders to magnify their QSBS tax benefits.

The exact exclusion percentage depends on the date a selling shareholder acquired the stock from the Company, rather than the date on which the stock is sold. The percentage options are 50%, 75%, and 100%, with the latter being applicable to QSBS acquired after September 27, 2010. No stock issued before August 11, 1993 can qualify as QSBS.

Section 70431 of the SFC proposal would provide for a tiered gain exclusion on a prospective basis. Instead of the current regime, which allows for an exclusion only after holding QSBS for more than five years, the SFC proposal would provide a 50% exclusion after three years, a 75% exclusion after four years, and a 100% exclusion after five years. This would expand the number of taxpayers that could benefit from a QSBS exclusion and not require them to go through the hoops of a qualified rollover under section 1045 if they sell before the five-year holding period requirement is met.

The SFC proposal would increase the cumulative per-issuer gain limit from $10 million to $15 million, indexed for inflation beginning in 2027. This would greatly expand QSBS benefits because, for most taxpayers, the $10 million limit is the effective cap on QSBS benefits (rather than the annual 10-times basis rule). Most start-ups are formed with a nominal amount of cash, which means the 10-times basis rule does not come into play. The annual 10-times-basis limit exceeds the cumulative $10 million limit only when a taxpayer’s basis exceeds $1 million. This typically arises after the incorporation of an ongoing business (i.e., a midstream incorporation) or the incorporation of a well-funded start-up, which is not that common.

The SFC proposal would increase the limitation ceiling on a corporation’s “aggregate gross assets” from $50 million to $75 million, indexed to inflation beginning in 2027. This, too, represents an expansion of QSBS because QSBS generally includes stock issued to shareholders only up to the point where a corporation’s aggregate gross assets do not exceed $50 million. If the proposal is enacted, QSBS will generally include stock issued before a company’s aggregate gross assets exceed $75 million.

Last, the SFC proposal would conform the gain limitation for married taxpayers filing separately to accommodate the increase in the cumulative per-issuer gain limitation from $10 million to $15 million, indexed for inflation. Currently, married taxpayers filing separately are each entitled to a $5 million exclusion, or one-half of the $10 million limit. The proposal would expand this to accommodate the $15 million exclusion amount, or $7.5 million to each spouse if they file separately. However, the proposal does not clarify the oft-discussed issue of whether married taxpayers filing jointly are entitled to a one cumulative per-issuer limit ($10 million), or two ($20 million, or $10 million for each spouse). If this is not clarified, some married taxpayers filing jointly are likely to claim a $30 million exclusion.

The effective date for the SFC proposal would be prospective – it would apply to stock issued or acquired, and to taxable years commencing on or after the date of enactment.

All in all, the SFC proposal would expand QSBS and increase its benefits. The proposal will now be considered by the full Senate, and possibly modified, before being sent to the House. The two chambers will then work to reach a compromise on the various provisions in their respective bills. That will be difficult given the likely differences and the various factions in the House that led to the compromises in the BBB. For example, the SFC proposal would not increase the current $10,000 state and local tax (SALT) deduction limitation to $40,000, as the BBB would, and not including the increased limit in the BBB is a non-starter for many House representatives (the so-called SALT Caucus) from high-tax states such as New York, New Jersey, Illinois and California. Compromise will be required, as evidenced by the SFC’s section-by-section summary of its proposal, which included a sentence stating that the SALT deduction cap “is the subject of continuing negotiations.”