Paul Lee’s presentation at the 60th annual Heckerling Institute on Estate Planning, “Scratching the 7 Year Itch: Quantum QSBS Exclusions,” focused on the changes to Internal Revenue Code Section 1202 qualified small business stock following the passage of the One Big Beautiful Bill Act and the resulting increase in both planning opportunities and potential pitfalls. Throughout the week, presenters approached the challenge of abbreviating the Act in a myriad of ways, among the most creative of which was Lee’s “OBuBBA.”
The Internal Revenue Service has provided very little guidance regarding IRC Section 1202, and as Lee notes, many of the changes brought by OBBBA are “brilliant concepts, executed terribly.” In essence, the OBBBA did little to dispel the existing fog around Section 1202 and instead created new gray areas that require clarification. The IRS has added Section 1202 regulations to its 2026 priority guidance list, and Lee anticipates that this guidance may limit some currently available planning opportunities.
Major Changes to Section 1202
The OBBBA made substantive changes to the holding period, applicable dollar limit (per-taxpayer limitation) and aggregate gross asset requirements of Section 1202. Lee suggests that many of these changes were rushed and don’t necessarily achieve their desired results as drafted.
Pre-OBBBA, the holding period for QSBS was five years, with up to 100% exclusion for eligible gain (depending on the date of acquisition). The OBBBA modified Section 1202(a)(5) to introduce a tiered system for QSBS acquired after July 4, 2025, where 50% of the eligible gain is excludable at three years, 75% at four years and 100% at five years.
The OBBBA also increased the Section 1202(b)(1)(A) applicable dollar limit on eligible gain exclusion from $10 million per taxpayer to $15 million per taxpayer, indexed for inflation. Any exclusion used before the passage of the OBBBA will be counted against the increased exclusion amount; the taxpayer can’t “double dip.” The 10 times aggregate adjusted basis rule of Section 1202(b)(1)(B) remains unchanged.
Finally, the Section 1202(d)(1)(A) aggregate gross asset requirement of $50 million was increased to $75 million, also indexed for inflation.
Areas for Clarification
Acquisition date. Per Section 1202(a)(6)(B), the “acquisition date” of stock acquired after July 4, 2025 will be determined with reference to IRC Section 1223, which governs the contribution of property to a corporation in exchange for shares and provides for the tacking of holding periods. This may create uncertainty around the correct acquisition date and holding period for QSBS. Taxpayers may be led to believe that they can take property held in excess of five years, contribute it to a C corporation (C corp) and be immediately eligible for QSBS status with a full 5-year holding period. Practitioners are advised to monitor this issue on behalf of their clients. The American College of Trust and Estate Counsel has submitted comments to Congress and the Treasury requesting that the OBBBA be modified to provide that the acquisition date of QSBS not be determined with reference to Section 1223, which would bring it in line with IRC Section 1045 (governing the rollover of gain from one QSBS to another).
Inflation adjustment. While the annual inflation adjustment to the $75 million aggregate gross asset requirement is effective for stock issued after July 4, 2025 and is determined with reference to tax year 2025 per the text of Section 1202(b)(4), the adjustment itself only becomes effective for “any taxable year beginning after 2026.” This means a taxpayer may begin using the inflation increase only in 2027. Lee believes one of these years is incorrect and will ultimately be changed.
The same “any taxable year beginning after 2026” language appears in the Section 1202(b)(5) language governing the inflation adjustment to the $15 million applicable dollar limit, but because the new limit only applies to stock issued after July 4, 2025, which meets a minimum 3-year holding requirement, this language won’t impact the taxpayer.
No increase once limit reached. New Section 1202(b)(5)(B) provides that a taxpayer who exceeds the applicable dollar limit of Section 1202(b)(1)(A) won’t be eligible to use the inflation adjustment the following year. Lee believes that Congress didn’t intend this result and that it will likely be corrected.
Retroactive aggregate gross asset requirement. For stock issued after July 4, 2025, the Section 1202(d)(1)(A) requirement that the aggregate gross assets of the corporation not exceed $75 million is retroactive to the original 1993 effective date of the IRC section. As a result, stock that might not previously have qualified for the QSBS exclusion may now be eligible. As with the inflation adjustment issues, Lee believes clarification may be forthcoming.
IRC Sections 174A and 168(k) and the Aggregate Gross Asset Requirement
Two of the OBBBA’s other notable changes involved the availability of immediate expensing for certain items. IRC Section 174A permanently repealed the capitalization regime for domestic research and experimental expenditures incurred after Dec. 31, 2024. This means that such expenditures, including salaries, may now be immediately expensed. Further, the OBBBA brought back IRC Section 168(k), which permits 100% bonus depreciation of qualified business property – including chips, data farms and similar equipment – with a recovery period of 20 years or less. As a result, their value won’t be capitalized and won’t contribute to the corporation’s inside basis.
These changes are important to the QSBS regime because Section 1202’s definition of “aggregate gross assets” doesn’t correspond, as one might think, to the company’s value. Instead, it’s a reflection of the tax basis inside the corporation at the time the stock is issued, specifically “the amount of cash and the aggregate adjusted bases of other property held by the corporation.”
In addition, Section 1202(d)(2)(B) clarifies that the adjusted basis of property contributed to a corporation will be equal to its fair market value at the time of contribution.
Packing is the New Stacking
Lee believes that the biggest opportunities in QSBS planning may now be found with “packing” – increasing the basis of qualifying stock to take advantage of the 10-times basis exclusion of Section 1202(b)(1)(B). With the new $75 million aggregate gross asset requirement, a taxpayer could potentially exclude up to $750 million of gain.
Conversion. The best opportunities for packing may arise from the conversion of a pass-through entity to a C corp. There are several ways to convert from a pass-through entity to a C corp, including “assets over,” which is the default under the check-the-box regulations, “assets up” and “interests up.” While each involves creating a corporation and liquidating a pass-through, they reach different results in terms of tax basis at the corporate and owner level, which may affect a company’s ability to meet the aggregate gross asset requirement.
Goodwill. In general, appraisers are now more open to including goodwill in the valuation of a corporation’s aggregate gross assets.
Division of pass-through entity. Where a pass-through entity owns intellectual property (IP) that’s used to support an operating business, Lee suggests considering dividing the entity to isolate the IOP in one pass-through and the operating business in another. A properly structured division is a tax-free event under the partnership rules, even where there’s debt. The IP entity may then license its property to the operating business entity. By structuring a limited license with a term and/or domestic restriction, value may be shifted between the IP and operating entities, which may then convert to C corps to meet the QSBS requirements.
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