QSBS Planning Under the OBBBA

The One Big Beautiful Bill Act (OBBBA) is a sweeping legislation initially introduced in the House of Representatives on May 20, 2025, and eventually signed into law on July 4, 2025. The OBBBA expanded aspects of Section 1202 of the Internal Revenue Code, which provides certain tax benefits to holders of Qualified Small Business Stock (QSBS). This article will provide a brief overview of Qualified Small Business Stock and the concept of “stacking” with trusts. Finally, it will summarize the key enhancements made to Section 1202 under the OBBBA. 

A Brief Overview of Qualified Small Business Stock

Section 1202 of the Internal Revenue Code was enacted via the 1993 Revenue Reconciliation Act (RRA) to encourage and incentivize taxpayers to invest in certain small businesses, at the time allowing for an exclusion of up to 50% of the capital gains associated with the sale of stock of those businesses from an owner’s federal taxes.

In 2010, the Small Business Jobs Act (SBJA) increased the exclusion available to taxpayers from 50% to 100%, meaning each taxpayer would be able to exclude up to $10 million of capital gains on the sale of qualifying stock acquired after September 27, 2010 (the date the bill was signed into law), provided certain conditions were met.

The stock being sold must meet the definition of “Qualified Small Business Stock” (commonly referred to as QSBS or Section 1202 Stock). QSBS is defined under the Internal Revenue Code, 26 USC §1202(c)(1), as any stock in a qualified small business “acquired by the taxpayer at its original issue … (i) in exchange for money or other property … or (ii) as compensation for services provided to such corporation…”. 

Under the SBJA, a “qualified small business” was defined as a domestic C corporation whose aggregate gross assets did not exceed $50,000,000 prior to issuance or immediately after issuance of the stock (taking into account amounts received in the issuance). 

The business also had to be an active business, and operate within a particular sector. 26 USC §1202(e)(1)(A) requires that “at least 80 percent (by value) of the assets of such corporation are used by such corporation in the active conduct of 1 or more qualified trades or businesses.” For more information, see Tony Nitt’s article on managing QSBS status and working capital.

Section 1202 enumerates the proscribed industries, including trades or businesses involved in personal services (health, law, engineering, architecture, accounting, performing arts, actuarial sciences, financial or brokerage services, performing arts, consulting, athletics); banking, insurance, finance, or leasing; farming and mining; and hospitality services (operating a hotel or restaurant). The IRS, through various private letters rulings and chief counsel memoranda, has provided guidance as to which sectors qualify for the exclusion and which companies may qualify notwithstanding that the company appears to be connected to one of the proscribed industries noted above. 

The final requirement under the SBJA was the stock had to be held by the shareholder for a period of five years before the shareholder could sell the stock. The inception of this period depended on how the stock was acquired.

QSBS Stacking with Trusts

The concept of QSBS “stacking” originates from the $10 million capital gain exclusion in Section 1202 being available to each taxpayer, allowing individuals to “stack” the exclusion benefits by gifting eligible stock to other taxpayers who can also avail themselves of the exclusion on the stock gifted to them. Under Section 1202, a person gifted Qualified Small Business Stock is treated as having acquired the stock in the same manner as the individual who gifted them the stock and their holding period for purposes of Section 1202 begins when the transferor’s holding period began.

The ability to stack QSBS exclusion benefits extends to non-grantor trusts, that is, trusts that are separate entities over which the grantor has relinquished sufficient control so as to cause the trust to be its own separate taxpayer. Thus, if structured properly, a taxpayer can create various non-grantor trusts and fund each of them with gifts of Qualified Small Business Stock, with each trust able to exclude up to $10 million of capital gains on the sale of such stock. 

Non-grantor trusts can take various forms depending on the estate planning needs of an individual. One type of trust commonly used in QSBS stacking is the incomplete gift, non-grantor trust, which is drafted so that the grantor gives up any power or control that would cause the trust to be taxed as a grantor trust for federal income tax purposes, but retains sufficient powers so that any gifts made by the grantor to the trust are considered “incomplete” gifts, causing the trust assets to be includible in the grantor’s estate. This provides an added benefit of allowing the trust(s) to receive a basis step up when the grantor dies, which is particularly beneficial if the stock has substantially increased in value (or will likely substantially increase in value). Even if the gift is considered incomplete from an estate tax perspective, it can still qualify as a gift for purposes of Section 1202.

When an incomplete gift, non-grantor trust is established in Delaware, with a Delaware resident trustee such as Commonwealth Trust Company, the trust obtains a fun acronym (the “DING trust”) while also receiving the added benefit of not being taxed in Delaware on any sale of qualifying stock to the extent there are no beneficiaries residing in Delaware. 

The result is a trust that can (i) exclude up to $10 million of federal capital gains tax on the sale of stock in each qualified small business held by the trust, (ii) eliminate state income tax imposed on the sale of that qualified stock to the extent there are no trust beneficiaries living in Delaware (assuming the trust is structured to avoid paying state income tax in other jurisdictions), (iii) include the grantor as a discretionary beneficiary, and (iv) receive a step up in basis upon the Grantor’s death.

It should be emphasized that QSBS planning with trusts requires a complex navigation of federal and state tax laws. It is therefore highly recommended that anyone who may hold QSBS stock and is contemplating the sale of such stock engage an attorney who is experienced in such matters. For example, careful drafting is needed to ensure the provisions of each trust are not substantially identical to each other in the view of the IRS, who may invalidate such trusts.

QSBS Under the OBBBA 

This brings us back to the OBBBA, which made some substantial changes to Section 1202, creating additional planning opportunities for QSBS shareholders. A summary of those changes is provided below.

First, the holding period requirement, which was previously set at five years, has been changed to a tiered structure, as outlined in 26 USC §1202(a)(1)(B) and (a)(5). For any qualified small business stock acquired on or after July 5, 2025, a shareholder can sell the qualified stock after holding it for three years and obtain a 50% exclusion on the federal capital gains tax on the sale. After holding the stock for four years, a shareholder can exclude up to 75% of the capital gains incurred on the sale. The full 100% exclusion still applies for any stock held for more than five years. 

A second significant change involves the amount available to shareholders for exclusion. As noted in 26 USC §1202(b)(4)(B), the $10 million capital gains tax exclusion has been increased to $15 million for any stock acquired after July 5, 2025, subject to inflation adjustments beginning in 2027.

Finally, a change was made to the definition of a “qualified small business” which will substantially increase the number of businesses that meet the threshold requirements. The OBBBA increased the “gross asset” value limit from $50 million prior to or immediately after issuance of such qualified stock to $75 million for any stock acquired after July 5, 2025, also subject to inflation adjustments beginning in 2027, provided the value of such stock did not exceed $75 million at any time on or after the enactment of the RRA.

The changes to Section 1202 under the OBBBA have expanded the pool of companies who are considered qualified small businesses and substantially increased the tax benefits available to shareholders of those companies. These changes are creating more opportunities for shareholders and their attorneys to employ the use of trusts in favorable trust jurisdictions for enhanced federal and state tax savings. Reach out to Commonwealth Trust Company to discuss how we can partner together on this planning.

Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.