QSBS after OBBBA: what the Section 1202 rewrite means for Texas business owners.

Section 1202 of the Internal Revenue Code is the closest thing to a free lunch in American tax law. It allows the founder of a qualifying small business, a domestic C corporation with under $50 million in aggregate gross assets at the time stock was issued, to exclude up to $10 million or 10 times their basis (whichever is greater) in capital gains from a sale of that qualified small business stock, federal tax-free, after a five-year hold. For founders of successful private companies, it has been the single most powerful exit-tax provision on the books since 1993.

On July 4, 2025, the One Big Beautiful Bill Act (OBBBA, P.L. 119-21) rewrote it.

The five-year hold is no longer mandatory, stock held three years now qualifies for a 50% exclusion, four years for 75%, five-plus years for the full 100%. The per-issuer cap rose from $10 million to $15 million, indexed for inflation starting in 2027. The aggregate gross assets ceiling rose from $50 million to $75 million, also indexed. The changes apply only to QSBS issued after July 4, 2025, which means founders now hold pre-OBBBA and post-OBBBA stock under entirely different rules.

For Texas business owners, specifically Texas-domiciled C corporations with Texas-resident shareholders, the OBBBA shift has uniquely strong implications. Texas conforms to federal Section 1202 treatment and has no state income tax, which means a 100% federal exclusion is a 100% effective exclusion. Combined with Senate Bill 29's codification of the business judgment rule and the new Texas Business Court, Texas now has a reasonable claim to be the most favorable jurisdiction in the country for holding QSBS and operating the underlying business. This article walks through what changed, why it matters more in Texas than elsewhere, and what founders should be doing now.

What Section 1202 does, 30 years of context

Section 1202 was enacted as part of the 1993 Omnibus Budget Reconciliation Act. The premise was straightforward: encourage equity investment in operating businesses by giving the holders of qualifying stock a partial capital gains exclusion at exit.

As originally drafted, the exclusion was 50%, half of the gain on a qualifying sale was excluded from federal taxable income, and the other half was taxed at a 28% rate. That 28% number would echo through the OBBBA changes thirty-two years later.

The provision was sharpened in two waves. The Small Business Jobs Act of 2010 raised the exclusion to 100% for stock acquired between September 27, 2010, and December 31, 2010. The Protecting Americans from Tax Hikes Act of 2015 made that 100% exclusion permanent for stock acquired after September 27, 2010, provided the stock met all the eligibility criteria and was held for more than five years.

The eligibility criteria are where Section 1202 has historically tripped people up. The issuing entity has to be a domestic C corporation. The shareholder has to be a non-corporate taxpayer, an individual, an irrevocable trust, certain pass-through entities. The stock has to be acquired at original issuance; buying stock from another shareholder doesn't qualify.

The corporation's aggregate gross assets can't exceed $50 million immediately before or after the stock issuance. At least 80% of the corporation's assets must be used in the active conduct of a qualified trade or business. And Section 1202 lists a long set of excluded trades or businesses, health, law, accounting, consulting, financial services, hotels, restaurants, farming, and others.

The combination of those rules has produced a tool that's powerful where it works and useless where it doesn't.

A Texas software company that incorporates as a C corporation, raises capital through original-issuance equity, stays under the asset threshold for the relevant testing periods, and reaches a successful exit five years later can deliver tens of millions of dollars in tax-free gain to its founder. A Texas law firm operating as a professional corporation, even an enormously successful one, gets nothing, because legal services are an excluded trade or business.

The OBBBA changes that matter, what's new for stock issued after July 4, 2025

OBBBA preserved the basic architecture of Section 1202, the C-corp requirement, the 80% active business test, the excluded business types, the original issuance rule. What changed is the math. Five substantive shifts apply to QSBS issued after July 4, 2025.

1. The five-year hold is no longer all-or-nothing. Stock held three years now qualifies for a 50% exclusion. Four years qualifies for 75%. Five-plus years gets the full 100%, as before. This is the largest practical change. Under the old rule, a founder who exited at year four, perhaps because the right offer arrived, got nothing under Section 1202. Under the new rule, the same exit captures 75% of the available exclusion. For founders who hold the full five years, the OBBBA didn't change the 100% exclusion at all. The pre-OBBBA reward stays in place. The new tiered structure simply adds optionality below it.

2. The per-issuer gain exclusion cap rose from $10 million to $15 million. Before OBBBA, a taxpayer could exclude the greater of (a) $10 million in lifetime gains from a single issuer, or (b) 10 times their adjusted basis. The new cap is the greater of $15 million or 10 times basis. For founders whose basis is small (most early founders), the meaningful number is $15 million per taxpayer per issuer. Starting in 2027, the $15 million number is indexed for inflation.

3. The aggregate gross assets ceiling rose from $50 million to $75 million. This is the threshold that determined whether an issuing corporation qualified as a "small business" at all. Under the old rule, a C corporation with $51 million in aggregate gross assets at the time of stock issuance was disqualified, even by a dollar. The new ceiling is $75 million, also indexed for inflation starting in 2027. The practical effect is that significantly larger growth-stage companies now qualify for QSBS treatment on stock they issue.

4. The new tiered exclusions are not AMT preference items. Under the prior 50%/75% exclusion regime (pre-2010), the excluded portion was an alternative minimum tax preference item, which clawed back some of the benefit for high-AMT taxpayers. That treatment does not reach the new tiered exclusions, because the Section 57(a)(7) preference applies only to stock acquired on or before September 27, 2010. The 50% and 75% exclusions are clean, no AMT add-back.

5. The effective date matters more than people realize. The new rules apply only to QSBS issued after July 4, 2025. QSBS issued on or before July 4, 2025, continues to be governed by the pre-OBBBA rules, five-year mandatory hold, $50 million asset ceiling, $10 million per-issuer cap. Founders who hold both pre-OBBBA and post-OBBBA stock in the same issuer have to track each block separately. Section 1202's acquisition-date carryover and tacking rules do not allow stock to be "refreshed" into the new regime through restructuring, stock dividends, or recapitalization. The acquisition date is the acquisition date.

Taken together, the five changes broaden the universe of companies that can issue QSBS, broaden the universe of taxpayers who hold QSBS that's eligible for some level of exclusion, and broaden the time window during which an exit captures meaningful federal tax benefit. They also create real complexity in tracking and timing decisions, most acutely for founders with both pre- and post-July 2025 stock.

Section 1202 mechanics: pre-OBBBA vs. post-OBBBA stock

	Pre-OBBBA Stock issued through July 4, 2025	Post-OBBBA Stock issued after July 4, 2025
Holding period structure	5 years (all-or-nothing)	3 yr: 50% / 4 yr: 75% / 5+ yr: 100%
Per-issuer gain cap	Greater of $10M or 10× basis	Greater of $15M or 10× basis (indexed from 2027)
Aggregate gross assets ceiling	$50M at issuance	$75M at issuance (indexed from 2027)
AMT treatment of partial exclusion	Preference item only for stock acquired on or before September 27, 2010 (7% of excluded gain)	Not a preference item
Rate on non-excluded portion within cap	28%	28% (unchanged)
Cross-block "refresh" via restructuring	Not allowed	Not allowed (unchanged)

The 28% rate detail most people miss

Section 1202's tiered exclusions sit on top of an unusual tax-rate rule that frequently surprises founders the first time they see it. When a taxpayer claims a partial exclusion under Section 1202, whether the new 50% tier, the new 75% tier, or one of the legacy 50%/75% tiers, the non-excluded portion of the gain is taxed at a special 28% capital gains rate. Not the standard 20% long-term capital gains rate. The portion of the gain that doesn't qualify for exclusion is taxed at 28%, plus the 3.8% net investment income tax for high earners, or 31.8% in total.

This is not a new rule, it's been on the books since Section 1202's inception in 1993, when the original exclusion was 50%, but it became dormant during the period when 100% exclusions were available for the only meaningful Section 1202 stock. OBBBA's reintroduction of the 50% and 75% tiers brings the 28% rate back into active play.

A worked example. Imagine a founder holds post-OBBBA QSBS in a single issuer with an adjusted basis of $200,000. Three years after issuance, the company is acquired for cash and the founder realizes a $20 million capital gain. Under the new rules, the founder's exclusion is the greater of $15 million or 10 times basis ($2 million), so the cap is $15 million. The three-year hold qualifies for a 50% exclusion. The taxpayer excludes 50% × $15 million = $7.5 million of gain. The remaining $7.5 million of gain within the cap, plus the $5 million of gain above the cap, is taxable.

The portion of gain within the cap that wasn't excluded, $7.5 million, is taxed at the 28% Section 1202 rate. The portion of gain above the cap, $5 million, is taxed at the standard long-term capital gains rate (20% federal, plus the 3.8% net investment income tax for high earners). The federal tax bill comes to roughly $7.5M × 31.8% (28% plus the 3.8% net investment income tax) = $2.385 million, plus $5M × 23.8% = $1.19 million, for a total federal tax of around $3.575 million on the $20 million gain, an effective federal rate of roughly 17.9%.

Compare that to the same founder holding the same stock for five-plus years instead of three. At five years, the entire $15 million cap is excluded at 100%. The taxable portion is just the $5 million of gain above the cap, taxed at 23.8%. Federal tax: $1.19 million on a $20 million gain. Effective federal rate: roughly 6%. The two extra years of patience save the founder roughly $2.4 million in federal tax. That's the price of trading the 100% exclusion for a 50% exclusion. The tiered structure is real and useful, but it's not free optionality.

Why this matters more in Texas

Section 1202 is a federal tax provision. The exclusion happens at the federal level. But state income tax is layered on top of federal income tax, and not every state conforms to the federal Section 1202 treatment. For founders thinking about an exit, state of residence at the time of the gain often matters more than the federal exclusion itself.

Texas conforms to federal Section 1202 treatment because Texas has no state income tax. Whatever the federal Section 1202 rules give a Texas-resident founder, Texas takes nothing back. A 100% federal exclusion is a 100% effective exclusion. A 50% federal exclusion at the new three-year tier means 50% of the federal gain is excluded, and the entire federal taxable portion is then taxed by Texas at zero percent. There is no state-level offset.

Several states actively diverge from federal Section 1202 treatment, applying their state income tax to QSBS gain regardless of the federal exclusion. A handful of others conform partially, with the conformity depending on facts. For a founder resident in a non-conforming state at the time of an exit, the federal exclusion does not change the state tax, the full gain is taxable at the state level. State of residence at the time of the gain therefore becomes a planning question that matters significantly.

The 2025 Texas governance overlay

The 2025 Texas governance overlay strengthens the picture. Senate Bill 29, signed by Governor Abbott on May 14, 2025 and effective immediately, codified the business judgment rule at Texas Business Organizations Code §21.419. Public Texas corporations are covered automatically; private corporations can opt in by including an affirmative election in their governing documents, such as their certificate of formation. SB 29 also allowed public corporations, and opt-in corporations with 500 or more shareholders, to set an ownership threshold of up to 3% for shareholder derivative actions, narrowed shareholder books-and-records inspection rights, and authorized jury waivers and exclusive forum-selection clauses in governance documents. The combined effect is a meaningfully more management-friendly governance regime than Delaware's, although Delaware responded in March 2025 by amending DGCL § 144 (Senate Bill 21) to add statutory safe harbors for controller-conflict transactions, which the Delaware Supreme Court upheld in Rutledge v. Clearway Energy Group on February 27, 2026.

The new Texas Business Court, operational since September 1, 2024 under House Bill 19, codified at Texas Government Code Chapter 25A, with House Bill 40 lowering the § 25A.004(d) threshold from $10 million to $5 million as of September 1, 2025 (the § 25A.004(b) threshold for governance claims was $5 million from the start), adds a specialized forum for the governance disputes that QSBS-issuing companies are most likely to face. Derivative actions, fiduciary duty claims, and TBOC-based actions involving publicly traded corporations all fall within the Business Court's jurisdiction.

The composite picture: a Texas-domiciled C corporation with Texas-resident founders, governed under SB 29's BJR codification, with disputes routed to the Texas Business Court, holding QSBS that qualifies for the OBBBA-expanded federal exclusions, in a state that takes nothing back at the state level. There is a defensible case that no other jurisdiction in the country currently combines federal QSBS treatment without state-level non-conformity drag and management-friendly governance the way Texas now does.

What changes for founders considering exits

Three behaviors change for founders holding or considering QSBS.

The three-year exit becomes a real option. Before OBBBA, a Texas founder considering a sale at year four had to choose between (a) accepting the offer and forfeiting Section 1202 entirely, or (b) waiting another year for the 100% exclusion to vest, hoping the offer survived the wait or another offer materialized. Under the new rules, the year-four exit captures a 75% exclusion. The year-three exit captures 50%. The decision moves from binary to gradient.

Strategic timing becomes more important, not less. When the choice was 100% or zero, timing was also binary, make sure you cross the five-year line before selling. The tiered structure introduces meaningful optimization questions. Between three and four years, the marginal benefit of waiting twelve months is the difference between a 50% exclusion and a 75% exclusion, a 50% increase in excluded gain. Between four and five years, the marginal benefit is the difference between 75% and 100%, a 33% increase. The slope of the benefit curve flattens as the holding period lengthens, and that has implications for how founders evaluate competing offers at different points in the holding period.

Pre-enactment QSBS stays under the old rules. Founders holding stock issued before July 4, 2025 cannot "refresh" that stock into the new tiered regime through restructuring, stock dividends, splits, or recapitalizations. The IRS treats those events as continuations of the original acquisition date. A separate stock issuance, in a separate corporation, after July 4, 2025, can qualify for the new rules, but the same stock in the same company cannot be reset. This means a founder with both pre- and post-July 2025 QSBS in the same issuer is holding two distinct tax assets that have to be tracked separately at exit. The caps are not additive. Gain excluded on the pre-OBBBA block, in the same year or earlier years, reduces the $15 million limit available to the post-OBBBA block under Section 1202(b)(4).

The four-year hold may be the new sweet spot for many founders. Year five remains the optimal holding period if the exit can wait. But for founders facing real liquidity questions or competing offers between years three and five, the 75% exclusion at year four is materially better than waiting an additional year for the 25-percentage-point upgrade to 100%. The math gets close enough that the operational and personal considerations, the offer that may not be there next year, the founder fatigue, the next chapter, start to dominate the tax analysis.

What changes for non-C-Corp businesses (the conversion analysis)

Section 1202 is C corporation-only. LLCs taxed as partnerships, S corporations, and sole proprietorships do not qualify. A Texas business owner operating as an LLC or S corporation who wants access to QSBS treatment has to convert the business to a C corporation before the relevant stock is issued.

The conversion analysis has gotten more interesting under OBBBA. The fundamental tradeoff hasn't changed: pass-through structures (LLC and S corporation) avoid the corporate-level tax that C corporations pay, at the cost of ineligibility for QSBS. C corporations pay corporate tax on operating income (currently 21% federal), but their stockholders can potentially access QSBS exclusion at exit. For businesses that distribute most of their earnings to owners as compensation or distributions, pass-through generally wins. For businesses that retain earnings, reinvest, and target an exit, C corporation plus QSBS eligibility can substantially outperform pass-through over the full lifecycle.

Three OBBBA changes shift the conversion math.

The $75 million aggregate gross assets ceiling means a business can grow significantly larger before stock issuances stop qualifying for QSBS. Under the prior $50 million ceiling, growth-stage companies often hit the asset cap mid-funding-round, after which subsequent issuances no longer qualified. The $25 million increase buys real runway.

The tiered exclusion at three and four years means the conversion-to-exit timeline can be shorter and still produce meaningful QSBS benefit. A business that converts to a C corporation, issues stock to its owners, and exits four years later now captures a 75% exclusion on up to $15 million per shareholder per issuer. Under the prior all-or-nothing five-year rule, that same exit would have produced no exclusion.

The $15 million per-issuer cap raises the ceiling on the QSBS benefit any individual shareholder can capture. For founders whose basis is small, the practical exclusion ceiling went from $10 million to $15 million.

The conversion mechanics matter. When an LLC or partnership converts to a C corporation, the stock issued to the converting owners qualifies for QSBS treatment based on the asset value at the time of conversion. The aggregate gross assets test is run at the moment of issuance, meaning the converting business's fair market value determines whether QSBS eligibility is preserved. For businesses approaching the $75 million threshold, conversion timing becomes a planning question.

When not to convert is just as important. Businesses without exit horizons, family-owned operating companies expecting to be held indefinitely, businesses where owners draw substantial salary or distributions year-over-year, generally don't benefit from C corporation conversion regardless of QSBS. The double tax on operating income outweighs the QSBS benefit when there's no near-term exit to capture it. The right framework for the conversion decision is to model the full lifecycle: the projected operating-income tax drag of being a C corporation, against the projected QSBS-excluded gain at exit, discounted back to the present.

The eligibility rules that didn't change (and still trip people up)

Five Section 1202 requirements survived OBBBA unchanged, and they remain the most common ways founders accidentally disqualify their stock.

Domestic C corporation only. The issuing entity must be a domestic C corporation throughout the relevant testing periods. A Texas LLC, a Texas LP, an S corporation, a foreign corporation, none of these qualify. Stock issued during a temporary C-corp window that later converts back to LLC or S-corp status loses QSBS treatment.

The 80% active business test. At least 80% of the corporation's assets must be used in the active conduct of one or more qualified trades or businesses throughout substantially the entire holding period. This is a continuing test, not a snapshot. A C corporation that begins life as an operating software business but accumulates substantial cash on its balance sheet, without that cash being deployed in the active business, can fail the 80% test partway through the holding period and disqualify the stock.

The excluded trade or business list. Section 1202(e)(3) explicitly excludes a wide range of service businesses from QSBS treatment: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, banking, insurance, financing, leasing, investing, farming, mineral extraction, and businesses where the principal asset is the reputation or skill of one or more employees. The list is broad and the IRS interpretive guidance is sparse. A SaaS business that helps law firms manage cases is clearly eligible. A SaaS business that is itself a law firm's internal tooling is not. The line between "specified service trade or business" and "qualified trade or business" gets fact-specific quickly.

The original issuance requirement. QSBS treatment requires that the stock be acquired at original issuance from the issuing corporation, in exchange for money, other property (not stock), or as compensation for services. Stock acquired by purchase from another existing shareholder, secondary market purchases, does not qualify. There are limited exceptions for gifts, inheritances, and certain reorganizations, where the holding period and QSBS character of the predecessor stock can carry over.

The redemption taint rules. Section 1202(c)(3) prohibits certain redemptions of stock from related parties around the time of QSBS issuance. A C corporation that redeems stock from a founder, a related person, or significant holders within a window before or after issuing new QSBS can disqualify the new issuance. The redemption rules are technical and frequently violated inadvertently, particularly in private companies where buybacks of departing employees' stock or estate planning transactions occur near in time to QSBS issuances.

These rules haven't changed. They remain the most common reasons QSBS treatment is lost, and they apply equally to pre- and post-OBBBA stock.

What to do now

The OBBBA changes create discrete actions for four groups of Texas founders and investors.

For founders holding existing QSBS issued before July 4, 2025: confirm the original issuance date in your records and establish a tracking discipline that distinguishes pre-OBBBA stock from any future post-OBBBA stock in the same corporation. The two blocks operate under different rules at exit. Avoid actions that might alter or muddy the acquisition date, restructurings, stock splits with unusual mechanics, sales-and-buybacks. Each of these can carry tax consequences that don't show up until five years later.

For founders considering issuing new QSBS: structure the issuance to qualify under the OBBBA rules. Confirm the corporation will be at or below the $75 million aggregate gross assets threshold immediately before and after issuance, with the test based on fair market value of contributed property and adjusted basis of other assets. Review the corporation's asset composition for compliance with the 80% active business test. Confirm the trade or business is not on the Section 1202(e)(3) excluded list. Avoid any redemptions of related-party stock within the relevant window before or after the new issuance.

For owners of LLCs or S corporations considering conversion to a C corporation: run the lifecycle analysis. Project the corporate-level tax drag of operating as a C corporation against the QSBS-excluded gain at the targeted exit window, factoring in the new tiered exclusions and the higher cap. Time the conversion to capture the full benefit of the higher asset ceiling. Coordinate the conversion with shareholder-level planning, including potential gifting strategies that "stack" the $15 million per-taxpayer cap across multiple non-grantor trusts.

For founders contemplating a relocation: state of residence at the time of the gain matters significantly. The federal Section 1202 exclusion is preserved across state lines, but a non-conforming state's income tax can substantially erode the after-tax benefit of an otherwise fully excluded federal gain. Texas conforms to the federal rules and has no state income tax, and a Texas residency established well before the gain is realized is materially different from a residency established in the months leading up to a transaction. The IRS and state taxing authorities both look at substance, not just paperwork.

Across all four groups, the planning is technical and the stakes are high. The rules in this article are accurate as of the date of publication, but Section 1202 implementation guidance from the IRS continues to develop, and individual fact patterns determine outcomes. This article is general information, not legal or tax advice, engage qualified counsel before making decisions that affect your QSBS treatment.