Qualified small business stock: the five year rule stopped being the whole rule in July 2025

For six years I answered the qualified small business stock question with one sentence. Hold the stock five years, sell it, and the first 10 million dollars of gain never reaches your return. I was wrong about two of the three numbers in my sentence from 4 July 2025 onwards. I kept saying it in board meetings for 3 more months, until a founder I have worked with since her seed round read the statute back to me in June and asked me, politely, where I had got that from.

The law that did it is Public Law 119-21. It amended section 1202 on the day it was signed. The holding period is no longer a single cliff. My ceiling number was stale, because the limit on excluded gain per company moved from 10 million dollars to 15 million. And the asset test that decides whether your shares were ever capable of qualifying moved from 50 million to 75 million, which is a test applied at a moment when nobody in the room is thinking about tax at all. For the bank that holds the money, Bank Index lists US banks with the regulator stated on every card.

So I went looking for this properly, about 6 weeks late. I read the amended text with the change notes open beside it, because the 4 law firm summaries I found first disagreed with each other about which shares the new rules actually reach. What follows is what the statute says, what it refuses to do for stock you already hold, and the short list I would write down at the next round. You should read the redemption part even if you skip everything else. None of it is complicated. All of it is easy to lose.

The cliff became a staircase

The statute now carries a small table, headed “Years stock held: Applicable percentage”. Three years takes half the gain out of income, four years takes three quarters, and five years or more takes all of it, which used to be the only door in the building. Whatever is left is taxed as 28-percent rate gain under section 1(h)(4). That sentence does more work than it looks like it does. Half a gain at 28 per cent is not the same thing as half your ordinary bill, and I have heard both described as the same outcome in the same meeting.

The staircase exists only for stock acquired after what the statute calls the applicable date, and that date is 4 July 2025. My older shares did not get any faster. Neither did yours, whatever the date on the certificate says. They cannot be made faster either, and I spent an afternoon looking for a way, which was an afternoon I am not getting back. The text borrows the tacking rules of section 1223 to fix the acquisition date, so a stock for stock exchange inside a reorganisation carries the original date along with it rather than starting a fresh clock.

Founders hear that and immediately start designing around it. I have sat through two versions of the conversation. Both ended with counsel saying no at greater length than anybody wanted.

The number that ends eligibility is measured at the raise

Here is the part I had assumed worked the other way round. It is the correction I most want on the record, because I gave the wrong version of it to at least three people. The asset ceiling is not a test you pass at exit. The statute asks whether “the aggregate gross assets of such corporation (or any predecessor thereof)” stayed under 75 million dollars before the issuance, and whether they stay under it immediately after, counting the money that arrived with the round itself.

So the test runs on the day the shares are issued. It settles the status of those shares and of nothing else. Earlier shares keep whatever they had. Shares issued after the company crossed the line are not qualified small business stock, no later shrinkage brings them back, and the cap table ends up split into two populations that are taxed differently for the rest of the company's life. I find that genuinely awkward to explain to a founder who has just closed a round she is proud of.

The definition of gross assets is narrow, and it is narrow in the friendly direction. Enterprise value never enters the calculation. It counts “the amount of cash and the aggregate adjusted bases of other property held by the corporation”. Basis rather than enterprise value, which is a distinction I had to say out loud twice before it stuck in my own head. A company carrying a 400 million dollar valuation can sit well under the ceiling if its balance sheet is mostly cash and laptops. That combination is more common than founders expect.

A second rule underneath it pushes the other way, and I nearly missed it. Contributed property is treated “as if the basis of the property contributed to the corporation were equal to its fair market value as of the time of such contribution”. A company built on assigned intellectual property can therefore start life with a much bigger number than its own bookkeeping suggests. I have not seen that bite anybody yet, though I would not hear about it if it did, since the number that goes wrong is one nobody outside the company ever sees and the consequence only surfaces at an exit years later. My suspicion is that it does, quietly, in the 1 or 2 companies a year that get spun out of something larger.

What I would write down at the next round

The record you need is short and almost nobody keeps it. Gross assets immediately before the issuance and immediately after it, computed the way the section defines them, with cash and basis on separate lines. The date of every issuance, since 4 July 2025 now cuts a cap table in half. A note of each buyback in the twenty four months around the round, with its value as a share of the whole company.

That fits on one page. It takes maybe twenty minutes while the round is closing. It takes most of a week to rebuild four years later, and I have watched a finance lead do exactly that, ending with a range rather than a figure, because the property contributed in the first year had no valuation attached to it at the time and nobody left in the building could remember what it was worth.

I am not going to tell you whether your own shares qualify. I would not believe anybody who told you that from a summary either, including me. This is our reading of a statute rather than advice, and the person who signs the return is the one who has to form a view. What a founder can usefully do is keep those three records, so whoever asks in 2031 has something to work from.

Fifteen million is a per company ceiling with a trap inside it

The applicable dollar limit is 10 million dollars for stock acquired on or before the applicable date, and 15 million for stock acquired after it. The alternative measure survived unchanged. You take the greater of the dollar limit or ten times your aggregate adjusted basis in the stock you sold that year. Founders whose basis is close to nothing live under the dollar limit and nowhere else, and that covers nearly everybody who took shares at incorporation for a hundred dollars.

Both ceilings are indexed for inflation, and only for taxable years beginning after 2026. The trap is one clause long. Once a taxpayer has used the limit in full, the statute says “the applicable dollar limit for such subsequent taxable year shall be zero”, so the indexing hands you nothing at all afterwards. I read the paragraph 4 times before I believed it. The drafting is plain enough and I simply did not expect the result.

Filing separately while married halves the older figure to 5 million dollars, and applies half the current amount to the newer one. I do not know how often that catches somebody in practice. It is the sort of clause that surfaces in the same month as a divorce and an eight figure liquidity event, and nobody in the room wants to be the person who raises it.

The alternative minimum tax problem is gone, and it is gone backwards

Part of the excluded gain used to be an item of tax preference. That paragraph now reaches only stock acquired on or before 27 September 2010. Better still, the effective date provision says the change applies “as if included in the enactment of section 2011 of the Creating Small Business Jobs Act”, which is a polite way of saying it was always meant to work this way. Anybody still pricing that risk into a model is carrying a worry from 2010. I did, until this summer.

A short digression about the word small

The name has done real damage. A corporation holding 74 million dollars of assets is a qualified small business for this purpose. A forty person company that has raised twice is nowhere near the ceiling. I have watched founders skip the entire question because they had decided they were too grown up for something with small business in the title, and I find it hard to read past that, since the phrase has nothing to do with headcount, revenue or how the company feels from the inside on a bad Tuesday. Anyway, back to the parts that get lost.

What did not change, and what it quietly kills

Four requirements survived the amendment untouched. None of them is new. In my experience they end more claims than the dollar limits ever will, and each of them is settled years before anybody sells anything, usually by somebody who was solving a different problem that week and had no idea that the choice they were making would still be binding on the tax treatment of the founders' shares most of a decade later.

The company has to be a C corporation for substantially all of your holding period. The words in the text are “such corporation is a C corporation”, and membership units in a limited liability company are not stock, so the years before a conversion buy you nothing at all. Your clock starts at the exchange. Stock also has to reach you at original issue, “in exchange for money or other property (not including stock)” or as pay for services. Buying shares from a departing founder leaves you holding an asset with no status under this section whatsoever, which is bad advice arriving several years late.

At least four fifths of the assets by value have to be used in the active conduct of a qualified trade or business. A company sitting on a large treasury position after a round can fail that test while feeling extremely healthy. It sits awkwardly beside every sensible instruction about putting idle cash to work, and in four years of treasury conversations I have never once heard anybody mention the test in one.

Then there are the redemptions, and if I had an hour with a founder I would spend it here. Stock “shall not be treated as qualified small business stock” if, at any point in a four year period beginning two years before the issuance, the company bought stock back from you or from someone related to you. A second rule kills an issuance where the company redeemed more than a twentieth of the aggregate value of its stock inside a two year window beginning a year before. A tender offer for early employees in the same twelve months as a round is exactly that shape, and everybody involved thinks they are doing something kind.

What I could not establish

How many companies actually cross the 75 million dollar line before their shares would have matured. I looked for a published breakdown and I could not find one. The IRS publishes aggregate statistics of income rather than a distribution of gross assets at issuance, so any figure you are offered for the share of startups that lose eligibility this way is somebody's estimate. Mine is that it happens less often than the panic suggests. That is a guess. I would not defend it hard, and I would be glad to be sent a real distribution by anybody who has one, because the question keeps coming up in rooms where the answer changes what a board decides about the size of a round and the timing of a secondary.

Whether the three year tier changes behaviour at all. My suspicion is that it matters most in acqui-hires and secondary sales under 20 million dollars rather than in headline exits, since quick exits at serious prices stay uncommon. I asked 2 finance leads whether their boards had discussed the new tiers. Both said the subject came up once and went straight to counsel. Neither could recall the outcome, 7 weeks later.

The detail I keep thinking about is the arithmetic of that zero, and it is worth 15 million dollars to exactly one kind of person. A founder who uses the whole allowance once gets nothing from any future indexing, while a founder who leaves a single dollar unused keeps a limit that grows with the cost of living for the rest of their life. Nobody I asked will say whether that asymmetry was deliberate, and it is the sort of clause that will read very differently in 2036 than it does today.