Incentivizing Innovation: How the One Big Beautiful Bill Act Supercharged QSBS

Getty/AFP/Alex Wroblewski

Introduction

Since 1993, U.S. tax law has quietly served as a powerful engine for entrepreneurship, creating a system that incentivizes investors to bet on emerging startups. That year, Congress added Section §1202 to the Internal Revenue Code (IRC), allowing investors to exclude a portion of their capital gains from selling stock in qualifying startups, known as Qualified Small Business Stock (QSBS). The One Big Beautiful Bill Act of 2025 (OBBBA) has expanded the QSBS provisions in a way that may encourage investors to take more risk, but also expand the benefits of the provision to more than just investors. 

What is QSBS?

In general, QSBS is stock issued by a qualified small business that meets strict requirements: the business must be a U.S. C-corp, have gross assets under $75 million, and use at least 80% of its assets in an active trade or business related to its chief purpose. Certain industries, such as services, finance, and hospitality, are excluded from counting as a small business for the purpose of QSBS. For qualifying stock, investors may exclude up to $15 million or 10 times their basis in gain if they meet the holding period requirements. 

Locally, QSBS has been an integral part of Silicon Valley, encouraging investors to take risks by offering the possibility of entirely tax-free investment income. 

Overview of Changes

The OBBBA made four key changes related to QSBS, along with one parallel change to the Qualified Business Income (QBI) Deduction.

1. Raised the Asset Threshold for Business to $75m

Ever since QSBS was created, a “Qualified Small Business” has been measured by the gross assets of the company. Set at $50 million in 1993, the prior cap often excluded capital-intensive startups, but the OBBBA raised the ceiling to $75 million (with inflation indexing beginning in 2027). This update gives growth-stage companies more room to qualify and broadens the pool of startups that can offer QSBS benefits. In practice, companies that require large-scale funding early on, such as biotech, AI, and climate tech, will now remain eligible for QSBS longer. The higher ceiling also discourages startup companies from incorporating abroad in search of tax advantages. 

2. Higher Exclusion Cap ($15m)

The OBBBA also raised the exclusion cap from $10 million to $15 million, allowing taxpayers to enjoy a $15 million exclusion on gains prompted by the sale or exchange of the QSBS issuer. 

The $10 million exclusion cap was not necessarily deterring investors from putting their money into a QSBS. In fact, most investors would not hit the cap in the first place. However, raising the cap allows for a higher potential for gain on investment without punishing investors for such success. In the eyes of Congress, a higher potential reward may encourage more investors to take a bigger risk. The higher exclusion cap paired with the threshold raise to $75 million will allow a broader range of businesses to qualify as a QSBS and encourage more corporations to convert into C corps in order to utilize these advantages.

3. Tiered Holding Periods 

Prior to the passing of the OBBBA, investors had to wait five (5) years before they were eligible for QSBS benefits. The Act replaces this system with the implementation of a tiered schedule, giving investors a 50% exclusion after three years and 75% after four, before reaching the full 100% at five years of holding. This makes QSBS more flexible by rewarding earlier liquidity, while still preserving the incentive to hold long-term. This change also strengthens secondary markets where early investors in pre-IPO, private companies are able to sell their shares; although the likelihood of a new startup going public in under five years is minimal, investors can now sell shares before then while still realizing tax benefits.

Under §1045 of the IRC, if QSBS has been held for more than six months and is sold before hitting a QSBS exclusion tier, the seller can defer the gain by reinvesting the proceeds from the sale into another QSBS within sixty days.

4. Expanded employee eligibility with ISO and NSO

QSBS benefits now also extend to stock acquired through exercising incentive stock options (ISOs) and nonqualified stock options (NSOs). This means engineers, designers, and other employees can exit work at startups with tax-free gains along with founders and venture capitalists. This change increases the incentive to take risks in the startup space and enhances the value of equity compensation packages offered by those companies.

5. QBI deduction became permanent 

In addition to QSBS, OBBBA made the 20% Qualified Business Income (QBI) deduction under §199A of the IRC permanent. First created in 2017, the QBI deduction allows owners of pass-through entities such as partnerships and S-corporations to deduct up to 20% of their qualified business income. Originally set to expire in 2025, this allows these entities to retain a significant tax advantage.  Together with QSBS, investors now have two significant ways to achieve tax benefits, both for their ongoing business profits and at their time of exit.

Who benefits from QSBS?

Historically, QSBS rules have benefitted those with the capital to take risks on emerging companies, whether they did so as a founder or an investor. These investors had to commit capital early and leave their QSBS investment untouched for five years in order to qualify for the benefit. However, new regulations have since expanded this opportunity. With the asset threshold raised and employee eligibility expanded, QSBS benefits a much broader group. Employees who receive and exercise stock options can now participate in tax-free upside, while capital-intensive industries like biotech and climate tech are less likely to outgrow eligibility before reaching major funding rounds.

Potential Market Effects

OBBBA’s reforms are likely to affect the startup ecosystem in several ways. Employers now have stronger incentives to join early-stage companies, since stock options carry the potential for significant tax-free upside. For founders, the new $75 million asset threshold will make valuation a larger part of the fundraising strategy, as staying under the cap preserves QSBS eligibility. Investors gain flexibility through tiered holding periods and an extended rollover window, which not only reduces risk but encourages reinvestment into new ventures. Looking forward, these incentives will leave broader policy questions: will shorter holding periods push companies towards early exits? Will high thresholds distort valuations by encouraging startups to raise just below the cap? The intertwining of tax treatment and corporate structure through OBBBA ensures QSBS will remain a powerful driver of the American startup evolution. 

Conclusion

The One Big Beautiful Bill Act modernizes QSBS for the first time in over three decades, expanding its reach to more businesses, more investors, and now even employees. By raising the asset threshold, increasing the exclusion cap, shortening holding periods, and making the QBI deduction permanent, Congress has doubled down on tax policy as a tool to drive innovation and keep businesses in the United States.

*The views expressed in this article do not represent the views of Santa Clara University.