QSBS Planning for Private Equity Under the OBBBA Rules

Consider the following situation: a Private Equity (PE) firm acquires a middle-market target that has $70 million in gross assets. Prior to July 5, 2025, that company would have been above the IRC Sec.1202 threshold, making any stock issued ineligible for qualified small business stock (QSBS) treatment. Today it may qualify, and the decisions the deal team makes before the acquisition closes, and new stock is issued will determine how much of that benefit the firm will capture at exit.

The One Big Beautiful Bill Act (OBBBA) made the largest substantive changes to IRC Sec. 1202 since 2010, which affects QSBS planning for private equity firms differently than it does for founders or early employees. These changes may prompt private equity investors to evaluate QSBS issues earlier in the dealmaking process. By raising the gross asset threshold, expanding the gain exclusion, and adding phased holding periods, the OBBBA introduced new planning opportunities for private equity firms, their portfolio companies, and investors.

At the same time, a US Department of the Treasury report recently identified supporting documentation as a recurring challenge for taxpayers claiming the IRC Sec. 1202 exclusion. These developments make IRC Sec. 1202 planning and record retention an increasingly important consideration throughout the investment process, from transaction structuring through exit.

Key Takeaways

• The OBBBA raised the IRC Sec. 1202 gross asset threshold from $50 to $75 million and the maximum gain exclusion from $10 to $15 million for stock issued after July 4, 2025.
• Taxpayers can now exclude 50% of gain after a three-year holding period and 75% after four years, replacing the prior all-or-nothing five-year rule.
• A Treasury Department analysis of tax years 2012 through 2022 found taxpayers excluded more than $140 billion of gain under the IRC Sec. 1202, with roughly 70% claimed by taxpayers with cumulative exclusions above $1 million.
• The burden of proving QSBS eligibility falls on the taxpayer, not the corporation, so documentation built at issuance matters as much as documentation gathered at exit.
• Private equity firms should evaluate transaction structure, entity conversions, and ownership stacking before stock is issued, since many IRC Sec. 1202 decisions cannot be revisited later.

What Changed for IRC Sec. 1202 Under the OBBBA?

For stock issued after July 4, 2025, the OBBBA increased the maximum exclusion amount from $10 million to $15 million and raised the gross asset threshold from $50 million to $75 million. The legislation also introduced a phased exclusion structure, allowing taxpayers to exclude some of their gains earlier, rather than the long-standing requirement to hold the stock for over five years. Under the OBBBA, the following holding period tiers apply:

Expanded Gross Asset Threshold Creates New Planning Opportunities

The increase in the gross asset threshold from $50 million to $75 million expands the number of companies that can qualify for QSBS treatment at issuance. The change may be particularly relevant for middle-market private equity, as more deals may qualify under the expanded gross asset test. In contrast, previously they may have exceeded the $50 million threshold.

Broader availability of QSBS creates more planning opportunities. For example, buyers can evaluate whether certain assets need to be carved out or distributed before stock is issued, examine working capital before funds are contributed, or structure acquisitions through separate entities where appropriate. Restored 100% bonus depreciation and immediate R&D expensing can reduce aggregate gross assets prior to stock issuances, allowing companies to satisfy the gross asset test.

The expanded threshold provides companies with another reason to evaluate entity conversions. Converting from a pass-through entity to a C corporation may allow a company to qualify for IRC Sec. 1202 under the newly expanded rules. However, conversion of an existing entity does not automatically create newly issued QSBS without proper structuring, nor does it exempt pre-conversion appreciation from ultimate taxation. Companies should carefully evaluate entity conversion and model different operating and exit scenarios to determine a beneficial structure for the company.

Phased Holding Periods Increase Flexibility

The OBBBA replaces the previous five-year all-or-nothing rule with a phased exclusion. Taxpayers can now exclude 50% of eligible gain after three years, 75% after four years, and 100% after five years.

The phased holding periods make transaction timing a crucial component of IRC Sec. 1202 planning. Rather than focusing only on the five-year holding period, private equity firms can now generate liquidity sooner while still obtaining partial exclusion benefits given the three- and four-year holding period. The firm may also want to identify specific shares to liquidate while retaining those that may meet the five-year holding period to optimize exclusion.

Private equity firms should evaluate how various instruments and transactions affect holding periods, including:

• Rollover equity and installment sales
• Transactions qualifying for rollover treatment under IRC Sec. 1045
• Stock options, warrants, SAFEs, and convertible debt
• Preferred stock conversions and restricted stock subject to an IRC Sec. 83(b) election
• Recapitalizations and other restructuring transactions

Firms should also track each block of stock acquired through multiple issuances or equity transactions, and maintain documentation supporting the applicable holding period for each.

Increased Exclusion Creates Additional Planning Opportunities

The OBBBA increases the maximum IRC Sec. 1202 exclusion from $10 million to $15 million for stock issued after July 4, 2025, and indexes the exclusion amount for inflation beginning in 2027.

With more gain per taxpayer now shielded, how ownership is structured before an exit matters more than it did under the old rules. Because each eligible taxpayer generally has a separate IRC Sec. 1202 exclusion, stacking through partnership interests, carried interests, non-grantor trusts, and other ownership structures can meaningfully increase the total exclusion available across the investor base. PE firms should evaluate these structures early, well before an exit, and revisit them when ownership changes, restructurings, or related transactions occur that could affect eligibility.

Why Is Documentation Becoming a Bigger Risk for QSBS Claims?

A Treasury Department analysis of tax years 2012 through 2022 found that taxpayers excluded more than $140 billion of gain under IRC Sec. 1202. Roughly 70% of that came from cumulative exclusions above $1 million, although the data also showed broad use across taxpayers claiming smaller exclusions. The report highlights the growth in IRC Sec. 1202 use and how taxpayers are claiming it.

A recurring issue from the report stands out: the burden of proving QSBS eligibility falls on the taxpayer, not the corporation. Corporations are not required to certify eligibility when they issue the stock, so taxpayers must rely on capitalization records, stock issuance documents, and other historical records to support a future claim. Because years often pass between stock issuance and a liquidity event, record retention is crucial for any IRC Sec. 1202 analysis. Taxpayers can lose the exclusion entirely without proper documentation.

Treasury also found taxpayers claiming IRC Sec. 1202 exclusions across multiple years, which may reflect installment sales and similar transaction structures. Together, the findings demonstrate both how widely the provision is used and how much of its benefits rely on records that substantiate the exclusion amount claimed.

This is particularly important for PE firms. Because the burden of proof for eligibility falls to the taxpayer, a partner who is audited will likely turn to the fund manager and the portfolio company to obtain the documentation needed to support the exclusion. PE firms should perform a QSBS analysis with supporting documentation from the outset. This protects the individual partners who stand to benefit and reflects the investor-friendly posture most funds aim for.

How Should PE Firms Plan for IRC Sec. 1202 Beyond the Exit?

The Treasury report also highlights why IRC Sec. 1202 should be addressed early in an investment rather than waiting until an exit transaction. PE firms make many of the decisions that affect IRC Sec. 1202 eligibility during transaction structuring and generally cannot be changed later.

Before a transaction closes, private equity firms should consider whether the fund is the direct purchaser of the stock, whether rollover equity preserves an existing IRC Sec. 1202 holding period for sellers, and whether the transaction is structured to qualify for IRC Sec. 1202. The OBBBA’s expanded gross asset threshold also creates additional planning opportunities when evaluating capital raises, entity conversions, rightsizing initiatives, and carve-out transactions.

After closing, private equity firms should continue monitoring restructurings, mergers, conversions, related-party stock repurchases, and other transactions that could affect eligibility. They should also maintain supporting documentation throughout the investment, as those records may be needed years later to support an investor’s IRC Sec. 1202 exclusion claim.

By the time a liquidity event occurs, PE firms have generally established the transaction structure. The focus then shifts to confirming that the applicable holding period has been satisfied, calculating the available exclusion, and confirming that the supporting documentation is available.

Steps to Take Now

The OBBBA expands the planning opportunities available under IRC Sec. 1202, but capturing them requires action before stock is issued and documentation that holds up years later. Private equity firms should consider the following:

1. Identify current and future investments that may qualify under the OBBBA’s expanded IRC Sec. 1202 rules.
2. Evaluate transaction structure before closing, including whether the fund is the direct purchaser and whether rollover equity preserves an existing IRC Sec. 1202 holding period.
3. Consider how capital raises, entity conversions, rightsizing initiatives, carve-out transactions, restructurings, mergers, and related-party stock repurchases may affect IRC Sec. 1202 eligibility.
4. Maintain supporting documentation throughout the investment, from stock issuance through exit.
5. Update existing IRC Sec. 1202 procedures to reflect the OBBBA’s expanded planning opportunities.

Moving Forward with EisnerAmper

EisnerAmper’s Private Equity Services Group, along with the National Tax Office, works with PE firms and their portfolio companies to perform pre-issuance QSBS analyses, structure transactions to preserve holding periods, and build the required documentation infrastructure to support investor exclusion claims through exit. Contact us to discuss how the OBBBA’s changes affect your funds, portfolio companies, and investors.