The passage of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, has transformed startup equity compensation. Significant updates to QSBS stock now offer new rules for option holders that include updated planning strategies and tax advantages, making the choice to exercise QSBS eligible stock options more appealing than ever. Notably, if you exercise stock options issued in the past, the stock you receive will qualify under the new OBBBA QSBS rules, provided all other criteria, such as the qualified trade or business, gross asset tests, excluded industries as well as the holding periods, are met.
Key QSBS Changes Under the OBBBA
The OBBBA fundamentally transforms the QSBS landscape through three critical changes for stock acquired after July 4, 2025:
Tiered Gain Exclusion Structure
- 3-year hold: 50% exclusion at 15.9% effective federal tax rate
- 4-year hold: 75% exclusion at 7.95% effective federal tax rate
- 5-year hold: 100% exclusion (unchanged from previous rules)
Increased Asset Threshold
Companies can now issue QSBS-eligible stock with gross assets up to $75 million (increased from $50 million), expanding eligibility for later-stage startups.
Higher Exclusion Cap
The per-issuer gain exclusion cap has increased from $10 million to $15 million, with inflation adjustments beginning in 2027.
However, with recent changes reducing the holding period for QSBS exclusions at both the federal level and most states (but not all), it’s worth taking another look. Shorter holding periods may make the tax benefits more significant and potentially tip the scales in favor of exercising stock options.
Understanding the QSBS 3 and 4-year Partial Exclusion Tax Calculations
The three and four-year QSBS partial exclusion tax rates are calculated based on the non-excluded portion of QSBS gains being taxed at a 28% rate (rather than regular capital gains rates of 23.8%) plus the 3.8% Net Investment Income Tax. For stock acquired after July 4, 2025, the excluded portion is not subject to Alternative Minimum Tax.
Federal calculations:
- 3-year hold: 50% × (28% + 3.8%) = 15.9% federal effective rate
- 4-year hold: 25% × (28% + 3.8%) = 7.95% federal effective rate
- 5-year hold: 0%
Federal-Only Tax Savings vs. Never Exercising Stock Options
For federal taxes alone, the comparison between choosing to exercise stock options early with QSBS benefits versus never exercising stock options (where the entire spread becomes ordinary income) shows dramatic advantages:
| Scenario | Top Marginal Federal Tax Rate | Savings vs. No Exercise |
|---|---|---|
| Never exercise stock options (ordinary income) |
37%* | — |
| QSBS 3-year hold | 15.9% | 21.1 percentage points |
| QSBS 4-year hold | 7.95% | 29 percentage points |
| QSBS 5-year hold | 0% | 37 percentage points |
*37% top federal income tax rate
NYC QSBS Tax Savings Example: The Full Picture
Using New York City, for example, a state that fully conforms with federal QSBS rules, the tax benefits are even more significant because QSBS stock options apply to the state as well. New York State fully adopts federal QSBS treatment, meaning qualified exclusions apply at both the federal and state and local levels. Without QSBS, capital gains in New York are taxed as ordinary income, with rates reaching up to 10.9% at the state level, plus an additional 3.876% for NYC local taxes, a total of 14.78%.
| Scenario | Top Marginal Combined NYC Rate | Savings vs. No Exercise |
| Never exercise stock options (ordinary income) |
51.8%* | — |
| QSBS 3-year hold | 23.3% | 28.5 percentage points |
| QSBS 4-year hold | 11.6% | 40.2 percentage points |
| QSBS 5-year hold | 0% | 51.8 percentage points |
*Includes federal ordinary income tax, NY state tax, and NYC local tax using the highest brackets. Does not include Medicare for simplicity.
The Path Forward
The new QSBS rules offer a fresh lens to view exercising stock options. These changes impact not only stock option tax planning under OBBBA but also key career and financial decisions. For founders or employees with substantial option grants or who anticipate receiving them, analyzing and exercising pre-ipo options soon after issuance should be reconsidered, and potentially QSBS stacking should be taken into account, considering all other factors.
While exercising stock options early can save significant taxes, everyone’s situation and company is different. In an ideal world, we could determine when an exit will occur and at what value, allowing for perfect timing and optimization decisions. But this isn’t realistic. Since everyone’s personal balance sheet and circumstances vary considerably, it’s essential to consult with qualified advisors familiar with these rules to make the best decisions for your unique situation.
FAQs
What is QSBS (Qualified Small Business Stock)?
QSBS is stock issued by a qualified small business that meets specific requirements under Section 1202 of the Internal Revenue Code. When you sell QSBS stock, you can exclude up to 100% of capital gains from federal taxes if you hold the stock for at least 5 years. Under the new OBBBA rules effective July 4, 2025, you can now get partial exclusions with shorter holding periods: 50% after 3 years and 75% after 4 years.
How much can I save with QSBS tax benefits?
With the new OBBBA rules, you can exclude up to $15 million in capital gains per taxpayer per company (increased from $10 million for stock issued after July 4, 2025). This represents potential federal tax savings of up to $3.57 million federally per company. In high-tax states like New York, combined federal and state savings can be significant.
What companies qualify to issue QSBS?
To issue QSBS, a company must be a U.S. C-corporation with gross assets under $75 million (increased from $50 million under the new rules) at the time of stock issuance. The company must also be an active business for at least 80% of its assets, excluding certain industries like banking, insurance, professional services, hotels, and restaurants.
What changed with the One Big Beautiful Bill Act (OBBBA) for QSBS?
The OBBBA, signed July 4, 2025, introduced three major changes:
1. Tiered exclusion system with shorter holding periods (50% at 3 years, 75% at 4 years).
2. Increased exclusion cap from $10 million to $15 million with inflation adjustments.
3. Higher company asset threshold from $50 million to $75 million.
Does the new QSBS rule apply to stock I already own?
No, the enhanced QSBS benefits only apply to stock issued on or after July 4, 2025. QSBS stock issued before this date remains subject to the original rules requiring a 5-year holding period for 100% exclusion and the $10 million cap.
How are the new QSBS tax rates calculated?
For QSBS stock issued after July 4, 2025, the non-excluded portion is taxed at 28% plus 3.8% Net Investment Income Tax. This results in effective federal tax rates of 15.9% for 3-year holds (50% exclusion) and 7.95% for 4-year holds (75% exclusion).
Do stock options qualify for QSBS benefits?
Stock options themselves don’t qualify for QSBS, only actual shares do. However, when you exercise stock options after July 4, 2025, the shares you receive can qualify for the new enhanced QSBS benefits if all other new QSBS stock requirements are met.
When should I exercise stock options for maximum QSBS benefit?
The best time to exercise stock options is when the strike price matches or is close to the current fair market value, which helps minimize taxable income at the time of exercise. This assumes the company qualifies for QSBS and anticipates a significant future exit that makes the choice to exercise stock options worthwhile. Under the updated rules, any exercise after July 4, 2025, will initiate the clock for the enhanced tiered exclusion system.
What’s the difference between early exercise and regular exercise for QSBS?
Choosing to exercise stock options early allows you to buy shares before they vest, potentially when the strike price equals fair market value (minimizing taxes). More importantly, it starts the QSBS stock holding period immediately, which under the new rules means you could get 50% exclusion after just 3 years.
What if I exercised my QSBS stock options before or after July 4, 2025?
If you exercised before July 4, 2025, your shares follow the old rules (5-year minimum for 100% exclusion, $10 million cap). QSBS stock options exercised after July 4, 2025, qualify for the new enhanced benefits with shorter holding periods and higher caps.
What industries are excluded from QSBS eligibility?
QSBS excludes businesses in banking, insurance, financing, leasing, investing, professional services (health, law, engineering, accounting, consulting), farming, mining, hotels, restaurants, and businesses where the principal asset is employee reputation or skill. Speak with an advisor on this topic if you are unsure.
Can I get QSBS stock benefits if I buy shares from another employee?
No, QSBS stock benefits only apply to shares purchased or acquired directly from the company at original issuance. Secondary purchases from other shareholders don’t qualify. However, gifting shares to certain family members or specific types of trusts can retain the QSBS status and is often used in the QSBS stacking strategy.
What’s the $75 million asset test for QSBS?
Under the new OBBBA rules, a company can have up to $75 million in gross assets (increased from $50 million) when issuing QSBS. This test applies both before and immediately after the stock issuance.
How does QSBS compare to never exercising stock options?
Never exercising stock options means the entire spread becomes ordinary income (up to 37% federal rate + state tax rate if applicable). With QSBS, you can achieve much lower effective tax rates: 15.9% for 3-year holds, 8.0% for 4-year holds, and 0% for 5+ year holds under the new rules.
Can I combine QSBS stock benefits with other tax strategies?
Yes, QSBS stock benefits can be combined with other strategies like advanced tax planning, trust planning, and charitable giving. QSBS is a very valuable tax strategy. Consult with an advisor who is knowledgeable about these advanced planning strategies.
What should I consider before exercising QSBS stock options?
Consider your cash flow needs, risk tolerance, company prospects, and overall financial situation. The new rules make choosing to exercise stock options more attractive, but everyone’s situation is different. Consult with qualified tax advisors familiar with the new QSBS rules.
Do states recognize QSBS benefits?
It varies by state. Many states, such as New York, fully conform to federal QSBS rules, providing additional tax benefits. Others may have different rules or not recognize QSBS at all. Always check your specific state’s treatment.
How much can I save by exercising options and qualifying for QSBS in high-tax states?
In high-tax states like New York, QSBS stock options can lead to significant tax savings. Without it, you might face combined federal, state, and local tax rates exceeding 50%. However, by exercising stock options and holding them for five years, you could reduce your tax liability to as little as 0%.
