A huge new tax break for start-ups just got even bigger | Expert Opinion

Want to save a lot of money on taxes? Then make sure the shares in your business can be categorized as “qualified small business stock” under Section 1202 of the IRS tax code.

To qualify, your business must be a C corporation and not a pass-through entity like an S corporation, partnership, or limited liability company. Companies under this rule must have less than $75 million in capital assets at start-up.

Another important rule is that at least 80% of your company’s assets must be used in a qualified trade or business, like manufacturing, distribution, or technology products and services. In other words, it can’t be passive like a holding company in real estate or some service-oriented businesses.

“Certain service-based industries are excluded, and founders in consulting, health, financial services, and similar fields often overlook this limitation until it’s too late,” said Mitchell Gerstein, a senior tax adviser at Isdaner & Co. in Bala Cynwyd.

The big savings won’t come now. They’ll come later when you exit your business.

If you own qualified small business stock and you hold on to that stock for at least five years from the time it was issued, you will not have to pay the 28% tax on your capital gain when you sell your shares. That exception applies for amounts up to $15 million or 10 times your investment, whichever is greater.

The savings is so huge that many of my clients who own pass-through businesses are considering converting to a C corporation, despite the complexity.

“Converting to a C corporation has upfront costs (legal, accounting, internal time and energy) and generally leads to greater net tax payments on operating income during the three- to five-year period of holding,” says Dean V. Krishna, tax chair at Philadelphia law firm Stradley Ronon Stevens & Young. But the benefits upon sale “are so significant that they oftentimes make conversion the smart tax strategy.”

Though not as well known, qualified small business stock has been around as a start-up tax benefit for decades. But last year it got even better.

Thanks to the 2025 One Big Beautiful Bill Act, you can sell your shares after only three years and still get capital gains tax exclusions of up to 50%. It’s 75% after four years.

This law also raised the capital assets limit from $50 million to $75 million and the maximum capital gains limit from $10 million to $15 million. These changes are applicable only to shares offered after July 4, 2025.

“Be careful of your timing,” Gerstein said.

There are no forms to fill out or IRS approvals needed. The shares just need to qualify, and business owners should be doing their best to ensure that they’re keeping the right documentation (minutes, share certificates, memorandums) to back up their qualification.

Gerstein advises that companies, especially growth-stage businesses, revisit their structure and capitalization strategy before their next equity issuance. Each issuance is its own opportunity or missed opportunity.

“Section 1202 is most powerful when it’s addressed at formation,” he said. “Whether stock qualifies under Section 1202 depends on when it’s issued and how much the company is worth at that time.”

Krishna says the decision is particularly important for business owners looking to sell or raise more capital in the future.

“With respect to formation and growth, oftentimes third-party investors are looking for qualified small business stock status with respect to their own investments,” he said. “It’s important for a company to understand whether it can market that status — and it may help attract investors.”

As existing business owners get older and retire, many are thinking about their succession plans. As many as 6 million small and midsize American businesses are set to be involved in a “great ownership transfer” by 2035, according to a recent McKinsey Institute report, with about 1 million of them expected to be sold in transactions cumulatively worth $5 trillion.

Even if your start-up or new company does qualify under Section 1202, you still have to be careful when you make any organizational changes in the future.

“Oftentimes business owners think their business is qualified and do internal restructurings for estate or business purposes without realizing that the qualification is not just based on the business itself, but also on chain of ownership,” Krishna said. “Actions such as contributing your stock into a partnership can disqualify your status.

That’s why considering a change in ownership to a qualified small business stock could be a very important estate planning strategy right now.

Gerstein says that business owners should carefully consider who receives stock and when, and that, if structured properly, each shareholder may qualify for their own exclusion.

“Some gifts and estate transfers can keep the tax benefits in place, but certain redemptions or company transactions can cause them to be lost,” he said. “With proper planning, families can preserve significant tax savings, but small mistakes can be expensive.”