Recently I wrote about a novel gifting strategy that might help clients reduce the tax implications of selling a concentrated stock holding. In this article, I’d like to touch on another gifting strategy that business owners should be aware of.

The focus here is on gifting Qualified Small Business Stock (QSBS) to family members and allowing them to take advantage of the Section 1202 exclusion. Section 1202 allows a taxpayer to exclude some or all of the gain from selling QSBS held for over five years.

Now is an opportune time to revisit this strategy, given the tax-code changes introduced by the recent passage of the One Big Beautiful Bill Act (OBBBA). Specifically, for those clients who are founders, owners, or early investors in a business, the OBBBA has improved the tax benefits available through changes to the Section 1202 exclusion, as outlined in the table below.

	Pre-OBBBA – Stock Acquired on or before July 4, 2025	Post-OBBBA – Stock Acquired after July 4, 2025
Required holding period	Must be held for more than 5 years	Must be held for at least 3 years
Percentage of gain excluded from gross income	50% if acquired after August 10, 1993, and before February 18, 2009	50% if held for 3 years
	75% if acquired after February 17, 2009, and before September 28, 2010	75% if held for 4 years
	100% if acquired after September 27, 2010	100% if held for 5 years or more
Per-issuer limitation	$10,000,000 (or 10x basis in the stock, if greater)	$15,000,000 (or 10x basis), adjusted for inflation beginning in 2027
Aggregate gross asset limit	$50,000,000	$75,000,000, adjusted for inflation beginning in 2027

 

As you can see, the Section 1202 exclusion has now been expanded not only based on the size of the business, but also the dollar amount that can be excluded. Along with that, because the holding period requirement has been reduced to three years, founders and investors may be able to achieve liquidity before five years while still benefiting from QSBS treatment.

The other main requirements to be aware of are that the company must be an active, domestic C corporation and the stock must be an original issuance. The table below illustrates how valuable this exclusion could be for a hypothetical business owner with a $17,000,000 capital gain.

Tax savings example	QSBS	Non-QSBS
Sale proceeds	$17,000,000	$17,000,000
Purchase price (basis)	$1	$1
Total gain	$16,999,999	$16,999,999
QSBS exclusion	$15,000,000	N/A
Remaining gain	$1,999,999	$16,999,999
Tax @ 23.8%	$476,000	$4,046,000
Tax savings on QSBS	$3,570,000

 

Gifting considerations for QSBS

Usually when we consider the tax implications of financial gifts, our main concern is cost basis. While this continues to be important, with QSBS, the more significant considerations are whether the stock qualifies as QSBS and the holding period. Fortunately, based on the way the tax code is written (Sec. 1202(h)(2)(A)), gifted stock retains its QSBS qualification as well as the original holding period of the transferor. That means that if a founder were to gift QSBS to a child, that child could then sell the stock and claim up to a $10 million exclusion from capital gains tax (for stock acquired on or before July 4, 2025, or 10x basis in the stock, if greater) or a $15 million exclusion (for stock acquired after July 4, 2025, or 10x basis, adjusted for inflation beginning in 2027) once the five-year holding period has been met.

But what if a founder has a much larger gain and more children? This is where we can use non-grantor trusts to “stack” QSBS exclusions. The question that might come to mind is, “How many of these trusts can I create?” There isn’t a hard-and-fast rule, but a conservative approach would be to ensure that a separate trust is created for each family member or individual. It’s crucial to consult your tax attorney when making this decision.

For example, imagine a scenario where a business owner is the founder of a tech firm that owns stock worth $45 million and has two children. In this case, the owner could set up two irrevocable non-grantor trusts, one for each child, and make a separate QSBS election for herself in order to exclude the $45 million in gains from capital gains tax.

Without this strategy, at a capital gains tax rate of 23.8%, the business owner would have faced a tax bill of over $10.7 million on the $45 million gain.

When implementing a QSBS stacking strategy using irrevocable non-grantor trusts, it’s critical that each trust is carefully structured to avoid being classified as a grantor trust under IRS rules. If a trust is deemed a grantor trust, the income and gains may be attributed back to the grantor, potentially disqualifying the trust from claiming its own QSBS exclusion. To preserve the integrity of the strategy, advisors should work closely with estate planning attorneys to ensure that each trust is independently operated, has a distinct beneficiary, and avoids provisions that could trigger grantor trust status.

One last consideration, especially for those clients who may be in a position to stack QSBS trusts, is that these gifts will count against their lifetime estate and gift tax exemptions. Because of this, it’s important to keep track of all gifts that have been made to ensure clients don’t unknowingly, after their death, saddle their surviving spouse or children with an estate tax liability. This makes a compelling case for gifting stock as early as possible, when its value is lower. Doing so would use up less of the grantor’s lifetime exemption and still allow the recipient to utilize the Section 1202 exclusion after sufficient time has passed to exclude any capital gains.

Tax changes open opportunities for advisors

The passage of the OBBBA demonstrates how tax changes may provide opportunities for advisors to bring ideas to clients that may yield significant tax savings today or estate-tax savings in the future. It also provides advisors with important considerations they can raise with clients who may be thinking of starting a business soon. Finally, remember that everyone’s tax situation is different, so be sure to consult your CPA and tax attorney to ensure any strategy meets your goals and adheres to the most up-to-date tax laws.

The information contained herein is for educational purposes only and should not be construed as financial, legal or tax advice. Circumstances may change over time so it may be appropriate to evaluate strategy with the assistance of a financial professional. Federal and state laws and regulations are complex and subject to change. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of the information provided. Janus Henderson does not have information related to and does not review or verify particular financial or tax situations, and is not liable for use of, or any position taken in reliance on, such information.