Beware of the Measurement Gaps in New Small Business Stock Rules

The 2025 federal tax-and-spending package known as the One Big Beautiful Bill Act expanded qualified small business stock exclusions under IRC Section 1202 in significant ways. A founder who holds QSBS for five years can now exclude up to $15 million in gains, index that cap for inflation starting in 2027, and benefit from a tiered holding structure that rewards earlier exits.

These are material changes to deal economics, and they will reshape how mergers and acquisitions practitioners approach founder liquidity events going forward. But the legislative drafting was thin in places. The statute creates measurement ambiguities that don’t appear in the legislative history. Practitioners who treat the OBBBA simply as a gift-wrapped expansion are walking into real compliance risk.

The time to address these ambiguities isn’t at the time of sale, when tax counsel is in reactive mode. It is now, when deal structuring conversations are happening and when careful documentation can prevent the disputes that the IRS will eventually pursue.

Three measurement problems stand out:

• The new $75 million gross asset threshold created an ambiguity: Did Congress mean to apply the same adjusted basis methodology that governed the old $50 million test, or something else?
• The compressed three-year and four-year gates in the tiered exclusion are going to accelerate M&A deal timing and create new structuring challenges, particularly for equity compensation and partnership contributions.
• The professional services exclusion remains jurisdictionally and factually unsettled, and recent IRS guidance hasn’t clarified where the line between a qualifying tech platform and an excluded service company sits.

Practitioners should take several key actions in transactions right now to avoid fighting with the IRS later.

What Sellers Know

The arithmetic is simple. Under prior law, Section 1202 offered a 50% exclusion, capped at $10 million, to any shareholder who held QSBS for at least five years. The OBBBA replaced that with a tiered structure: 50% exclusion after three years, 75% after four years, 100% after five years.

The cap rose to $15 million and will be indexed for inflation starting in 2027. For a shareholder with a $100 million gain who holds for the full five years, the difference is roughly $5 million in additional federal tax savings.

This isn’t a marginal change. It is enough to shift the incentive structure around founder liquidity, employee participation in acquisition deals, and strategic timing for secondary sales.

Practitioners have already absorbed the basic mechanics. What they haven’t absorbed, because it hasn’t been adequately discussed, is what to do about the measurement problems embedded in the statute.

Problem in Sight

The OBBBA raised the gross asset test from $50 million to $75 million. Section 1202 requires the issuing corporation to have gross assets of not more than the specified amount, measured at the time of issuance and continuously thereafter.

Here is where the drafting breaks down. Prior law applied an “adjusted basis” methodology to determine whether a corporation exceeded the $50 million ceiling. The adjusted basis of all assets held by the corporation, not their fair market value, determined whether the corporation qualified.

This methodology was critical because many high-growth companies, particularly software and technology companies, carried substantial unrealized gains. A company worth $150 million in fair market value could still qualify for Section 1202 if its adjusted basis in assets was under the $50 million line.

The OBBBA doesn’t explicitly state whether Congress intended to carry forward the adjusted basis methodology for the new $75 million threshold. The legislative history on this point is effectively silent. A plain reading of the statute suggests the test applies to “gross assets,” which could be interpreted as fair market value rather than adjusted basis.

But that interpretation would fundamentally change who qualifies, and it would make no sense to apply a fair market value test when Congress had spent decades refining the adjusted basis approach.

Practitioners should proceed with the assumption that the adjusted basis methodology continues to apply. Document this assumption in the company file. When advising on Section 1202 status, explicitly confirm with the client the adjusted basis of all assets held by the issuer, not just the fair market value of the enterprise. For holding companies, blocker corporations, and any structure that holds appreciated assets, run both the adjusted basis and fair market value calculations and disclose the gap to the founder.

When the inevitable audit or letter ruling request comes, it will matter that the practitioner identified and analyzed this ambiguity. The alternative—assuming the statute is self-explanatory when the legislative history doesn’t support that assumption—is indefensible.

Exits and Timing

The tiered structure creates genuine optimization opportunities while introducing new coordination problems in M&A transactions.

The three-year gate has become psychologically important. Founders and early employees now have a clear milestone: If the company can be sold within three years of their stock issuance, they capture a 50% exclusion without waiting the full five years.

For acquisition targets in software, fintech, and other high-velocity sectors, this is an important incentive to accelerate exit conversations. Expect deal flow to spike around year three for portfolio companies with QSBS-eligible shareholders, particularly in lower-valuation scenarios where the difference between a three-year and five-year exit is meaningful in terms of gross dollars.

This timing pressure interacts poorly with equity compensation. If a company grants restricted stock units or unvested equity to new hires, those grants don’t begin the holding period until vesting. But if the company is acquired before vesting is complete, the acquired equity may never clear the three-year gate for QSBS purposes.

A Section 83(b) election accelerates the holding period to the grant date, not the vesting date, which preserves QSBS eligibility even if the acquisition occurs before the vesting schedule is complete.

Practitioners need to flag this in every transaction where QSBS is at play. If the target company issued significant unvested equity, and an acquisition is contemplated within the three-year window, the timing of an 83(b) election becomes a material tax optimization question. This should be surfaced in the letter of intent as a point to coordinate between the buyer, seller, and equity holders, not left as a surprise in the tax representation and warranty discussion.

Blurry Line

Section 1202(e)(3) excludes stock in corporations that derive more than 50% of gross income from the performance of services in health, law, accounting, consulting, financial services, investment services, or trading in securities or commodities.

This is a bright-line test on paper. In practice, it isn’t. The line between a technology platform that incidentally involves professional services and a professional services firm that happens to use technology is fact-intensive and contested.

The IRS has issued conflicting guidance. A 2021 Private Letter Ruling held that an insurance agency operating through a digital platform wasn’t disqualified under Section 1202(e)(3) because the company performed substantial administrative services beyond those of a mere intermediary.

By contrast, a 2022 Chief Counsel Advice examined an online marketplace for rental property agreements and concluded that, notwithstanding the technological sophistication of the platform, the company derived its income from facilitating transactions between lessors and lessees as a mere intermediary and therefore was excluded.

The distinction doesn’t turn on a single factor. Both rulings looked at the source of revenue, the nature of the primary business purpose, the percentage of time spent on technology development versus service delivery coordination, and the substantive value of the platform. Courts and the IRS haven’t produced a unified theory that practitioners can safely apply.

What practitioners can do is document the company’s business in granular terms:

• What percentage of gross revenue derives from licensing the software platform versus charging for access to service providers?
• What portion of the organization’s headcount is devoted to technology development, as opposed to service coordination?
• Does the company own the intangible property that drives the value, or does it merely operate a marketplace that the service providers could replicate?

For ambiguous cases, fintech platforms that provide credit analysis services, legal tech platforms that provide document assembly, health-care platforms that perform triage functions, the safe approach is to obtain a private letter ruling before the stock is issued, or to structure the transaction so that the QSBS position is not load-bearing to the deal economics.

Relying on the hope that the IRS won’t audit the professional services exclusion isn’t a defensible position when the guidance is this unsettled.

State Conformity

Federal QSBS benefits are a red herring if the taxpayer can’t recognize them at the state level. Practitioners regularly miss this.

California repealed the Section 1202 exclusion in 2013 and has never conformed to the federal provision, even after the OBBBA expansion. A California resident with $50 million in QSBS gains will exclude $15 million at the federal level but pay California tax on the full $50 million. The state’s refusal to conform is rooted in the Commerce Clause principle that states can’t tax federal tax benefits. That principle doesn’t prevent a state from refusing to provide its own conforming exclusion.

Pennsylvania also doesn’t conform to Section 1202, but at a flat 3.07% state rate, the exposure on a $15 million QSBS gain is roughly $460,000, making it a lower-priority planning concern than California, where the same gain triggers nearly $2 million in state tax. New Jersey recently conformed through P.L. 2025, c.67 (A4455), signed June 30, 2025, creating planning opportunities for founders in the tristate area.

In any transaction involving a multistate founder, the state-level analysis must be part of the core tax strategy, not a footnote. A founder who is a California resident but derives income in New York, or who plans to move to another state before the sale closes, needs explicit modeling of the state tax consequences. Some transactions will be structured differently once the state-level cost is quantified.

For holders domiciled in non-conformity states, the OBBBA changes are less generous than they appear. For holders who can manage their residency around the exit date, the tax planning opportunities are materially larger. This should be discussed with the founder and the client, not assumed away.

Compliance Anchoring

The practitioners who will avoid the disputes that the IRS will inevitably pursue are the ones who build QSBS analysis into the deal process from the letter of intent forward. This means:

• Following the Section 1202 checklist at the outset of every M&A conversation involving founder or employee equity holders.
• Confirming the adjusted basis in the company’s assets relative to the new $75 million threshold.
• Identifying whether equity compensation is vested or restricted, and whether an 83(b) election is tax advantaged.
• Analyzing the company’s revenue mix and business purpose against the professional services exclusion.
• Running a state-level tax model for any holder domiciled outside the federal conformity states.

Documentation of these decisions and assumptions should be part of the tax work file. If the IRS raises a question later, the practitioner having identified the relevant variables and made informed decisions about them, rather than simply assuming the statute was self-evident, will shape the auditor’s posture.

The OBBBA’s expanded benefits are real and material. But the statute’s measurement gaps are equally real. Practitioners who move quickly to address these gaps now will deliver more certainty to their clients and will position themselves advantageously for the disputes that will follow.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Delina Yasmeh is a California attorney focused on mergers and acquisitions tax strategy and entity structuring.

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