The Qualified Small Business Stock Boost: Jet Fuel on Fire for Texas Capital Formation
Chuck Kraus and Brian Elliott unpack the One Big Beautiful Bill Act expansion of Section 1202, tiered exclusions at three and four years, the $15M cap with inflation indexation, the $75M gross asset ceiling, and what this means for Texas capital formation, founder entity decisions, and Canadian-US flips.
In this episode
Eight chapters, ~18 minutes
- Why QSBS just got dramatically better
- What QSBS is and how it's used
- What changed: tiered exclusions, $15M cap, inflation indexation
- Texas implications: stacking with no state income tax
- Action items: entity conversions and timing
- International dimension: Canadian and UK flips
- How QSBS compares to the Canadian Lifetime Capital Gain Exemption
- Practical advice for general counsel
What this episode covers
- QSBS explained for founders and investors
- The new tiered holding period structure (50% / 75% / 100%)
- Increased gain exclusion caps ($10M to $15M, indexed to inflation)
- Converting from LLC or S-corp to C-corp for QSBS eligibility
- International dimension: Canadian and UK companies considering US flips
- How QSBS compares to the Canadian Lifetime Capital Gain Exemption
Why this episode matters
QSBS is the most powerful federal tax provision available to Texas business owners building toward an exit. The OBBBA changes don’t just expand the tool, they change how founders should think about exit timing, entity structure, and state of residence at the time of sale. For Texas specifically, the absence of state income tax means the federal exclusion is the effective exclusion, putting the state in a uniquely favorable position relative to non-conforming jurisdictions. The international dimension is equally consequential: the QSBS expansion has materially shifted the calculus for Canadian and UK founders considering whether to set up a U.S. holding company structure ahead of their next capital raise.
Mentioned in this episode
Statutes & legislation
Concepts
Geographic
People & roles
Related reading from the desk
Related episodes
Common questions from this episode
QSBS, Qualified Small Business Stock, refers to provisions in Section 1202 of the Internal Revenue Code that exclude federal capital gains tax on the sale of stock in qualifying small business C-corporations. The exclusion is per-issuer rather than per-taxpayer, and applies to original issuance stock held for the required period.
Three changes. First, tiered exclusions: 50 percent gain exclusion at three years held, 75 percent at four years, and the original 100 percent at five years (previously holders received nothing under five years). Second, the per-issuer cap rose from $10 million to $15 million, indexed for inflation starting 2026. Third, eligibility extended to companies with up to $75 million in gross assets, up from the prior $50 million.
No. QSBS applies only to stock issued by C-corporations from original treasury issuance. Companies organized as LLCs taxed as partnerships, or as S-corporations, would need to convert to C-corp status before issuing the stock that becomes QSBS-eligible. Many companies structured as flow-through entities are now considering that conversion specifically to position for QSBS treatment on a Series A or subsequent capital raise.
At the time the stock is originally issued by the C-corporation. The holding period does not relate back to the date of incorporation, and it does not include time the holder owned predecessor entity interests, such as LLC units that were converted to corporate stock. Founders considering the conversion path need to factor this clock into their exit timing.
The federal exclusion eliminates federal capital gains tax. State tax treatment varies. In Texas, where there is no state income tax, the federal exclusion is the effective exclusion, there is no state-level reduction. In states like California and New York, the federal exclusion does not eliminate state-level capital gains tax, so the practical benefit is reduced for residents of those states.
Yes. By forming a new U.S. C-corporation and reorganizing the foreign entity as a wholly-owned subsidiary of the new U.S. parent, subsequent U.S. investments can be structured as QSBS-eligible. Existing shareholders who exchange their foreign shares for U.S. stock in the flip itself generally do not receive QSBS treatment, because the exchange is not an original treasury issuance, but post-flip raises by U.S. investors create QSBS-eligible stock.
The two operate on different dimensions and shouldn't be directly compared in absolute dollar terms. The Canadian LCGE is a per-taxpayer lifetime cap on capital gains from qualifying dispositions, currently around CAD $1 million indexed. QSBS is a per-issuer cap of $15 million (or 10x basis, whichever is greater) with no lifetime limit on the number of issuers a single taxpayer can claim against. A taxpayer with positions in multiple QSBS-eligible companies can claim the exclusion separately against each.
The One Big Beautiful Bill Act provisions took effect for stock issued after the bill's signing in summer 2025. Stock issued before that date remains under the prior rules. For founders and investors, this creates an inflection point: stock issued under the old rules has the old terms, stock issued under the new rules has the new terms, and the timing of any conversion or new raise determines which set of rules applies.
Full transcript
Conversation between Chuck Kraus and Brian Elliott. Lightly edited from auto-transcription, ad reads removed, paragraphs grouped, speakers attributed where determinable. Listen on Apple Podcasts or Spotify for the original audio.
So, Brian, welcome back. I think it's episode 13 of Y'all Street Law Podcast. Today, we're going to talk about a pretty significant improvement to capital formation that was included in that One Big Beautiful Bill Act. I think these four letters are the four most important letters in U.S. capital markets. They are QSBS, stands for Qualified Small Business Stock, as you know, and it just got a shot in the arm.
Yeah, thanks, Chuck. I think we were all having our barbecues over the summer, and we saw this bill come by, and the real narrative was about deficit spending and taxes. And there was a lot included in the bill that got lost. One of the things is the QSBS rules, and I'd like to get into that. But timing is key. So why don't you give us the start at the top, Chuck, and tell us what changed, what's new, and what should we expect?
Yeah, to set the stage: QSBS is provisions in the tax code, Section 1202, that gives special treatment to exclude from gain stock that is Qualified Small Business Stock. It used to be that you had to hold the stock for no less than five years. If you were four years and 364 days, that was not enough, you had to hold for more than five years. But if you did, you got an exclusion of the greater of 10x your basis or $10 million.
That was great, but this is even better. This now tiers the exclusions. The exclusion starts at three years, and the cap has moved from $10 million to $15 million, and thereafter it's going to be indexed to inflation. Either one of those were a big change. Both of them together are fantastic, and it's already spurring more and more conversations about conversions from other types of entities into C-Corps, which are eligible for this, and spurring conversations about Delaware flips or conversions from foreign entities into U.S. C-Corps.
Yeah, I mean, if we could just take a step back, and let's look at it at a broader level: we're talking about exclusions from tax on the sale of stock on an exit, right? So why don't you just walk us through what does QSBS mean for founders and investors, and how is it normally used?
Yeah, so normally where this gets exciting is you're raising external capital, you're doing your Series A, B, C, D, whatever, and these investors have the ability, if they hold the stock for the requisite period of time, to exclude from capital gains stock that meets the requirement of qualified small business stock. So they can invest in a startup company, they can fund its growth, then the company exits via M&A or stock sale, and if the stock qualifies as QSBS, that gain is excluded from tax. Very powerful.
Excellent. So besides the caps being lifted, did anything else change? Are there any other provisions that we should know about?
Yeah, so let's walk through it. The first big thing, as I mentioned, is it used to be you had to hold no less than five years. Now there are tiered exclusions. Starting at a three-year hold period, there's a 50 percent gain exclusion. If you hold for four years, you get a 75 percent gain exclusion. And if you hold for five years, and this was the old rule, if you hold for five years, you get a 100 percent gain exclusion. So the change is that you now get partial exclusion starting at three years, and a 75 percent exclusion starting at four years.
Yeah, and that's up to a certain maximum point, right? A certain cap level. It used to be $10 million?
Yeah. So the second big thing is that there is a per-issuer gain exclusion cap. That cap used to be the greater of $10 million or 10 times your basis. That cap on a per-issuer basis is now increased to the greater of $15 million or 10 times your basis. And then starting in 2026, that cap is indexed for inflation. So the $15 million will rise as inflation rises.
Well, that's a pretty significant jump and a good benefit for holders of QSBS stock.
It's enormous, frankly, when you think about the greater of $15 million or 10x your basis, that can be massive amounts of exclusion from capital gains. This applies, of course, nationally; this is in the One Big Beautiful Bill.
What are the Texas implications? How does that relate to what we're doing here?
Yeah, this is the federal tax code, so this is an exclusion from federal taxes. But as we think about it in our home state of Texas, you add to that exclusion the fact that Texas has no state income tax. So the QSBS exclusion is incredibly valuable here. I think that, combined with all the other capital formation initiatives in the state of Texas, makes it extremely valuable.
So talk to me about who should consider taking action, and what kind of actions should we be thinking about with respect to this rule change?
Yeah. The conversations we started having immediately were with companies that are currently structured as something other than a C-corporation, that is, an entity not taxed as a C-corp. So it's not an LLC that's taxed as a partnership, and it's not an S-corporation. It only applies to entities that have elected C-corp status. So it immediately started to filter into conversations we have with companies about potentially converting from one of those flow-through entities into a C-corporation.
Oftentimes our clients will start as an LLC or as a partnership because they're going to generate significant losses in the first few years, and they don't want those losses to be stuck in the corporation. They want those losses to flow through to the owners. But if you're an entity that's past that, that's nearing the point where you're going to start to generate some taxable earnings and profits, it's a great time to consider flipping to a C-corporation.
The other way it started coming up in conversations is with entities that are about to do their first significant raise, that Series A raise. The principal purpose: having stock that is eligible for QSBS, that is C-corporation stock, is a very attractive, often mandatory thing for outside money coming in. And so in order to set yourself up to go out and raise that money, you want to put yourself in a position to be able to do that conversion, be a C-corporation at the time to issue the stock.
And as for new formations, is this something that a new company would consider right away, where normally they would tend to lean toward perhaps an S-corp or LLC? Does this give you more incentive to go to a C-corp right away?
Yeah, potentially. I still think that the timing is more important when you're going to raise that external capital. So if you're a company that is going to shoestring it for the first little while, or you have investors who would prefer to fund the deficits until the company gets to a steady, sustainable state, we deal with lots of companies that start as a flow-through and then convert to a C-corporation once they've got their feet under them and are ready for that first big raise.
And the holding period starts at the time of issuance?
Yes. The holding period starts at the time the stock is issued. So you need that three-to-five-year clock to start to run at the time the initial stock is issued. It doesn't go back to the date of incorporation.
Good considerations. Let's talk about how this affects international. You've been doing a lot of work with Canadian and UK companies and their considerations when they're looking for a US-domicile company. Tell us how those considerations come into play.
Yeah. The last few months, it's been two words in those conversations: tariffs, and now QSBS. I think that all the tariff concerns in the first half of the year were driving lots of foreign companies who wanted to access the US market to just look seriously at taking the leap and setting up a presence in the US, or directly flipping their org structure to put a US entity at the top of the structure. Part of the considerations there were tariffs, setting up a presence here to manufacture or sell directly here. And then the other is this consideration of QSBS and being able to issue stock that would be eligible.
When they're looking to make that flip, does the international founder get benefits in this situation?
No. In the conversion, the shareholders that are converting in what is a stock-for-stock transaction do not then get QSBS treatment, because it has to be an original treasury issuance. But if you convert, then any money you subsequently raise in the United States can be structured to be QSBS-eligible to those investors.
In the Canadian example, I know you do a lot of work in Canada, Chuck, how does this compare to the Canada Lifetime Capital Gain Exemption?
It dwarfs it incredibly. The Lifetime Capital Gain Exemption is something around, well, a billion dollars per investor per lifetime is way too generous a description; it's much smaller than that. This QSBS exclusion is $15 million, not per taxpayer, but per issuer, or 10x basis. So it's just monumental. I had some conversations on LinkedIn and then private phone calls where participants in the Canadian capital markets were really pointing out that there's just nothing in Canada that compares to this. I think I called it jet fuel on fire. And on top of that, the business-friendly environment in Texas gives a lot of Canadians especially a good reason to look at Texas as a place to redomicile a Canadian company.
Yeah, that's exactly right. You form a new company, you replicate basically your Canadian cap table in the United States, you make the Canadian entity a wholly-owned subsidiary so you can continue those operations, and then you have the ability to issue stock that would be QSBS-eligible for U.S. investors in the United States.
Well, that's a lot of strategy to think about. And this is all coming fast, the new rules just went into effect. So there's lots to think about. If you're talking directly to a GC of a corporation that may be in one of these situations, what are you telling them? What should they be thinking about right now?
Yeah. The conversation I just had very recently was one around conversion. It was laying out how attractive this could be: if they were a U.S. top company, they could still have all their operations in foreign subsidiaries. The cost of capital is a big consideration for a senior management team, for a CFO and GC. The familiarity that you get in going to raise and describing to investors the sheer terms of a Texas entity or a Delaware entity, as compared to another jurisdiction, just really greases the wheels and makes the raise a lot smoother.
It's a fascinating rule change. And one, I've got to say, that just slid under the radar during the summer with all the talk about tariffs and deficits. It really hasn't got the attention that I think it deserves. What's your prognosis on this? Where do you think it's going, and how is this new rule change going to play out?
Yeah, I think you're going to continue to see more and more focus on this. Like I said at the outset, I think we were distracted by a lot of noise in the summer. But it's another example of a really positive change trying to get ahead of where the market is going and enabling capital formation. We've got another episode where we're going to talk about preemptive legislation in advance of technology developments, in advance of market developments, whether that's autonomous driving or crypto or whatever. And I think this is just another example of a positive change. We're going to see the benefits of this in capital formation for years and decades.
Great overview, Chuck. Any final thoughts or other things that people should be aware of?
If you have questions about this, if you're wondering how to structure properly, give us a call. We're happy to walk you through it and partner with you to make this QSBS exclusion available to your shareholders.
Perfect. Well, it's been a great walkthrough of the new QSBS rules, and we look forward to updates on boots on the ground, how is it rolling out? How is it affecting our clients in the months to come? And we'd love to hear those actual stories in coming episodes.
Absolutely. We will bring back one of the GCs of one of these successful deals to talk about it. But it's great. Amazing.
Thanks, Chuck. Talk again soon.
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