The recently enacted One Big Beautiful Bill Act (OBBBA) introduced several key changes that may prompt some family-owned businesses to reconsider their corporate structure. One of the most significant updates expands the ability for business owners to exclude a portion, or even all, of the capital gains tax on the sale of their stock. This is known as the Qualified Small Business Stock (QSBS) incentive under Section 1202.
What’s Changed Under the New Rules
Prior to the OBBBA, the QSBS exclusion was only available to shareholders of C-corporations who held their stock for at least five years. The gain exclusion was capped at $10 million, and eligible businesses had to have less than $50 million in assets.
The new legislation significantly increased the exclusion to $15 million and expanded the definition of a small business to include companies with up to $75 million in assets.
In addition, a new tiered holding period exemption was introduced:
- 50% exclusion after three years
- 75% exclusion after four years
- 100% exclusion after five years
Who Qualifies for the QSBS Incentive
To take advantage of the QSBS incentive, a business must be a domestic C-corporation with assets under $75 million. The stock must be issued directly to the shareholder by the C-corporation, and it must be held for at least three years. The company must also meet the “active business” requirement and operate within a qualifying industry; generally, manufacturing, retail, technology, and wholesale/distribution. Holding companies or passive investment entities do not qualify.
Certain industries are explicitly excluded, including service-based businesses, finance, banking, farming, mining, and hospitality. Specifically, this includes any trade or business in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset is the reputation or skill of one or more of its employees. Industries such as banking, insurance, finance, leasing, investing, farming, mining, hotels, motels, and restaurants are also excluded.
What This Means for Family Businesses
Planning opportunities exist for newly formed businesses who can choose their structure from inception, as well as existing S-Corporations that may now want to reconsider conversion to a C-corporation.
The motives of the business’s owners matter greatly in these decisions.
Family businesses looking to reinvest their profits are much better candidates to consider this structure. Those looking to extract the profits from the business for personal use will face a double taxation in a C-corporation structure, making them much less ideal candidates.
Planning Considerations
There are complex tax and legal considerations when converting an existing entity to a C-corporation:
- Structure matters. An exchange of assets will have an entirely different outcome than an exchange of stock.
- Valuations are required to establish and justify the tax basis.
- Shareholder makeup at the time of conversion and at the time of stock sale will impact the overall tax savings.
Bottom Line
While the expanded QSBS provisions may make the C-corporation structure more appealing, the right answer depends on your unique facts, goals, and exit timeline. The details are complex, which makes it important to consult your tax, legal, and financial advisors who can advise you on the full impact to your company and your family’s long-term plans.
Schedule a Planning Discussion
Contact our team to evaluate whether a C-corporation structure could benefit your family business. We’ll review how the new QSBS rules may affect your current structure and future exit strategy.