Section 1202 QSB: Revisiting life sciences investments after OBBBA

With the enactment of the One Big Beautiful Bill Act (OBBBA), there is heightened buzz around the gain exclusion under section 1202 of the Internal Revenue Code due to expansions of its application. But what is it, and how does it specifically benefit taxpayers in the life sciences industry? We take a closer look.

What is section 1202?

This provision was originally adopted as part of the Revenue Reconciliation Act of 1993. Though it dates to the 1990s, section 1202 has gained attention in recent years. Some attribute its newfound popularity in part to the lower corporate income tax rate. In a nutshell, section 1202 allows a taxpayer the opportunity to exclude as much as 100% of the capital gain realized on the sale of qualified small business (QSB) stock. However, for QSB stock to qualify, certain requirements must be met at both the corporate level and the shareholder-taxpayer level.

One gating issue is whether the C corporation is a QSB at the time of each issuance of corporate stock. A QSB has generally been defined as a company in a qualifying trade or business whose aggregate gross assets, including those of its corporate subsidiaries, do not exceed $50 million (the Aggregate Gross Asset Test). Under the OBBBA, that asset threshold has increased to $75 million, as discussed below.

The rules around what constitutes a qualified trade or business were not impacted by the OBBBA. There is a laundry list of trades and businesses, including health services, that are specifically excluded under section 1202(e)(3). Still, some businesses that are seemingly excluded, such as life sciences businesses, could potentially qualify.

At the shareholder-taxpayer level, one main requirement for gain exclusion is that the taxpayer must hold the stock for at least five calendar years plus a day to reap the full benefit. Now, the provisions of the OBBBA-amended section 1202 provide some benefit, though not the 100% exclusion, for shorter holding periods.

For a more detailed discussion of the general requirements, see Understanding the qualified small business stock gain exclusion.

Expansion of section 1202 under the OBBBA

The OBBBA expands the scope and benefits of this provision, which is designed to incentivize investment in startups and small businesses. With respect to section 1202, it mainly enacts the following three changes applicable to QSB stock issued after July 4, 2025:

• A tiered exclusion correlated to shorter holding periods

Prior to the OBBBA, a taxpayer could qualify for the benefit only if holding on to their stock for more than five years. The amendment to section 1202 allows for some benefit even if the stock is held for only three years.

• An increased per-issuer limitation

The benefit under section 1202 was previously limited to the greater of $10 million or 10 times the taxpayer’s initial basis, as adjusted. Now, the limitation is increased to the greater of $15 million or 10 times the taxpayer’s initial basis, as adjusted.

• An increased Aggregate Gross Asset threshold for qualification

As mentioned above, the new threshold has gone up from $50 million to $75 million, which increases the number of C corporations that may qualify.

For a more detailed discussion of the OBBBA changes, read our article The OBBBA expands QSBS exclusions: What it means for businesses and investors.

Opportunities for life sciences businesses

Section 1202 offers a huge benefit to qualifying taxpayers invested across many industries, and those investing time and money into life sciences businesses are no exception.

The life sciences industry as a whole is not excluded under section 1202(e)(3). Research and development of pharmaceutical drugs and therapies, medical device development, and the manufacturers of these products are generally qualifying businesses.

Notably, qualifying as a QSB can be a valuable incentive when recruiting talent and raising capital in the early stages of a life sciences company. The expansion of section 1202 under the OBBBA to include companies with assets between $50 million and $75 million means that more companies may qualify. This expansion can translate to more investors qualifying for the benefits of section 1202 and companies receiving larger investment amounts. The increase in the per-issuer limitation to $15 million has created additional incentive to use section 1202.