Tax Law Center Blog

For tax professionals with New Jersey clients, a significant change is on the horizon. A new state law (P.L. 2025, Chapter 67 (A4455/S4503)), signed by Governor Phil Murphy on June 30, 2025, brings New Jersey’s Gross Income Tax (GIT) into alignment with the federal exclusion for Qualified Small Business Stock (QSBS) under IRC Section 1202. This landmark legislation, effective for tax years beginning on or after January 1, 2026, marks a pivotal shift for investors and business owners in the state.

Qualified Small Business Stock (QSBS) is a powerful (but under-utilized) tax tool to exclude large gains from tax.

Key Provisions and Implications

Prior to this law, New Jersey residents were unable to exclude gains from the sale of QSBS from their state income tax, even if those gains were exempt at the federal level. This new legislation changes that, allowing for a New Jersey exclusion that mirrors the federal treatment.

The new law allows for an exclusion of 50% to 100% of the capital gains from QSBS, with the maximum exclusion being the greater of $15 million (or $10 million for stock issued on or before July 4, 2025) or ten times the taxpayer’s basis in the QSBS.

A critical point for tax professionals to note is the law’s dynamic reference to IRC Section 1202. This means that New Jersey’s law is expected to incorporate the significant changes made by the federal One Big Beautiful Bill Act (OBBBA), which became effective July 4, 2025.

The Impact of OBBBA

The OBBBA modified the requirements for QSBS, particularly for stock issued after July 4, 2025. To qualify for this exclusion, the stock must be acquired directly from a domestic C corporation that had gross assets of $75 million or less at the time of issuance. The corporation must also be engaged in a qualified trade or business, and the stock must be held for a minimum of three years.

While the New Jersey exclusion applies to gains realized in 2026 and subsequent years, it is crucial to remember that it does not apply to gains realized before this period. It is anticipated that the New Jersey Division of Taxation will issue further guidance to confirm that the OBBBA changes will be incorporated into the GIT.

This legislative change provides a significant opportunity for private equity and venture capital investors, as well as business owners, to improve their after-tax returns and enhance investment flexibility within New Jersey.

Section 1202 Basics

For a comprehensive understanding, here are the foundational requirements for stock to qualify as QSBS and for a taxpayer to be eligible for the federal exclusion under IRC Section 1202.

Requirements for the Stock and Corporation:

• Entity Type: The stock must be issued by a domestic C corporation. Stock issued by S corporations or LLCs does not qualify.
• Original Issuance: The stock must be acquired directly from the corporation in exchange for money, property (not including stock), or services. It cannot be purchased on the secondary market.
• Asset Test: At all times before and immediately after the stock is issued, the corporation’s aggregate gross assets must not exceed a specific threshold. For stock issued before July 4, 2025, this limit was $50 million, and for stock issued after that date, it is $75 million.
• Active Business Test: The corporation must be engaged in a “qualified trade or business” and use at least 80% of its assets in the active conduct of one or more of these businesses. Certain types of businesses, such as those in the fields of law, accounting, finance, and hospitality, are generally excluded.

Requirements for the Shareholder:

• Non-Corporate Taxpayer: The exclusion is only available to non-corporate taxpayers, including individuals and trusts.
• Holding Period: The stock must be held for a minimum period to qualify for an exclusion. The length of this period and the resulting exclusion percentage depend on the date the stock was acquired.
  • For stock acquired on or after September 28, 2010, the exclusion is 100% of the gain if held for more than five years.
  • For stock acquired after July 4, 2025, the holding period is tiered: 50% exclusion after three years, 75% after four years, and 100% after five years.
• Gain Cap: The amount of eligible gain that can be excluded is limited. The exclusion is capped at the greater of $10 million (or $15 million for stock issued after July 4, 2025) or 10 times the taxpayer’s adjusted basis in the stock. This limitation is applied on a per-taxpayer, per-corporation basis.

The benefits of the federal exclusion include a potential 100% exclusion from federal capital gains tax and the 3.8% Net Investment Income Tax (NIIT), making it a powerful incentive for investment in businesses.