Fund Structure, QSBS, and Section 163(j): What Changed Under OBBBA and Why It Matters at Onboarding

The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, made two changes that directly affect private equity fund managers: it expanded the Qualified Small Business Stock (QSBS) exclusion under Section 1202, and it permanently restored the EBITDA-based calculation for the Section 163(j) business interest limitation. Both changes reward funds that get their structuring decisions right at formation and onboarding, rather than after a deal has already closed.

For fund managers raising capital or actively deploying it, these aren't background tax trivia. They change how portfolio company entities should be chosen, how debt should be structured at the deal level, and how exit timing should be modeled for LPs. Below is a breakdown of what changed, what stayed the same, and where the planning opportunity actually sits.

What Is QSBS and Why Did OBBBA Change It?

Section 1202 of the Internal Revenue Code allows noncorporate taxpayers — individuals, trusts, and pass-through entities allocating to individual partners — to exclude some or all of the capital gain from the sale of Qualified Small Business Stock. Only C corporations issue QSBS; the exclusion does not apply to gains realized by C corporation taxpayers themselves.

Before OBBBA, the rule was rigid: a taxpayer had to hold QSBS for more than five years to claim any exclusion at all, capped at the greater of $10 million or 10 times the taxpayer's adjusted basis in the stock, and the issuing corporation's gross assets could not exceed $50 million at issuance.

The New Tiered Holding Period

For QSBS issued after July 4, 2025, OBBBA replaces the five-year cliff with a graduated schedule:

• 3 years held: 50% of gain excluded
• 4 years held: 75% of gain excluded
• 5 years held: 100% of gain excluded

The portion of gain that isn't excluded on 3- or 4-year stock is taxed at a flat 28% rate rather than standard long-term capital gains rates, so the benefit is real but the math has to be run carefully rather than assumed.

Higher Caps Across the Board

OBBBA also raised the per-issuer gain exclusion cap from $10 million to $15 million (now indexed for inflation), and raised the gross asset threshold a company can have and still issue qualifying stock from $50 million to $75 million. Both changes only apply to stock issued after July 4, 2025 — there is no grandfathering mechanism that converts previously issued stock to the new rules. Stock issued on or before that date remains under the old five-year, $10 million, $50 million framework regardless of when it's eventually sold.

Why This Matters for Fund Managers

For funds that invest in or help structure portfolio companies as C corporations, the new rules change the calculus on two fronts: entity choice at the term sheet stage (is a C corp now more attractive given the expanded thresholds and shorter path to partial exclusion?), and exit timing (a 3-year hold with a 50% exclusion may now beat waiting for the old five-year mark, depending on the deal). Both of these decisions are far easier to get right during initial structuring than to retrofit later.

Section 163(j): The EBITDA Calculation Is Back — Permanently

Section 163(j) limits a taxpayer's deductible business interest expense to 30% of adjusted taxable income (ATI). How ATI is calculated has swung back and forth since the provision was introduced by the Tax Cuts and Jobs Act in 2017:

• Through 2021: ATI was calculated on an EBITDA basis — depreciation, amortization, and depletion were added back, which meant a larger deduction base.
• Starting in 2022: The calculation tightened to an EBIT basis, removing the depreciation and amortization addback and shrinking the allowable interest deduction, particularly for capital-intensive, leveraged portfolio companies.

OBBBA permanently restores the EBITDA-based calculation for tax years beginning after December 31, 2024, once again allowing the addback of depreciation, amortization, and depletion when computing ATI.

For leveraged buyouts and other debt-financed portfolio company structures, this is a meaningful and permanent increase in deductible interest capacity, especially for companies with significant fixed assets or intangibles.

A New Wrinkle: Elective Interest Capitalization

Under the prior regime, some businesses recharacterized interest as capitalized cost (for example, into inventory or self-constructed assets) to sidestep the 163(j) limitation entirely. Starting in tax years beginning after December 31, 2025, OBBBA closes that door: any business interest expense that is electively capitalized to property retains its character as interest and stays subject to the Section 163(j) limitation. Deal teams that have relied on this technique in debt structuring need to revisit it before the rule takes effect.

Fund Structure Still Drives the Outcome

Neither of the above changes replaces the fundamentals of sound fund formation. The entity decisions made at the outset — GP/LP structure, use of blocker corporations to shield tax-exempt or foreign LPs from unrelated business taxable income (UBTI) or effectively connected income (ECI), and the design of management fee waiver arrangements tied to carried interest — continue to be the largest lever most funds have over their overall tax outcome. The QSBS and 163(j) changes are reasons to revisit these decisions now, not replacements for doing the structuring work in the first place.

Frequently Asked Questions

Does the new QSBS holding period apply to stock I already own?

No. The tiered holding period, the $15 million cap, and the $75 million gross asset threshold apply only to QSBS issued after July 4, 2025. Stock issued on or before that date remains subject to the prior rules: a five-year holding period, a $10 million cap, and a $50 million gross asset threshold at issuance.

Can a fund itself claim the QSBS exclusion?

The exclusion is available to noncorporate taxpayers — individuals, trusts, and estates. A fund organized as a partnership can hold QSBS and pass the exclusion through to its individual partners under look-through principles, but C corporation taxpayers, including corporate LPs, cannot claim the exclusion directly.

How does the restored EBITDA calculation under Section 163(j) affect leveraged portfolio companies?

Because depreciation, amortization, and depletion are added back to taxable income when computing adjusted taxable income (ATI), the base against which the 30% interest limitation is applied is larger — meaning more interest expense is deductible in a given year for capital-intensive, debt-financed businesses, for tax years beginning after December 31, 2024.

Will elective interest capitalization still help lower my 163(j) exposure?

Not after 2025. For tax years beginning after December 31, 2025, OBBBA requires that electively capitalized interest keep its character as interest and remain subject to the Section 163(j) limitation, closing a planning technique some businesses previously relied on.

Working With a CPA Who Understands Fund Mechanics

Fund formation and portfolio company tax planning require a level of specificity that general small-business tax guidance doesn't cover — from QSBS eligibility tracing across ownership changes, to ATI modeling for leveraged deals, to blocker structures for cross-border and tax-exempt LPs. We work with private equity fund managers on exactly this intersection, including cross-border structuring for LPs and portfolio investments connected to the MENA region.