Tax
The QSBS Bill That Would Fix Convertible Notes and Leave SAFEs Behind
Two bills would let a convertible instrument's QSBS clock tack onto its stock. But the definition says “evidence of indebtedness,” and a SAFE isn't debt.
By 409.AI Team - 2026-08-27
# The QSBS Bill That Would Fix Convertible Notes and Leave SAFEs Behind
An angel investor who wired $500,000 into a seed round asked a version of this question recently: there's a bill in Congress that makes my SAFE count toward the five-year QSBS clock, so if it passes, am I already most of the way there?
The bill is real. Two of them, in fact. [H.R. 1199, the Small Business Investment Act of 2025](https://www.govinfo.gov/content/pkg/BILLS-119hr1199ih/html/BILLS-119hr1199ih.htm), was introduced by Representative David Kustoff on February 11, 2025 and referred to the Committee on Ways and Means. [A companion Senate bill, S. 695](https://www.govinfo.gov/content/pkg/BILLS-119s695is/html/BILLS-119s695is.htm), was introduced by Senator John Cornyn on February 24, 2025 and sent to Finance. Section 3 of each carries the same heading: "Tacking Holding Period of Convertible Debt Instruments." That is genuinely the fix people are describing.
Then you read the definition of which instruments get it. The bills say "any bond or other evidence of indebtedness." A SAFE isn't indebtedness. It was designed specifically not to be.
Where the clock starts today
Current law is unforgiving about this, and the reason is structural rather than punitive. [Section 1202(c)(1)](https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section1202&num=0&edition=prelim) grants qualified small business status to stock acquired by the taxpayer at its original issue, with the company tested against the qualified small business requirements "as of the date of issuance." Everything hangs on the day shares actually land in your name.
Section 1202 does allow a holding period to carry across in one narrow case. Subsection (f) is titled "Stock acquired on conversion of other stock," and it does exactly what the title says: if you acquire stock solely by converting *other stock in the same corporation* that was already QSBS in your hands, the new stock inherits both the QSBS character and the holding period. Preferred converting to common at an IPO is the classic example.
A SAFE converting into newly issued preferred is not that transaction. Neither is a convertible note. In both cases the stock is originally issued on the conversion date, so the clock starts then. We walked through the mechanics and the cost in [why your Section 1202 clock starts at conversion](https://409.ai/articles/safes-qsbs-holding-period-conversion-section-1202), and none of that has changed. The bills would change it, for some instruments.
The six words that decide it
Here is the operative definition from Section 3 of H.R. 1199, which S. 695 repeats verbatim:
> the term 'qualified convertible debt instrument' means any bond or other evidence of indebtedness (i) which is originally issued by the corporation to the taxpayer, (ii) the issuer of which (I) from issuance until conversion, is a qualified small business, and (II) during substantially all of the taxpayer's holding period of such bond or evidence of indebtedness, the corporation meets the active business requirements of subsection (e), and (iii) which is convertible into stock in the corporation.
"Bond or other evidence of indebtedness" is the gate. A convertible promissory note walks through it without argument. It accrues interest, it has a maturity date, and the company owes the money back. Y Combinator, which wrote the SAFE, draws the line plainly in its own [comparison of the two instruments](https://www.ycombinator.com/safe/safe-vs-convertible-note): a convertible note is "debt that converts to equity," carrying interest of roughly 2 to 8 percent and a maturity date that can force repayment or default. A SAFE is a "convertible security" with no interest rate, no maturity date, and no repayment obligation.
That's not a drafting accident in the SAFE. Removing the debt features was the entire point of the instrument. Founders adopted it because nobody could call the note due at the worst possible moment. The same design choice is what appears to keep a SAFE outside a definition built around evidence of indebtedness.
Worth being precise about the confidence level here. Neither bill has a committee report, there's no Treasury guidance to read, and no court has construed language that isn't law. Text can be amended in markup, and a determined drafter could widen that phrase in an afternoon. But as the bills are written today, a founder or investor planning around "my SAFE will finally count" is planning around a reading the text doesn't support.
Part of this bill already passed, by a different route
The headline provision in both bills is Section 2, which replaces the flat five-year cliff with a table: 50 percent of gain excluded at three years, 75 percent at four, 100 percent at five.
If that sounds familiar, it's because it's law. The One Big Beautiful Bill Act, signed July 4, 2025, delivered the same tiered ramp, lifted the per-issuer cap to $15 million, and raised the aggregate gross assets ceiling to $75 million. We covered the full set of changes in [what OBBBA changed about Section 1202](https://409.ai/articles/qsbs-one-big-beautiful-bill-act-section-1202-changes). Both bills predate that law by about five months, which is why their Section 2 reads like a proposal for something you already have.
So the live question isn't the ramp. It's Sections 3 and 4: the convertible debt tacking, and a separate expansion that would open QSBS to S corporation stock by striking "C corporation" from Section 1202(c) and (d). Neither has moved. As of the most recent status updates, both bills sit in committee with no recorded action beyond the initial referral and no cosponsors listed.
Two conditions that would trip up real notes anyway
Even for an investor holding an unambiguous convertible note, Section 3 is stricter than the headline suggests, in a way that rewards reading clause (ii) slowly.
The first condition is that the issuer must be a qualified small business "from issuance until conversion." Read that against current law, where 1202(d) tests the aggregate gross assets ceiling before and immediately after the issuance. The proposed tacking rule asks for something continuous instead of a snapshot. A company that funds itself on notes, crosses $75 million in aggregate gross assets somewhere in the middle, and then converts everyone at a later round would fail that condition, and the tacking would simply not be available. The gross assets trap that already voids QSBS eligibility at conversion would also void the holding-period benefit.
The second condition is that the company must meet the active business requirements of Section 1202(e) during "substantially all" of the holding period of the note. That's the same qualified trade or business test that quietly disqualifies more companies than founders expect, particularly anything that reads as consulting or professional services. If the business drifted across that line during the note's life, the note holder loses the benefit even though the company qualifies on the conversion date. Our breakdown of [the consulting test under Section 1202](https://409.ai/articles/qsbs-qualified-trade-or-business-consulting-test-section-1202) covers where that boundary actually sits.
There's a third detail worth flagging for anyone with an interest-bearing note. The tacking rule applies where stock is acquired "without recognition of gain, solely through the conversion." Accrued interest converting into equity alongside principal is the kind of wrinkle that deserves a conversation with a tax advisor rather than an assumption.
What it would be worth, and to whom
Take two investors who put $500,000 into the same company on the same day in March 2027, assuming for the sake of argument the bills had been enacted in late 2026. One uses a convertible note, the other a SAFE. The round converts in September 2029, the company sells in December 2031, and each investor's gain is $3 million.
The SAFE holder counts from conversion: two years and three months. That clears the one-year mark for long-term treatment but falls well short of the three-year tier, so the exclusion is zero and the full $3 million is taxed at ordinary long-term capital gains rates. At 20 percent plus the 3.8 percent net investment income tax, call it $714,000.
The note holder tacks back to March 2027 for a holding period of four years and nine months, which lands in the 75 percent tier. That excludes $2.25 million. The remaining $750,000 is Section 1202 gain, generally taxed at a maximum 28 percent rather than the usual long-term rate, with the 3.8 percent net investment income tax potentially on top. Call it $238,000.
Roughly $475,000 of federal tax separates two investors who wrote identical checks, on identical days, into identical companies, before any state tax enters the picture.
That gap is the reason this matters even though the bills are going nowhere fast. It's also the reason not to overreact to it. If you're staring at an early exit that lands short of a tier, [Section 1045 lets a QSBS gain roll into replacement stock](https://409.ai/articles/section-1045-qsbs-rollover-defer-gain-early-sale) on a tight timetable, and that tool exists under current law rather than a hypothetical one.
The retroactivity question nobody asks
This is the part that undoes the original question entirely.
Section 3's effective date says the amendments "shall apply to debt instruments originally issued after the date of the enactment of this Act." Section 4 applies to stock acquired after enactment. Nothing in either bill reaches backward.
So even in the world where Congress passes this next month with the definition untouched, the SAFE signed in 2024 gets nothing, and the convertible note signed in 2024 gets nothing either. Every instrument currently outstanding on every cap table in the country is outside the benefit. The bills change the arithmetic on paper you have not signed yet.
That's a very different planning conversation from the one people are having. It isn't "wait and see whether my clock gets fixed." It's "if this ever becomes law, the instrument choice on my next round carries a tax consequence it doesn't carry today."
What to do with this now
Track conversion dates in your cap table as first-class data, separate from signature and wire dates, because under current law that's the only date Section 1202 cares about. If you're modeling how those instruments move your own numbers, [how SAFEs affect your 409A valuation](https://409.ai/articles/how-safes-affect-your-409a-valuation) and [convertible notes and your 409A](https://409.ai/articles/convertible-notes-effect-on-409a-valuation) cover the valuation side of the same events.
Don't restructure a round around either bill. A tax bill with no cosponsors that hasn't left committee in eighteen months is not a planning assumption, and the version that eventually moves, if one does, may not resemble this text.
And if someone tells you a bill in Congress is about to make your SAFE count, ask them to show you the definition rather than the summary. Six words in, at "indebtedness," the answer is usually already sitting there.