QSBS, and what California does with it.
Section 1202 can exclude millions of dollars of gain from federal tax when you sell stock in a qualifying company. California does not follow it. For a California resident, a gain that is entirely tax-free federally is still fully taxable by the state, at rates reaching 13.3%.
That single fact is missing from most national guidance on this subject, and it is the difference between a plan that works here and one that was written for somewhere else.
Four things have to be true.
All of them, not most of them. Each is a question about the company and about how you acquired the shares.
- The company is a C corporationIt must have been one when the stock was issued and remain one for substantially all of the time you hold it. Companies that converted from an LLC or S corporation have a start date for this, and it is not the date you joined.
- You acquired the stock at original issueDirectly from the company, for cash, property, or as compensation for services. Shares bought from another shareholder on a secondary market do not qualify, even though they are stock in the same company. For employees this usually means shares from exercised options can qualify, while shares acquired some other way may not.
- The company was under the gross assets ceiling when the stock was issued$75,000,000 for stock issued after July 4, 2025, $50,000,000 before that. This is measured at issuance, so a company that later grows far past the ceiling does not retroactively disqualify stock issued when it was small.
- The company runs a qualifying trade or businessAt least 80% of assets by value must be used in an active qualified trade or business for substantially all of your holding period. The statute excludes a specific list of fields, and whether a given company qualifies is a determination for tax counsel rather than an assumption.
What changed in 2025.
The One Big Beautiful Bill Act split Section 1202 by acquisition date. Which set applies to you depends on when your stock was issued, not on how long you have held it.
| Issued after July 4, 2025 | Issued on or before | |
|---|---|---|
| Held 3 years | 50% excluded | No exclusion |
| Held 4 years | 75% excluded | No exclusion |
| Held 5 years | 100% excluded | 100% excluded |
| Cap per company | $15,000,000 | $10,000,000 |
| Company asset ceiling at issuance | $75,000,000 | $50,000,000 |
The exclusion stops at the state line.
California does not conform to Section 1202. The Franchise Tax Board requires the entire gain to be entered on the California return, with no reduction for the federal exclusion. California repealed its own version of the provision in 2013, after a court held that the version then in force was unconstitutional because it favored companies keeping payroll in the state.
The practical effect is straightforward and expensive. A California resident who excludes $15,000,000 of gain from federal tax still reports all $15,000,000 to California and pays at ordinary rates, since California gives capital gains no preferential treatment. On a cap-sized gain the California liability alone runs to seven figures.
This does not make QSBS worthless. It makes the federal benefit real and the state benefit zero, which changes what the planning is for. Residency, timing, and how shares are held all matter more here than they would in a state that conforms, and none of that works as an afterthought at the point of sale.
What people get wrong.
- Assuming the five-year rule still applies to everythingFor stock acquired after July 4, 2025, there is a tiered exclusion: 50% at three years, 75% at four, 100% at five. Stock acquired earlier is still all or nothing at five years. Two people at the same company can be under different rules depending on when their shares were issued.
- Assuming every share sold into a tender gets the same treatmentIn a tender offer you are the seller; the company or an outside investor is buying. So the question is not how you acquired shares in the tender, it is whether the shares you are selling qualify and whether you have held them long enough. Shares from exercised options can qualify, RSU shares generally do not, and a single tender can include blocks with different answers. They have to be tracked separately.
- Treating the cap as per person rather than per companyThe limit is per issuer: $15,000,000 under the current rules, $10,000,000 under the old ones. Someone holding qualifying stock in two different companies may have two separate limits.
- Forgetting the exclusion is federal onlyCalifornia does not conform. The federal exclusion produces no California benefit whatsoever, and California is not a small number here.
Figures cited are 2026 amounts. This is educational information, not individualized tax or legal advice. Whether particular stock qualifies under Section 1202 is a legal determination that depends on the company's structure, its asset values at issuance, and its actual trade or business. Work it through with your tax professional and the company's own confirmation.
When this is worth outside input.
If you hold stock you acquired directly from an early-stage C corporation and a sale is plausible within a few years, this is worth establishing before you need the answer. Confirming qualification is far easier while the company is still cooperative and the records still exist than it is during a transaction.
It matters most when the gain is large enough that the California treatment changes your decisions, when you hold blocks acquired at different times and possibly under different rules, or when you are weighing a move out of state. Austin Creek Capital works alongside your tax professional on the planning; we do not make the legal qualification determination ourselves.
Common questions.
Does California really tax gain that is federally excluded?
Yes. California does not conform to Section 1202 or Section 1045, and the Franchise Tax Board requires the entire gain to be reported on the California return. A resident excluding $15,000,000 federally still owes California tax on the full amount, at rates reaching 13.3%. California repealed its own version of the exclusion in 2013 after a court found it unconstitutional.
Which businesses are excluded from qualifying?
The statute names services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics and financial services, along with brokerage, banking, insurance, financing, leasing and investing, farming, extraction of depletable products, and hotels and restaurants. Any business whose principal asset is the reputation or skill of its employees is also excluded. Whether a particular company falls inside or outside this list is a legal determination.
Can I defer the gain instead of excluding it?
Section 1045 allows a rollover: if you held the stock more than 6 months and reinvest the proceeds in other qualified small business stock within 60 days, the gain is deferred rather than recognized. California does not conform to Section 1045 either, so this defers federal tax while California taxes it now.
How do I know whether my shares qualify?
You generally cannot determine it alone, because the tests depend on the company's structure, its asset values at the time of issuance, and what it actually does. Many companies will confirm QSBS status or provide an attestation on request. That confirmation, plus your own record of how and when you acquired each block, is what makes the answer knowable.
Is it worth moving out of California before selling?
It is a question people ask, and the answer is more complicated than changing an address. California taxes residents on all income and sources equity compensation by where the work was performed. A change of residency is a factual matter the state scrutinizes, and the planning has to happen well in advance of a sale rather than around it. This is one to work through with a tax professional.
Does QSBS matter if I only have RSUs?
Usually not directly. RSUs generally produce ordinary compensation income at vest rather than stock acquired at original issue for a purchase price, so the exclusion typically does not apply to them. It matters most for founders, early employees who exercised options, and anyone who bought shares directly from the company.
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