Introduction
Heard you can sell startup stock tax-free under Qualified Small Business Stock (QSBS) rules? That’s only partially true especially if you live in California.
In 2025, many founders mistakenly believe the QSBS 0% exclusion applies at the federal and state level. But California repealed its state QSBS exclusion, and it’s time to separate fact from myth.
IRC and CA Tax Code References
- IRC §1202 – Federal QSBS exclusion (up to 100% on $10M or 10x basis)
- IRC §1045 – QSBS rollover rules
- FTB Legal Ruling 2012-03 – Denial of state exclusion
- Cal. R&TC §18038.5 – Federal conformity exceptions in CA
- Cal. Schedule CA (540) – State adjustment to exclude QSBS benefit
What is QSBS?
QSBS allows eligible holders of startup stock to exclude up to $10 million or 10x the basis in capital gains if:
- Stock is held for 5+ years
- Business is a C-Corp with assets < $50M at issuance
- At least 80% of assets are used in active business (non-service)
- Stock was acquired at original issuance
Federal law offers 100% capital gains exclusion under IRC §1202.
Why California Doesn’t Honor QSBS Exclusion
Since 2013, California decoupled from IRC §1202 due to constitutional concerns about discrimination against out-of-state businesses.
What that means:
- You still pay full California capital gains tax (~9.3% or higher)
- You still get the full QSBS benefit on your federal return
- You must adjust on Schedule CA (540) to reverse the exclusion
Example: Selling $8M in Startup Shares (2025)
Example: Priya, a CA resident, sells QSBS stock in her SaaS C-Corp for $8 million after holding it for 6 years.
- Federal Tax: She pays $0 on $8M capital gain (meets §1202)
- California Tax: She pays ~$744,000 (9.3% x $8M), no exclusion
She uses Schedule D (Federal) to claim exclusion, but adds back the $8M gain to Schedule CA (540) on the California return.
Step-by-Step: Filing QSBS as a CA Resident (2025)
- Sell QSBS stock after 5-year holding period
Ensure eligibility under IRC §1202. - Claim exclusion on federal Form 8949 and Schedule D
Attach §1202 gain exclusion and holding statements. - Complete California Schedule CA (540)
Add back the federal gain as a positive adjustment. - Pay California state tax on gain
No exclusion applies at the state level. - Consider entity planning if pre-liquidity
Moving domicile, trust planning, or NV/WA strategy may help before sale.
Conclusion
California does not allow the QSBS exclusion. Founders must plan accordingly: while the federal 0% tax on QSBS is real, you’ll still owe California capital gains tax on the full amount.
Before selling startup shares, get strategic state taxes can erase hundreds of thousands in savings.
Call to Action
Planning a major equity exit?
Book a tax mitigation call with Anshul Goyal, CPA, EA, FCA
He can help you:
- File the QSBS exemption federally
- Navigate CA add-back requirements
- Plan trust, residency, or pre-sale structures to reduce tax
Don’t leave 9.3% on the table. Get tax-smart before you sell.
https://calendly.com/anshulcpa/
Disclaimer
This blog is for informational purposes only and does not constitute legal or tax advice. Please consult a qualified tax professional regarding your individual tax situation.
Anshul Goyal, CPA, EA, FCA, is a licensed Certified Public Accountant in the United States, admitted to practice before the IRS as an Enrolled Agent. He also represents clients in IRS litigation and specializes in helping U.S. and Indian businesses meet complex tax compliance requirements.
Top 5 High-Searched FAQs (2025)
1. Does California recognize QSBS exclusion?
No, California decoupled from IRC §1202 in 2013.
2. What’s the state tax rate on capital gains in CA?
It’s treated as ordinary income around 9.3% to 13.3% depending on income.
3. Can I claim QSBS on my federal return if I live in CA?
Yes, the federal exclusion still applies.
4. What form do I use for CA QSBS adjustment?
Schedule CA (540) add back the excluded federal gain.
5. Can I avoid CA tax by moving before the sale?
Possibly. Domicile change and trust planning may reduce or defer CA tax.