The One Big Beautiful Bill Act expanded the Section 1202 QSBS exclusion, increasing the federal tax-free gain limit and broadening eligibility criteria. However, the changes primarily benefit founders who are not California residents, since California does not conform to the federal QSBS exclusion and taxes the full gain at ordinary state income tax rates regardless.
The One Big Beautiful Bill Act (OBBBA) signed into law on July 4, 2025 made significant changes to Section 1202 that affect every startup founder in Silicon Valley. The gross assets threshold increased from $50 million to $75 million for stock issued after July 4, 2025, and is now indexed for inflation starting in 2027. A new tiered exclusion system allows 50% exclusion for QSBS held three years, 75% for four years, and the full 100% for five or more years. The per-issuer exclusion cap increased to the greater of $15 million or ten times basis. Gurpreet Bal advises founders to structure their equity issuances with these new thresholds in mind from the date of incorporation.
No. California does not conform to the federal QSBS exclusion under IRC Section 1202. California founders who qualify for the federal exclusion still owe California state income tax on the full gain from their stock sale, currently at rates up to 13.3%. This creates a significant gap between the tax treatment of California-based and non-California founders.
This is where most founders and even many advisors get it wrong. California does not conform to the federal Section 1202 exclusion. California taxes capital gains on QSBS as ordinary income at rates up to 13.3%. This means a California-resident founder who sells qualifying QSBS and excludes $10 million from federal tax still owes California approximately $1.33 million in state income tax on that same gain. Gurpreet S. Bal has represented sellers and individual founders in sale transactions that regularly max out the QSBS exclusion — and has seen firsthand the shock when founders realize the federal exclusion does nothing to reduce what California takes. He regularly counsels Silicon Valley founders on the California QSBS gap and the pre-transaction planning strategies available, including the timing and mechanics of establishing bona fide residency in a state that does conform to Section 1202 before a liquidity event.
The most commonly missed QSBS requirements are the active business test (at least 80% of assets must be used in a qualified trade or business), the original-issue requirement (stock must be acquired at original issuance, not on the secondary market), and the $50 million gross assets test at the time of issuance. Stock received for services rather than cash or property may also fail to qualify.
QSBS qualification requires stock in a domestic C corporation with gross assets not exceeding the applicable threshold, acquired at original issuance in exchange for money, property, or services, where the corporation uses at least 80% of its assets in an active trade or business. Several business types are excluded, including professional services, financial services, and hospitality. In Gurpreet Bal's practice, the most common qualification failures involve companies that converted from LLC to C corporation mid-life (only post-conversion stock qualifies), stock acquired in secondary transactions rather than original issuance, and companies that inadvertently tripped the gross assets test during a large funding round.
Founders can multiply QSBS exclusions by gifting qualifying stock to multiple trusts or family members before a liquidity event, since the $10 million per-issuer exclusion applies separately to each taxpayer. Each trust or individual recipient can claim their own exclusion on the same stock, but the planning must be done well in advance of any sale.
The Section 1202 exclusion is per taxpayer per issuer. Founders approaching exits with gains exceeding the individual cap can multiply exclusions by gifting QSBS to irrevocable non-grantor trusts for the benefit of family members before the sale. Each trust is treated as a separate taxpayer with its own exclusion. This requires careful coordination between startup counsel, tax advisors, and estate planning attorneys. Gurpreet S. Bal works with founders and their advisors on pre-transaction QSBS optimization, including the interaction between trust-based exclusion stacking and California source-income rules that can complicate the state tax analysis.
Gurpreet's view: this is an area where good counsel genuinely matters — but first, a perspective check. Tax complexity at exit is a problem for the successful. If you are founding a company without expecting to be successful enough to have a significant tax problem, you should recalibrate your expectations before you start. Beyond that: taking QSBS planning seriously early sends a useful signal to investors. It demonstrates that you expect a high level of return, that you are thinking about the full arc of the company, and that you are running the business like someone who plans to win. Do the QSBS analysis early, with your lawyer and your tax accountant in the same conversation. The interaction between federal exclusion mechanics, California's non-conformity, and trust planning strategies requires both disciplines, and getting one without the other is how founders leave real money on the table.
Gurpreet S. Bal is a Partner at Foley and Lardner LLP in Silicon Valley, where he advises startups, founders, and investors on SAFE financings, venture capital rounds, mergers and acquisitions, acquihires, and IPOs. He has represented clients in hundreds of transactions with aggregate deal value exceeding $60 billion across AI, semiconductors, fintech, and emerging technology. Prior to his career as a corporate lawyer and transaction advisor, he served with the U.S. Department of Justice and as an international and cross-border tax advisor at a Big 4 accounting firm.