QSBS State Tax: California and States That Don't Follow

Does California recognize QSBS?

No. California does not follow the federal exclusion for qualified small business stock (QSBS), including the larger exclusion the 2025 federal law added (FTB summary of federal changes). A California resident enters the entire gain on Schedule D (540) and pays California tax on all of it (Schedule D (540) instructions). California also does not follow the section 1045 rollover, so gain deferred federally is taxed in the sale year.

Many other states with an income tax start from federal income, so they follow the exclusion unless their law says otherwise. A few say otherwise, and the list changed for sales in 2026.

What makes a case harder than a lookup:

• You moved, or plan to. The state you live in on the sale date generally taxes the gain, so a recent or planned move needs care.
• Payments arrive over several years. Escrow, holdback and earnout money may be taxed in a later year, under that year's state rules.
• Your state changed its law. Oregon, Illinois and New Jersey changed their rules for 2026.

Gather your residence history with dates, each lot's purchase or exercise date and cost, the expected sale price and date, and the deal documents.

Which states don't follow the federal QSBS exclusion?

California and Pennsylvania tax the excluded gain in full; Oregon and Illinois begin adding it back for 2026. Hawaii and Alabama follow only part of the federal rule, and Massachusetts has its own rules. The table covers only states whose rule could be confirmed in official sources; for any other state, check its current instructions.

For 2026, Hawaii updated its general tie to the federal code but kept section 1202 as it stood at the end of 2024, minus the paragraphs for higher exclusions, which generally leaves 50% of the gain excluded (Act 35 (2026); 26 U.S.C. 1202(a)). Alabama's summary addresses only the 2025 changes; how Alabama treats older QSBS gain is not stated there, so confirm it before relying on the federal figure.

States with no personal income tax do not tax the gain as income. A state may still have a separate tax on capital gains; the moving guide compares common destinations.

How much will California tax on a QSBS sale?

California taxes the gain as regular income at rates up to 12.3%, plus a 1% Behavioral Health Services Tax on taxable income over $1,000,000. California has no lower rate for long-term gains, so a large sale is taxed mostly at the top rate plus the surcharge.

The bracket thresholds come from the latest published rate schedules; the surcharge is in the 2026 estimated tax instructions. To estimate: take the gain, add your other California taxable income, and apply the rate schedule, then add the surcharge on the amount over its threshold.

Which states changed their QSBS rules for 2026 sales?

Oregon and Illinois stopped following the exclusion, and New Jersey started. For a calendar-year individual, each change covers every sale made during 2026.

• Oregon adds back any gain excluded under section 1202 on the federal return, for tax years beginning on or after January 1, 2026 (SB 1507, sections 5 and 10). The add-back covers all excluded gain, not only the 2025 federal increase.
• Illinois adds back the gain excluded under section 1202 for tax years ending on or after December 31, 2026 (Public Act 104-0468). A sale in January 2026 falls in that year.
• New Jersey excludes gain from qualified small business stock to the extent it is exempt federally, for tax years beginning on or after January 1, 2026 (P.L. 2025, c.67). A sale in an earlier year gets no New Jersey exclusion.
• New York had not changed its rule when checked. A Senate bill to add the gain back, retroactive to tax years beginning in 2025, was last amended and sent back to committee (S8921A). Check its status before a New York sale.

Does my state follow the 2025 federal QSBS changes?

It depends on how your state ties to the federal tax code. A state that uses the current code picks up the larger exclusion automatically; a state tied to the code as of a fixed date does not until it updates. The changes cover only stock acquired after July 4, 2025, so they do not affect a sale before mid-2028 (Public Law 119-21, section 70431).

California never follows the exclusion, so the federal changes make no difference there (FTB). Alabama says it is not tied to the expansion, and Hawaii keeps section 1202 as it stood at the end of 2024. Oregon and Illinois add back the whole exclusion, so the federal tiers do not matter there either. For what the federal changes are, see QSBS for founders and early employees.

How do I report the California QSBS difference on my return?

California uses Schedule D (540) to report the gain the federal return excluded. Enter the entire gain in column (e), then carry the difference between the federal and California totals to Schedule CA (540), Part I, Section A, line 7a, column C, as an addition (Schedule D (540) instructions; Schedule CA (540) instructions).

Other states that do not follow report the excluded gain as an addition to federal income on their own forms; use that state's instructions for the year of the sale. Keep the federal Form 8949 and Schedule D detail with the state return, since the state addition starts from the amount you excluded. How to claim the federal exclusion is in the QSBS guide.

Do I owe state estimated tax in the year I sell?

Usually, yes. A gain the IRS excludes can still create a large state balance, and California requires estimated payments during the year rather than at filing.

California's 2026 instructions set these rules (Form 540-ES instructions):

If your California adjusted gross income is $1,000,000 or more ($500,000 if married or a registered domestic partner filing separately), you must base estimates on the current year's tax, generally 90% of it; last year's tax is no safe harbor. A large sale usually crosses that line. If the sale closes late in the year, the annualization option matches payments to when the income arrived. Once an estimate or extension payment exceeds $20,000, or a filed return shows total tax over $80,000, later payments must be electronic. Federal estimates after a closing are covered in taxes when your startup is acquired.

Does state tax depend on where I live or where the company is?

Where you live. Gain from selling stock is generally sourced to the state where the seller resides at the time of the sale, not where the company is based or incorporated.

California's residency guide says gain on stock has a source where you are a resident at the time of the sale; an Oregon resident selling stock of a California corporation has an Oregon-source gain that California does not tax (FTB Publication 1031). A California resident is taxed on all income, wherever the company is. Different rules can apply to options and to stock held as part of a business. Moving before a sale, and how options are sourced, belong to moving to another state before selling startup shares.

Example

These examples are illustrative; figures are in US dollars and assume the shares qualify federally.

California founder

A single California resident sells founder shares for a $10,000,000 gain, all excluded on the federal return. California taxes the full $10,000,000. If the gain is her only income, the latest California rate schedule plus the surcharge puts her California tax at roughly $1.3 million. Because her California adjusted gross income is above $1,000,000, her estimates must be based on the sale year's tax.

Pennsylvania resident

A Pennsylvania resident sells qualifying shares for a $2,000,000 gain excluded federally. Pennsylvania taxes the full gain at its flat 3.07% rate, about $61,400.

Oregon engineer, sale in March 2026

An Oregon resident sells qualifying shares in March 2026 for a $1,000,000 gain that is fully excluded federally. Because the sale falls in a tax year beginning on or after January 1, 2026, Oregon adds the $1,000,000 back and taxes it at Oregon's regular rates. The same sale in December 2025 would have had no Oregon add-back.

Different for you?

• You are not sure the shares qualify federally: start with QSBS for founders and early employees.
• You moved, or plan to move, before the sale: see moving to another state before selling startup shares and get individual tax help.
• The deal pays in buyer stock, or as a merger or asset sale: see taxes when your startup is acquired.
• You are selling before the holding period ends and want to defer: see rolling over QSBS gain into new startup shares; California will still tax the gain.
• You are selling in a tender offer or secondary: see selling startup shares in a tender offer.
• You live in Canada: see Canadian founder selling US startup shares.
• A large sale is coming and your state taxes the gain: plan estimated payments and residency records with individual tax help.