QSBS by State: Where the Federal Exclusion Actually Applies (2026)

The Section 1202 exclusion eliminates federal capital-gains tax on qualifying QSBS gains — but it is a federal provision. Whether your state honors it is a separate question, and the answer can mean seven figures. Six jurisdictions — California, Oregon, DC, Pennsylvania, Alabama, and Mississippi — currently do not conform to IRC §1202. If you live or work in one of them at the time of a liquidity event, you can owe full state tax on a gain that is entirely federal-tax-free.

State conformity at a glance

Non-conforming states — state taxes QSBS gains even when federally excluded

No state income tax — QSBS exclusion is effectively complete

In these states, there is no state income tax on capital gains, so the federal §1202 exclusion means you pay zero at both the federal and state level:²

• Texas, Florida, Nevada, Alaska, Wyoming, South Dakota — no state income tax at all.
• Tennessee — no state income tax on wages or capital gains.
• New Hampshire — no general income or capital-gains tax.
• Washington — has a 7% capital gains tax on gains above $250,000, but QSBS gains that are federally excluded are also exempt at the state level.³

Conforming states — federal exclusion carries through to state return

All remaining states conform to IRC §1202 in whole or substantial part, meaning the gain excluded federally is also excluded at the state level. Startups in these states include major ecosystems:⁴

• New York (10.9% top rate) — conforms; QSBS-excluded gains owe no NY state tax.
• Massachusetts (5.0%) — conforms via rolling conformity effective January 1, 2022.
• Colorado (4.55%), Georgia (5.75%), Illinois (4.95%), Maryland (5.75%), Minnesota (9.85%), Virginia (5.75%) — all conform.
• New Jersey (10.75%) — newly conforming as of January 1, 2026 (Bill A4455/S4503, signed June 30, 2025); previously non-conforming.

California: the biggest exposure in startup finance

California is home to the largest concentration of QSBS-eligible companies and is also the most aggressive non-conforming state. California Revenue and Taxation Code §18152 explicitly provides that IRC §1202 "shall not apply" for California income tax purposes — full stop, no exceptions.¹

The California problem has three dimensions:

1. Residents pay CA tax on the full gain. If you live in California at the time of a sale, the federally excluded gain is fully taxable at ordinary income rates — up to 13.3% for incomes above ~$1M. A $15M QSBS-excluded gain costs $1.995M in CA tax.
2. Sourcing rules can reach non-residents. California taxes income "sourced" to California, and the FTB has argued that stock options exercised while working in CA generate CA-source income regardless of where you live when you sell. If you worked in California when you received or vested the stock, you may owe CA tax even after moving.
3. Post-move tax exposure is not zero. Moving from CA to another state before a sale is a legitimate strategy — but California's residency audit unit aggressively scrutinizes high-income exits that occur within 12–18 months of a stated domicile change. "Moving" to Nevada the week before an acquisition closes does not work.

Oregon: the 2026 surprise

Oregon had conformed to IRC §1202 — until it didn't. Governor Kotek signed SB 1507 on April 9, 2026, decoupling Oregon from the federal QSBS exclusion retroactively to January 1, 2026. This means Oregon founders whose liquidity events closed earlier in 2026 (before the law was signed) face state tax on gains that were expected to be excluded.⁵

Oregon's top rate is 9.9%. On a $10M gain, that's $990,000 in state tax that was not in the plan six months ago. Governor Kotek's signing letter indicated the issue may be revisited in 2027, but that is not a commitment and founders should plan for the current law.

District of Columbia

DC decoupled from §1202 via emergency legislation effective December 20, 2025, at a 10.75% top rate. Because DC is a municipality, not a state, its residents do not have the option of changing state residency as a planning tool — the only exit from DC's reach is a genuine relocation of domicile, which carries the same audit risks as a California move.

Pennsylvania, Alabama, Mississippi

These three states have never recognized the §1202 exclusion. Pennsylvania taxes gains as ordinary income at a flat 3.07% rate, which is lower in dollar terms but applies to the full excluded gain. Alabama and Mississippi both top out at 5.0%. These states are less likely to host large startup ecosystems, but angel investors and fund LPs can have exposure if they are domiciled there regardless of where the portfolio company is located.

What "conforming" means — and doesn't mean

When a state conforms to §1202, it means the gain excluded federally is also excluded on the state return. But conformity has limits:

• You still owe state tax on non-excluded gains. If your position exceeds the §1202 cap — for example, a $30M gain where only $15M is excluded — the remaining $15M is taxable at ordinary income rates both federally and at the state level.
• Partial conformity states may have rules. Hawaii has limited recognition; verify with a CPA if you have Hawaii exposure.
• State AMT can complicate things. Some states have their own AMT regimes that may partially recapture excluded gain. This is uncommon but worth confirming in high-rate conforming states.

Planning strategies for non-conforming state exposure

Residency change before the exit

Changing your domicile to a no-income-tax state (Texas, Florida, Nevada, etc.) well before a liquidity event is the most direct solution. "Well before" is not a legal term — it's a function of facts and audit risk. The general rule of thumb used by tax practitioners is 12–18 months of genuine residency change, but California can and does audit shorter moves when the timing is suspiciously close to a large exit. You need to actually live there: change your driver's license, register to vote, open local bank accounts, move your primary household, and break California connections. The paperwork matters less than the facts.

Stacking with trusts in conforming states

A non-grantor trust can be a separate taxpayer for both federal and state purposes. A trust formed and administered in a conforming state may avoid the non-conforming state's reach on trust income, even when the grantor lives in a non-conforming state. This is complex and jurisdiction-specific — the trust's nexus, situs, trustee location, and beneficiaries all factor in — but it can be a meaningful strategy for large positions where state conformity is a significant variable. See our QSBS stacking guide for the federal mechanics; state-level trust planning needs an attorney who knows your specific state's rules.

§1045 rollover and state tax

A Section 1045 rollover defers federal gain into replacement QSBS — but non-conforming states generally don't recognize §1045 either. If you use §1045 to defer a federal gain, you may still recognize the full gain for California or Oregon purposes in the year of the original sale. This is a critical planning consideration: a §1045 rollover that solves the federal problem may not solve the state problem. See the Section 1045 rollover guide for the federal mechanics, and get state-specific advice before executing.

Installment sale treatment

If a sale is structured as an installment sale, some states (though not all) treat the recognized gain in each installment year under the residency rules of that year. This is highly state-specific and depends on the sale structure. It's worth modeling if your exit is being structured and you are mid-residency-change.

Sources

1. IRC § 1202 (federal); California Revenue and Taxation Code § 18152: "Section 1202 of the Internal Revenue Code...shall not apply." California's explicit statutory rejection of the federal exclusion — always in effect.
2. Tax Foundation — State Individual Income Tax Rates and Brackets (2026): no-income-tax states confirmed. Tennessee eliminated its Hall tax on investment income as of 2021; no capital gains tax.
3. Washington State DOR — Capital Gains Tax: Washington's 7% capital gains tax applies to gains above $250,000; federally excluded QSBS gains are exempt from the Washington capital gains tax.
4. Keystone Global Partners — QSBS State Tax Conformity Guide: conforming states list; New Jersey conformity via Bill A4455/S4503 (signed June 30, 2025, effective January 1, 2026).
5. Foster Garvey — Oregon SB 1507: QSBS decoupling enacted (April 2026): SB 1507 signed April 9, 2026; retroactive to January 1, 2026; decouples Oregon from entire §1202 framework.

State tax law changes frequently. This page reflects law as of June 2026. Verify current conformity status with a qualified tax professional before any transaction, especially in states where recent legislation is pending or under referendum. This is educational only — not legal or tax advice.