QSBS Tax Planning
Which States Don't Conform to the QSBS Exclusion?
A state-by-state guide to Section 1202 tax conformity for founders. Not every state honors the federal QSBS capital gains exclusion, and the gap between what you exclude federally and what you owe at the state level can reshape your entire exit strategy.
Schedule a ConsultationThe Basics
What QSBS State Conformity Means for Founders
Section 1202 of the Internal Revenue Code allows founders and investors to exclude a portion of capital gains from the sale of qualified small business stock (QSBS) at the federal level. However, each state decides independently whether to follow that federal exclusion. States that conform honor the federal QSBS exclusion for state income tax purposes. States that do not conform require taxpayers to add the excluded gain back into state taxable income, meaning the founder owes state tax on gains that were excluded federally. This gap can create significant, unexpected tax liability depending on where the founder resides.
As of mid-2026, the majority of states with an income tax conform to the federal QSBS exclusion. However, four states explicitly do not conform, one offers only partial conformity, and one recently changed its position. Understanding your state's treatment before a liquidity event may help avoid surprises that no amount of post-transaction planning can fully resolve.
Key takeaway: Under the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, the federal QSBS exclusion cap increased from $10 million to $15 million per issuer for stock issued after July 4, 2025 (the greater of $15 million or 10 times the taxpayer's adjusted basis). OBBBA also introduced a tiered "waterfall" exclusion: 50% for stock held 3+ years, 75% for 4+ years, and 100% for 5+ years, with the non-excluded portion at the 3- and 4-year tiers taxed at 28% federally. The aggregate gross assets limit rose from $50 million to $75 million. Stock issued on or before July 4, 2025 remains under prior rules ($10 million cap, 100% exclusion after 5-year hold). But in non-conforming states, none of these federal improvements reduce your state tax bill. The combined federal-plus-state effective rate on QSBS gains in a non-conforming state may be materially higher than founders expect.
Source: IRS Section 1202; OBBBA (P.L. 119-21, signed July 4, 2025); 2026 state conformity matrices compiled by practitioner sources, including CT Acquisitions and QSBS Expert, as of June-July 2026. See source compilation. Tax treatment varies by individual circumstances and state residency rules.
2026 State-by-State Map
QSBS Tax Treatment by State: A Comparison Table
The table below categorizes states based on their 2026 treatment of QSBS gains excluded under federal Section 1202. This reflects state tax law and conformity guidance as of June-July 2026; state rules may change and should be verified with a tax professional before any transaction.
| State | Conformity Status | State Tax Treatment of QSBS Gains | Approx. Top State Rate (2026) |
|---|---|---|---|
| California | Non-conforming | Explicit decoupling; full QSBS gain added back to state income | 13.3% (plus 1% MHST) |
| Pennsylvania | Non-conforming | No Section 1202 analog; full gain taxed as ordinary income | 3.07% (flat) |
| Mississippi | Non-conforming | QSBS exclusion not recognized; full gain taxed | 4% (flat) |
| Alabama | Non-conforming | Federal exclusion added back to state taxable income | 5% (flat) |
| Hawaii | Partial conformity | Only 50% exclusion allowed, even when federal is 75% or 100% | 7.25% on remaining gain |
| New Jersey | Conforming (as of 2026) | Conformed under P.L. 2025, Ch. 67; pre-2026 dispositions still taxed | 10.75% (pre-2026 gains) |
| New York | Fully conforming | Federal exclusion followed; QSBS-excluded gain not taxed | N/A on excluded gain |
| North Dakota | Fully conforming | Rolling conformity; federal exclusion honored | N/A on excluded gain |
| Rhode Island | Fully conforming | Rolling conformity; federal exclusion honored | N/A on excluded gain |
| Wisconsin | Fully conforming | Conformed under 2023 Act 36; full 100% exclusion at state level | N/A on excluded gain |
| Texas, Florida, Nevada, Wyoming, SD, TN, AK, NH | No state income tax | No personal income tax on QSBS gains; federal exclusion governs | 0% |
| Washington | LTCG excise tax only | 7% excise on long-term capital gains above threshold; no QSBS exclusion built in | 7% (above threshold) |
| All other income-tax states (approx. 30+) | Generally conforming | Federal exclusion typically honored for state tax purposes | N/A on excluded gain |
Sources: 2026 QSBS state conformity matrices compiled by CT Acquisitions, QSBS Expert, and state revenue department guidance, as of June-July 2026. See source compilation. State tax rules are subject to change. This table is informational and does not constitute tax advice.
Pennsylvania Focus
Pennsylvania Does Not Conform: What It Means for Pittsburgh Founders
Pennsylvania does not conform to IRC Section 1202. The Pennsylvania personal income tax code (72 P.S. Section 7301 et seq.) does not incorporate the federal QSBS exclusion, and the PA Department of Revenue has confirmed that it does not follow Section 1202. This means that while a founder may exclude QSBS gains federally, the full gain is taxed as ordinary income at Pennsylvania's flat 3.07% rate.
For founders in Pittsburgh and across Pennsylvania, this creates a state-level tax obligation on gains that were excluded at the federal level. Several bills to conform have been introduced in the Pennsylvania legislature in recent years, but as of mid-2026, none has passed. Founders should model both federal and state outcomes before structuring any exit.
For a detailed analysis of Pennsylvania's QSBS treatment, including installment sale restrictions and capital gains planning, see our dedicated Pennsylvania capital gains tax guide and our QSBS stacking resource.
PA QSBS at a Glance
State Treatment
Full QSBS gain taxed as ordinary income; no state-level exclusion
PA Flat Rate
3.07% on all taxable income, including capital gains
Legislative Status
Conformity bills introduced but not enacted as of mid-2026
Planning Implication
PA residents must add back the federal QSBS exclusion on state returns
Non-Conforming States
States That Tax QSBS Gains Despite Federal Exclusion
Four states do not conform to the federal QSBS exclusion as of mid-2026. In each, the full QSBS gain is subject to state income tax even when excluded federally. Founders residing in these states should account for this gap when modeling after-tax proceeds from a business sale.
California
California explicitly decoupled from Section 1202 after the Cutler v. Franchise Tax Board ruling. California Revenue and Taxation Code Section 18152 requires the federally excluded QSBS gain to be added back to state adjusted gross income. With top marginal rates reaching 13.3% plus a 1% Mental Health Services Tax, California represents one of the most significant state-level QSBS tax burdens in the country. The Franchise Tax Board's Publication 1001 confirms this treatment for 2026 returns.
Pennsylvania
Pennsylvania taxes the full QSBS gain at its flat 3.07% personal income tax rate. While the rate is lower than California's, Pennsylvania also taxes capital gains as ordinary income with no preferential long-term rate, prohibits installment reporting for stock sales, and offers no loss carryforwards. These rules compound the state-level impact for founders structuring a stock sale exit. For more detail, see our Pennsylvania capital gains tax guide.
Mississippi
Mississippi does not incorporate Section 1202 into its state income tax. The full QSBS gain is taxed at Mississippi's personal income tax rate, which is scheduled to be 4% flat in 2026 under the state's 2022 tax-cut legislation. Mississippi residents who qualify for the federal QSBS exclusion still owe state tax on the otherwise-excluded gain.
Alabama
Alabama's individual income tax does not recognize the QSBS exclusion. The federal exclusion is added back to state taxable income, and the gain is taxed at Alabama's flat 5% personal income tax rate. Founders in Alabama must report the full QSBS gain as state-taxable income on 2026 returns, regardless of the federal exclusion amount.
Partial and Transitional States
States With Special QSBS Rules
Hawaii: Partial Conformity
Hawaii allows only a 50% QSBS exclusion under HRS Section 235-2.4, even when the federal exclusion is 75% or 100%. The remaining gain is taxed at Hawaii's capital gains rate, which is approximately 7.25% at the top in 2026. This means that in Hawaii, half of an otherwise-fully-excluded federal QSBS gain is still subject to state tax.
New Jersey: 2026 Conformity Change
New Jersey historically did not conform to Section 1202. However, under P.L. 2025, Chapter 67 (A4455/S4503), New Jersey began conforming to the federal QSBS exclusion for tax years beginning on or after January 1, 2026. This creates a timing-sensitive transition: dispositions before January 1, 2026 remain fully taxable at the state level (top rate 10.75%), while dispositions on or after that date may qualify for the state-level exclusion. Founders planning an exit should carefully consider the timing of their sale relative to this transition.
Washington State note: Washington does not impose a broad individual income tax, but it does levy a 7% long-term capital gains excise tax on gains above a statutory threshold. The state has not built a QSBS-style exclusion into this excise tax, meaning QSBS gains that exceed the threshold may be subject to the 7% state excise even when excluded federally.
Sources: 2026 state conformity matrices and state revenue department guidance, as of June-July 2026. See source compilation. State rules are subject to legislative change.
Strategic Implications
How QSBS Stacking Interacts With State Non-Conformity
QSBS stacking is a strategy that multiplies the Section 1202 exclusion across multiple taxpayers and trusts before a sale. Under OBBBA, the federal exclusion cap increased to $15 million per issuer for stock issued after July 4, 2025, meaning stacking may now multiply a larger exclusion amount. However, OBBBA also introduced a tiered waterfall: 50% exclusion at 3 years, 75% at 4 years, and 100% at 5 years, with the non-excluded portion at the 3- and 4-year tiers taxed at 28% federally rather than the standard 20% long-term capital gains rate.
In a non-conforming state like Pennsylvania or California, the state taxes 100% of the gain regardless of whether the founder is at the 50%, 75%, or 100% federal tier. A founder who sells at the 3-year tier in Pennsylvania faces federal tax on 50% of the gain at 28% plus state tax on 100% of the gain at 3.07%. The $15 million per-issuer cap under OBBBA may increase the federal exclusion available through stacking, but in non-conforming states the state still taxes the full gain. Founders should model both federal and state outcomes for every entity involved in a stacking structure before executing transfers.
For more on how QSBS stacking trusts work, see our guide on QSBS stacking trusts and estate planning for founders, or explore the broader QSBS for founders resource.
Why State Conformity Matters Before You Stack
QSBS stacking involves complex legal and tax structuring. Results vary by individual circumstances and may involve trade-offs. Consult with qualified tax and legal professionals before implementing any stacking strategy.
QSBS Planning From a Team That Has Lived It
As Founders ourselves we've lived through and experienced QSBS maximization and optimizing for taxes. Our team integrates QSBS eligibility, stacking, and state tax conformity into a coordinated plan designed around each founder's specific exit timeline and residency situation.
Integrated Approach
QSBS State Planning Within a Broader Wealth Strategy
QSBS state conformity is not a standalone question. It sits at the intersection of entity structure, estate planning, residency decisions, and investment management. Our firm coordinates these dimensions through the Atlas Framework, applying tax, architecture, and succession disciplines simultaneously rather than in isolation.
For founders in non-conforming states, the state-level QSBS tax gap may influence decisions about trust situs, residency changes before a sale, entity restructuring, and the timing of QSBS stacking transfers. These are decisions that are difficult to reverse after a transaction closes, which is why pre-exit planning is where the most meaningful tax outcomes are typically created.
Schedule a ConsultationFAQ
Frequently Asked Questions About QSBS State Conformity
What states do not allow QSBS?
As of mid-2026, four states do not conform to the federal QSBS Section 1202 exclusion: California, Pennsylvania, Mississippi, and Alabama. In these states, the full QSBS gain is taxed at the state level even when excluded federally. Hawaii offers only partial conformity, allowing a 50% exclusion rather than the full federal amount. Under OBBBA, the federal exclusion cap increased to $15 million per issuer for stock issued after July 4, 2025, with a tiered waterfall (50% at 3 years, 75% at 4 years, 100% at 5 years), but non-conforming states tax the full gain regardless of the federal tier or cap.
Does Pennsylvania tax QSBS gains?
Yes. Pennsylvania does not conform to IRC Section 1202. The PA Department of Revenue has confirmed that QSBS exclusions are not recognized under Pennsylvania personal income tax. The full capital gain is taxed at Pennsylvania's flat 3.07% rate, regardless of the federal exclusion. For a detailed analysis, see our Pennsylvania capital gains tax guide.
Does California tax QSBS gains?
Yes. California explicitly decoupled from Section 1202. California Revenue and Taxation Code Section 18152 requires the federally excluded gain to be added back to state income. With top marginal rates reaching 13.3% plus a 1% Mental Health Services Tax, California represents one of the highest state-level QSBS tax burdens in the country.
How does the OBBBA waterfall affect QSBS in non-conforming states?
Under the One Big Beautiful Bill Act (OBBBA), stock issued after July 4, 2025 follows a tiered exclusion: 50% for stock held 3+ years, 75% for 4+ years, and 100% for 5+ years. The non-excluded portion at the 3- and 4-year tiers is taxed at 28% federally, rather than the standard 20% long-term capital gains rate. However, non-conforming states like California, Pennsylvania, Mississippi, and Alabama tax 100% of the gain regardless of which federal tier applies. This means a founder selling at the 3-year tier in a non-conforming state faces federal tax on 50% of the gain at 28% plus state tax on 100% of the gain at the state rate. The OBBBA waterfall improves the federal picture but does not change the state-level treatment in non-conforming states.
Does QSBS stacking work in non-conforming states?
QSBS stacking can still reduce the federal tax burden in non-conforming states, but the state-level benefit depends entirely on whether the state conforms. Under OBBBA, the $15 million per-issuer cap means stacking may multiply a larger federal exclusion than under prior law, but non-conforming states still tax the full gain. In states like Pennsylvania and California, trusts and entities that hold QSBS shares may still owe state tax on the gain allocated to them, even though that gain is excluded federally. Founders should model both federal and state outcomes for every entity in a stacking structure before executing transfers. See our QSBS stacking guide for more detail.
Can an LLC own QSBS stock?
An LLC can hold QSBS stock, but whether the Section 1202 exclusion passes through to the LLC's members depends on the entity's tax classification and how the stock was acquired. If the LLC is taxed as a partnership, the QSBS exclusion generally flows through to the partners. However, state conformity rules still apply at the member level, meaning members in non-conforming states may owe state tax on their share of the QSBS gain regardless of the federal exclusion.
Did New Jersey start conforming to QSBS in 2026?
Yes. Under P.L. 2025, Chapter 67, New Jersey began conforming to the federal QSBS exclusion for tax years beginning on or after January 1, 2026. Dispositions before that date remain fully taxable at the state level (top rate 10.75%), while dispositions on or after January 1, 2026 may qualify for the state-level exclusion. This creates a timing-sensitive planning window for founders in New Jersey.
Do no-income-tax states affect QSBS?
States without a personal income tax, including Texas, Florida, Nevada, Wyoming, South Dakota, Tennessee, Alaska, and New Hampshire, do not impose state tax on QSBS gains. In these states, the federal exclusion effectively governs the entire tax picture. However, Washington State levies a 7% long-term capital gains excise tax on gains above a threshold, with no QSBS-specific exclusion built in.
Plan Before the Exit
Model Your QSBS Outcome Before the Transaction Closes
State conformity can change the after-tax math on a QSBS exit by hundreds of thousands of dollars or more. If you are a founder planning a liquidity event, coordinating federal QSBS strategy with state tax planning before the sale is where the most meaningful outcomes are typically created.
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