The Federal QSBS Benefit Stops at Some State Lines

Under federal law, qualifying taxpayers can exclude up to 100% of their gain from qualified small business stock (QSBS) under IRC Sec. 1202. This already appealing provision became even more lucrative under the One Big Beautiful Bill Act (OBBBA), which expanded the exclusion.

However, a federal exclusion does not always determine the state income tax result. States decoupling from QSBS can reduce expected shareholder proceeds, change the value assigned to equity, and create additional documentation and reporting needs before a sale. Currently, ten jurisdictions deny that income exclusion or have recently changed their treatment of QSBS.

Key Takeaways

• Federal law allows taxpayers to exclude some or all gain from the sale of QSBS, but states do not uniformly follow the federal exclusion
• State treatment of QSBS is changing, with Illinois and Oregon requiring a full addback of the federal exclusion beginning in 2026, while New Jersey will begin allowing the exclusion.
• Some states decouple from the federal rules by either denying the exclusion or, like Hawaii, allowing only a portion of it.
• Shareholders should consider state treatment before a QSBS sale, as federally excluded gain could still be subject to state income tax.

What Is the IRC Sec. 1202 Exclusion?

IRC Sec. 1202 allows holders of QSBS to exclude 50% to 100% of capital gains on the sale of QSBS. The amount of gain eligible for exclusion is limited to the greater of $10 to $15 million, depending on the date the taxpayer acquired the stock, or ten times the taxpayer’s basis in the QSBS. The shareholder must acquire the stock at original issuance from an eligible domestic C-corporation and hold it for the required period, which ranges from three to five years. To be qualified, the corporation issuing the stock must meet gross-asset thresholds of $50 or $75 million , be a qualified trade or business under IRC Sec. 1202, which is maintained at substantially all times, and other statutory requirements.  

The burden of establishing QSBS eligibility generally rests with the shareholder claiming the QSBS gain exclusion. The corporation often holds the records needed to support the exclusion, including capitalization tables, stock issuance documents, gross-asset calculations, and records of the corporation’s activities. Shareholders may need to request this information from the corporation to prove eligibility years down the road, making contemporaneous records from the beginning an important planning consideration.

What Changed Under the OBBBA?

For QSBS acquired after July 4, 2025, the OBBBA allows a 50% exclusion after three years, a 75% exclusion after four years, and a 100% exclusion after five years. It also increased the per-issuer dollar limit from $10 million to $15 million, indexed for inflation for tax years beginning after 2026, and raised the issuing corporation’s gross-assets ceiling from $50 million to $75 million. The prior rules, which require the shareholder to hold the stock for more than five full years to receive any tax benefit, continue to govern stock acquired before the new law took effect.  

Why Does State Decoupling Matter?

States follow the IRC through rolling, fixed-date, or selective conformity. A state may generally conform to the IRC while specifically decoupling from IRC Sec. 1202 and taxing gain excluded for federal purposes.

For example, if an eligible founder sells QSBS and realizes $8 million of gain, they can exclude 50% to 100% of the entire gain for federal income tax reporting purposes. That QSBS is generally taxable only in the shareholder’s state of residency. If the shareholder’s resident state conforms to the IRC, then the gain from the sale of the QSBS is similarly excluded from the state income tax base. However, a nonconforming state can have income modification or “addback” provisions that result in taxing some or all of the $8 million gain. Accordingly, the shareholder’s resident state can materially impact tax planning and estimated tax payments.

What States Have Had Recent Changes?

As a result of the expansion under the OBBBA, some states made changes to their treatment of QSBS.

District of Columbia: Full Conformity

DC was briefly poised to decouple from portions of the OBBBA, including IRC Sec. 1202, but Congress overturned the legislation. As a result, DC currently conforms to the federal QSBS rules. However, taxpayers in DC should continue to monitor the law for any future changes.

Illinois: Full Addback Effective 2026

Illinois generally follows rolling conformity, but recently decoupled from IRC Sec. 1202 under

SB 3019. For tax years ending on or after December 31, 2026, individuals, estates, trusts, and partnerships must add back all federally excluded QSBS gain, regardless of when the stock was acquired.    

Maine: Addback on stock acquired after July 4, 2025

Maine follows fixed-date conformity and adopted a targeted addback for QSBS first acquired after July 4, 2025, under enacted Budget Bill LD 2212. For a shareholder who holds QSBS acquired before the OBBBA cutoff date, Maine fully conforms to the pre-OBBBA federal rules. However, for stock acquired after the OBBBA went into effect, Maine completely decouples from the federal exclusion. Accordingly, shareholders in the same company can receive different Maine treatment, making accurate issuance dates and capitalization records critical.

New Jersey: Conforms Beginning in 2026

Historically, New Jersey did not allow the IRC Sec. 1202 exclusion until Bill A4455 was passed in June of 2025. The bill brings the state into conformity with IRC Sec. 1202 for tax years beginning on or after January 1, 2026. New Jersey’s legislature kept these changes even after the OBBBA expanded the QSBS exclusion.

Oregon: Full Addback Effective 2026

Under SB 1507, Oregon now requires taxpayers to add back the full IRC Sec. 1202 exclusion for tax years beginning on or after January 1, 2026, regardless of whether the stock was acquired before or after that date.

What States Require an Addback?

Some states require taxpayers to include QSBS gain that was excluded from federal income when calculating state taxable income. These states include Alabama, California, Mississippi, and Pennsylvania. This adjustment is commonly referred to as an addback. An addback puts federally excluded gain back into the state tax base, making it subject to state tax. For example, Pennsylvania does not conform to the IRC, so gains excluded federally remain subject to Pennsylvania tax. However, state-specific exclusions may still apply. Mississippi has its own exclusion for certain sales of stock in Mississippi companies. Founders and investors should consider state tax when determining how much they expect to receive from a QSBS sale.

Hawaii: Limited Addback

Hawaii is unusual in that it requires a partial addback. Act 35 modified Sec. 235-2.45 of Hawaii’s tax law, which applies IRC Sec. 1202 as it existed on December 31, 2024. Accordingly, Hawaii does not conform to the changes made by the OBBBA and instead follows fixed-date conformity, with selective exceptions. Hawaii also does not conform to the 75 or 100% exclusion, instead limiting the exclusion to 50%, meaning some gain excluded federally could remain taxable for Hawaii purposes.

Summary Chart

What Should Taxpayers Consider?

Businesses planning a stock issuance, financing, or a liquidity event should consider IRC Sec. 1202 when deciding how to structure the business. If QSBS treatment is important, businesses should preserve records supporting original issuance, gross assets, qualifying business activities, acquisition dates, and holding periods.

The federal QSBS exclusion does not always apply at the state level. Businesses should review state conformity early, as a state may tax gains that are federally excluded.

EisnerAmper’s Tax professionals can help businesses and shareholders assess QSBS treatment before a stock issuance or sale, determine whether the federal exclusion applies, and how the gain will be taxed in the shareholder’s state. Contact a member of our team below to see how we can assist you.