California does not conform to the federal QSBS exclusion under IRC Section 1202, so California-resident founders who qualify for the federal exclusion still owe California state income tax on the full gain — currently up to 13.3%. A founder in Texas or Florida pays zero state tax on a qualifying gain; a California founder in the same transaction owes California tax on every dollar, creating a material gap that grows with the size of the exit.
The federal Section 1202 exclusion allows eligible stockholders to exclude 100% of qualifying gain — up to $10 million or 10 times the adjusted basis of the stock — from federal taxable income. This is an extraordinary benefit available to most early employees and founders of qualifying C corporations. However, California does not conform to Section 1202. The state taxes the full gain as ordinary income at rates that currently reach 13.3% for high earners. For a founder with $25 million in proceeds, the California tax alone can exceed $3 million — on top of any federal tax owed on amounts above the exclusion. In 2026, with Bay Area housing and living costs at historic highs, the gap between gross and net proceeds has never felt wider. Gurpreet S. Bal has seen this gap reshape founders' post-exit plans in ways they didn't anticipate.
On a $25 million qualifying QSBS gain, a federal exclusion eliminates federal capital gains tax entirely. But a California founder still owes California income tax at rates up to 13.3%, resulting in a California tax bill of roughly $3 million or more on a gain that a non-California founder would pay nothing on. The combined effective rate for a California founder can exceed 13%, versus zero for founders in no-income-tax states.
Walk through a simplified version of the math with Gurpreet S. Bal and it becomes clear quickly. Assume a founder holds $25 million in qualifying QSBS stock — all of which is federally excluded from tax under Section 1202. At the federal level, she owes nothing on the first $10 million and long-term capital gains rates on the remaining $15 million (which, depending on the year, could be 20% plus the 3.8% net investment income tax). California taxes the entire $25 million as ordinary income at the top marginal rate. Add in a 10–15% escrow holdback that may not be released for 12 to 24 months, and by the time actual cash is in hand, the founder's effective take-home on a $25 million deal can be closer to $13 to $14 million. Gurpreet S. Bal says plainly: "The number on the term sheet is not your number."
The One Big Beautiful Bill Act increased the federal Section 1202 QSBS exclusion limit and expanded eligibility criteria, making federal QSBS more valuable for qualifying founders in states that conform to federal law. For California founders, however, the benefit is unchanged — California continues to not conform to Section 1202, so the federal expansion provides no California tax relief regardless of how much the federal exclusion grows.
The One Big Beautiful Bill Act, signed into law on July 4, 2025, made the most significant changes to Section 1202 in years. For stock issued after that date, the gross assets threshold — the ceiling a company's assets must stay under at the time of issuance for the stock to qualify — increased from $50 million to $75 million, with inflation adjustments beginning in 2027. The Act also introduced a tiered exclusion: QSBS held for three years now qualifies for a 50% federal exclusion, four years for 75%, and the full 100% exclusion still requires five years. The per-issuer exclusion cap increased to the greater of $15 million or ten times basis. For California founders, none of this changes the state tax picture — California still taxes the full gain. But the higher gross assets threshold means more companies now qualify at the federal level, and the tiered structure means earlier liquidity events carry partial benefit rather than none at all. Gurpreet S. Bal advises founders to understand these changes at formation, not at exit.
California founders can reduce the state tax gap through trust planning to shift the gain to lower-tax beneficiaries before a liquidity event, establishing domicile in another state well before the sale (though California will challenge short-term relocations), or structuring transactions in ways that defer gain recognition. None of these strategies eliminate the California tax entirely, and each involves its own complexity, cost, and risk.
Gurpreet S. Bal is candid about the limits of what can be done without advanced planning. Charitable strategies — including contributing appreciated stock to a donor-advised fund before sale, or using a charitable remainder trust — can reduce taxable income and benefit causes the founder cares about. Some founders explore residency changes prior to a known exit event, though California's aggressive tax enforcement and residency rules mean this requires careful planning over at least a full tax year. Qualified opportunity zone investments can defer federal (but not California) capital gains. The consistent advice from Gurpreet is to bring in a tax advisor before the term sheet is signed — not after. Once the deal documents are signed and the closing is scheduled, the structural options narrow considerably. The time to plan is when there's still time to act.
California founders should understand the tax gap and plan around it, but it should not materially change how they approach building and funding their companies. The more important planning opportunity is ensuring QSBS qualification from the beginning — correct entity structure, proper capitalization, and active business compliance — so that the federal exclusion is available even if California won't honor it.
Gurpreet S. Bal is direct on this point: no. "Still life-changing," he says. "But making $13 million versus $25 million in one of the highest cost-of-living places on earth really does affect your life in different ways." The point is not to discourage founders from building companies in California or to suggest that exits are bad outcomes. The point is that founders who build accurate expectations from the beginning make better decisions — about how much to sell, when to sell, what kind of liquidity events to pursue, and how to structure their financial lives after a transaction. Gurpreet S. Bal has spent his career helping founders navigate these transitions, and the consistent pattern he observes is that surprises at closing are almost always avoidable with early, honest planning.
Gurpreet S. Bal is a corporate partner with 16 years advising on private equity, merger transactions, and public offerings for companies and investors at three of the world's top law firms. He has represented clients in hundreds of transactions with aggregate deal value exceeding $60 billion across AI, semiconductors, fintech, and emerging technology. For more information and to get in touch, visit gurpreetbal.com.