The California Qualified Small Business Stock (QSBS) Tax Exclusion: A Hidden Tax Break for Startup Owners

If you're a startup founder or small business owner in California, you might be sitting on one of the most powerful tax breaks available, and not even know it. The Qualified Small Business Stock (QSBS) exclusion can allow you to exclude up to 100% of capital gains from federal taxes when you eventually sell your business. This isn’t a loophole, it’s written directly into federal tax code. And if your business qualifies, it could mean saving thousands or even millions of dollars in taxes down the road.

While much of the tax world focuses on yearly deductions or expense strategies, the QSBS exclusion is a long term planning opportunity that rewards owners who build and eventually exit a successful business. It’s ideal for LLCs that convert to C-Corps, early stage startups, or even solo founders who intend to sell their companies within a few years.

What Is the QSBS Exclusion and How Does It Work?

The QSBS exclusion comes from Section 1202 of the Internal Revenue Code. If you meet the criteria, you can sell shares in your company and exclude up to $10 million (or 10 times your basis) in capital gains from federal taxes. To qualify, the company must be a domestic C-Corporation, the stock must be held for at least five years, and the company must meet certain active business and size requirements. The rules are technical, but the outcome is clear: if structured properly, your sale could be nearly tax free at the federal level.



The benefit originally included both federal and state tax exclusions. But California made changes over a decade ago that many business owners still find confusing, which brings us to a key point of clarification.

Does California Still Offer This Exclusion? Not Exactly, but It’s Still Worth Pursuing

In 2013, California repealed its own conformity to the federal QSBS exclusion, which means that state capital gains taxes still apply, even if you qualify for the federal exemption. While this limits the total benefit, it doesn’t eliminate it. In fact, federal capital gains taxes are often the larger portion of the liability, especially for sizable exits. The misconception that “QSBS doesn’t work in California” causes many startup owners to overlook this tax saving strategy entirely.

This is where proper tax planning becomes critical. A business owner who structures their company correctly and understands QSBS eligibility may still save hundreds of thousands in federal taxes,  even if they’ll pay some state tax. At DRS Accounting PC, we help founders and business owners across California understand when and how to build a tax smart strategy around QSBS, and how to avoid disqualifying mistakes.

Who Should Be Thinking About This Now?

If you’ve recently formed a startup, invested in a growing company, or plan to sell shares in the future, now is the time to understand whether QSBS applies to you. Eligibility hinges on when and how your stock was issued, how your company is structured, and what kind of business you run. Waiting until you’re ready to sell is too late, because one wrong move (like converting out of C-Corp status or failing to track your holding period) can eliminate the benefit entirely.

Even if you’re not ready to sell now, understanding QSBS gives you more control over your exit strategy. And if you’re a founder who took the risk to start something from scratch, you deserve to take advantage of every available reward.

Final Thoughts

Tax law isn’t always intuitive, and some of the most valuable opportunities are buried under layers of technical language. But the QSBS exclusion is one of those rare breaks that can make a meaningful difference, if you know about it and plan early. At DRS Accounting PC, we help small business owners and startup founders in California build tax strategies that prepare them for success, including exits. Schedule a free consultation if you’d like to know whether you qualify or need help planning the right structure.



There may be no shortcuts in business, but there are definitely smarter paths, and this is one of them.