What Section 1202 actually does
IRC §1202 allows eligible shareholders of Qualified Small Business Stock to exclude up to the greater of $10 million or 10 times their basis in federal capital gain on the stock, provided (a) the company was a domestic C-corporation at issuance, (b) gross assets were under $50 million at the time of issuance, (c) the company was in a qualified trade or business, and (d) the shareholder held the stock at original issuance for more than five years.
Why Pennsylvania matters here
Pennsylvania does NOT conform to federal Section 1202. Even if the federal exclusion eliminates $10M of gain from your federal tax bill, Pennsylvania still taxes the full gain at up to 3.07%. For a founder or early employee with multi-million-dollar QSBS gains, moving to a conforming state (or a no-income-tax state) 12-24 months before the sale is the single most valuable planning move. The execution is hard: residency must be truly established, not just claimed.
Stacking strategy at this size
The federal $10M cap is per-taxpayer, per-issuer. Transferring QSBS to irrevocable non-grantor trusts (or to family members) before the sale creates multiple separate taxpayers, each with its own $10M cap. At a $7.5M gain, you would need approximately 1 stacked exclusions to fully exempt. This requires trust-and-estates counsel, a tax attorney, and typically 12-24 months of administration.
Frequently asked
- Does Pennsylvania conform to federal QSBS?
- No. Pennsylvania explicitly does not conform to federal Section 1202. You pay federal tax on the taxable portion above the exclusion cap, AND Pennsylvania state tax on the full gain at up to 3.07%. This is the single largest state-level QSBS gotcha.
- What's the exclusion cap on a $7.5M gain?
- With $50k of basis (used here as illustration), the cap is the greater of $10M or 10 times basis. That's $10M. The first $10M of gain is federally excluded at 100%; the portion above that is taxed at 20% federal long-term rate plus 3.8% NIIT. On this gain, $7,450,000 is excluded and $0 is taxable federally.
- Can I stack QSBS exclusions?
- Yes. The $10M cap is per-taxpayer, per-issuer. Gifting QSBS to irrevocable non-grantor trusts before the sale creates additional taxpayers, each with their own $10M cap. A founder with $80M of QSBS could stack 8 trusts and potentially exclude the full amount federally. The execution bar is high: trusts must be set up well before the sale, funded with real basis-transferring gifts, and administered as separate taxpayers.
- What's the effective tax rate at this size in Pennsylvania?
- 3.1% on a $7.5M gross gain. Pennsylvania's non-conformity means the state alone adds approximately 3.1% of full-gain tax on top of federal.
Related
- QSBS eligibility calculator
- Pennsylvania QSBS overview
- Complete Section 1202 guide
- Leaving Pennsylvania cleanly before a liquidity event
Educational · 2025 brackets · Assumes $50k basis, acquired after 9/27/2010 (100% exclusion rate) · Not tax advice