A Roseville founder signs a letter of intent. Her 2020 founder shares will bring about $30 million, and her advisor says federal law excludes $10 million of the gain, with gifts to trusts for her two children adding $10 million each. True enough. What often goes unsaid: California has allowed no such exclusion for any sale after 2012, and the Franchise Tax Board expects tax on all $30 million.
Whether the trusts change that turns on California’s trust residency rules.
How does gifting QSBS multiply the federal exclusion?
Under 26 U.S.C. § 1202(a), a noncorporate taxpayer excludes gain on qualified small business stock, or QSBS: C corporation stock bought directly from the company when issued, while its gross assets sat under a ceiling. S corporation and LLC interests never qualify, so the entity choice at formation matters. Pub. L. 119-21, § 70431, enacted July 4, 2025, gives later-acquired stock a 50 percent exclusion at three years, 75 percent at four and 100 percent at five, and raises the ceiling to $75 million for stock issued after that date. Earlier shares acquired after September 27, 2010 keep the old rule: 100 percent after more than five years.
For a big exit the binding limit is section 1202(b): per issuer, the greater of a dollar limit or ten times the basis of the shares sold that year. The dollar limit is $10 million for stock acquired by July 4, 2025 and $15 million for later stock, indexed after 2026. It belongs to each taxpayer, so a second owner brings a second limit.
Section 1202(h) makes the gift work. A person who receives shares “by gift” is treated as acquiring them the way the donor did and holding them for the donor’s period, so the original-issuance test in section 1202(c)(1)(B) is still met. The donor’s acquisition date carries over too. A child given 2020 shares this year stays under the $10 million limit and the five-year rule.
Which trusts get their own cap, and when will the IRS combine them?
Only a separate taxpayer gets a separate cap. Revocable and other grantor trusts are disregarded for income tax, so their sales use the founder’s limit. A non-grantor trust funded by a completed gift files its own Form 1041 and adds a limit.
The anti-stacking tool is 26 U.S.C. § 643(f): trusts with substantially the same grantor and primary beneficiary are treated as one when a principal purpose is avoiding federal income tax, with spouses counted as one person. The regulation is final, not proposed. Treas. Reg. § 1.643(f)-1 came out in T.D. 9847 (Feb. 8, 2019), minus the 2018 proposal’s definition of “principal purpose” and its examples. I want one trust per child and a written non-tax reason for the design.
One open point: section 643(f) applies “for purposes of this subchapter,” the trust income tax rules, while the cap sits in section 1202. Treating trusts as one trust most naturally means one cap, but I have found no court applying it to QSBS.
Does California allow any QSBS exclusion in 2026?
No. California’s version, Rev. & Tax. Code § 18152.5, required issuers to keep most payroll and assets in the state, and Cutler v. Franchise Tax Board, 208 Cal. App. 4th 1247 (2012), held that this discriminated against interstate commerce. FTB Notice 2012-03 then denied the exclusion for taxable years beginning on or after January 1, 2008. The Legislature’s fix, AB 1412 (Stats. 2013, ch. 546), allowed a 50 percent exclusion for 2008 through 2012 sales without the in-state requirements, waived the related penalties and interest, and let the section expire January 1, 2016.
The FTB’s 2025 Schedule D (540) instructions say California does not conform to section 1202; enter the entire gain. It is ordinary income, taxed up to 12.3 percent plus 1 percent above $1 million under Cal. Rev. & Tax. Code § 17043, now labeled the Behavioral Health Services Tax. Trusts pay the same.
Can a trust outside California avoid California tax on the sale?
Sometimes, but a Nevada trustee alone is not enough. Cal. Rev. & Tax. Code § 17742 taxes all of a non-grantor trust’s income if a fiduciary, or a beneficiary whose interest is not contingent, lives in California, and sections 17743 and 17744 apportion when only some do. In Steuer v. Franchise Tax Board, 51 Cal. App. 5th 417 (2020), the Paula Trust had trustees in California and Maryland. Reading section 17743 with Cal. Code Regs., tit. 18, § 17743, the court held the trust taxable on all of its California-source income regardless of trustee residence. It also held that a beneficiary paid only at the trustee’s sole and absolute discretion is contingent.
Founder stock gets help from section 17952, which treats a nonresident’s stock gain as non-California income unless the stock has a business situs here. A completed-gift trust with out-of-state trustees and purely discretionary terms may owe California nothing at sale. FTB Legal Ruling 2026-01 (July 7, 2026) agrees, with a catch: once the trustee decides to distribute current-year gain to a California beneficiary, the trust is taxable on that amount.
Then the throwback. Section 17745(b) taxes a California beneficiary when income that escaped tax because the interest was contingent is later paid out, as if received ratably over that year and the five before (or a shorter accumulation period). A child who settles in Sacramento and gets the proceeds at 30 pays then. Nobody can promise where a ten-year-old will live.
The incomplete-gift route is closed. Section 17082, added by SB 131 in 2023, taxes the grantor on an incomplete gift nongrantor (ING) trust’s income starting with 2023 tax years. Only a completed gift moves the gain off the founder’s own California return.
What does gifting founder stock cost on the gift and estate side?
The donee takes the donor’s basis under 26 U.S.C. § 1015. Stock held until death instead gets a fair market value basis under section 1014, which California follows, erasing state and federal gain alike. For an older founder with no sale coming, holding can beat any gift.
Section 2010(c)(3) sets the 2026 basic exclusion amount at $15 million, and Rev. Proc. 2025-32 sets the 2026 annual exclusion at $19,000. A gift in trust is usually a future interest outside section 2503(b) unless beneficiaries hold a temporary withdrawal (Crummey) right. I covered the $15 million figure in the A/B trust post.
How would the numbers work for a Roseville founder?
An illustrative case: Dana, single, lives in Roseville. In 2020 she paid $30,000 for founder shares at original issuance. In 2022, with each one-third block appraised near $1.5 million, she gave one block to each of two completed-gift non-grantor trusts, one per child. In December 2026 a buyer pays $30,030,000 for everything, $10 million of gain per block.
Without the gifts, Dana excludes $10 million federally and owes roughly $4.76 million on the other $20 million (20 percent plus the 3.8 percent net investment income tax). With them, Dana and each trust exclude $10 million apiece, wiping out the federal tax if the trusts hold up. On California’s 2025 single and fiduciary schedule, ignoring deductions and credits, Dana alone owes about $3.96 million. If both trusts have a California trustee, each owes about $1.30 million, as does Dana, roughly $3.90 million total. With out-of-state trustees and discretionary terms, Dana owes her $1.30 million and the trusts’ $20 million is reached only on a later California distribution.
Each federal filer uses Form 8949 code Q, entering the exclusion as a negative amount in column (g) per the Form 8949 instructions; Dana’s Schedule D (540), or a California trust’s Schedule D (541), carries the full gain. A seller-financed sale of closely held stock can use 26 U.S.C. § 453; section 453(k)(2) bars only public stock. Keep the stock ledger, issuance papers, gross-assets figures at issuance, gift appraisals, Form 709, and trustee residence and distribution records.
| Strategy | Federal result | California result | Main risk |
|---|---|---|---|
| Founder keeps and sells | One cap | Full gain taxed, up to 13.3% | Large state bill |
| Revocable or grantor trust | Shares the founder’s cap | Taxed to the founder | No income tax benefit |
| Outright gift to adult children | A cap for each child | Taxed if the child lives here | Lost control |
| Non-grantor trust, California trustee | Own cap unless § 643(f) applies | Full gain taxed to the trust | Look-alike trusts aggregated |
| Non-grantor trust, out-of-state trustee, discretionary | Own cap unless § 643(f) applies | Untaxed at sale; throwback later | Children’s future residence |
| ING trust | Own cap, if respected | Taxed to grantor under § 17082 | No state benefit |
Frequently Asked Questions
Can I give QSBS to my children directly instead of to a trust?
Yes. The federal gift rule covers outright gifts, and each child gets a separate per-issuer cap. A child living in California pays California tax on that share, while a child living elsewhere generally owes California nothing on the stock gain.
Does a grantor trust or a SLAT get its own section 1202 cap?
No. A grantor trust is ignored for income tax, so its sale counts against the founder’s own limit. It can still serve estate planning goals.
What happens if the trustee pays sale proceeds to my child in California?
Distributing current-year gain makes the trust taxable in California on that amount under FTB Legal Ruling 2026-01. Paying out gain accumulated tax-free triggers the throwback, taxing the child as if it arrived over that year and the prior five, or over a shorter accumulation period.
Does the new $15 million cap apply to shares I got in 2020?
No. Stock acquired by July 4, 2025 keeps the $10 million limit and the five-year rule. A donee takes over your acquisition date, so gifting does not convert old shares.
When should I make the gift?
Long before a buyer appears. An early gift is appraised lower and uses less exemption. A gift made mid-negotiation invites the argument that the gain was already fixed when the shares moved.
How North Star Law Firm Can Help
North Star Law Firm models federal and California tax on founder stock sales through its business sale tax structuring practice. When a trust holds the shares, the firm prepares its Form 1041 and Form 541 through its trust and estate tax returns practice, and entity selection planning at the start helps a new company issue stock that can qualify. Phillip Zagotti is a California attorney and a CPA, admitted to the U.S. Tax Court.
If you are thinking about gifting company stock, contact North Star Law Firm or schedule a consultation before the letter of intent is signed.