New York Proposal to Decouple from Federal Qualified Small Business Stock (QSBS) Exclusion Under IRC § 1202

New York lawmakers recently advanced, and then quickly withdrew, a proposal that would have disallowed for New York state tax purposes the qualified small business stock (QSBS) gain exclusion that is allowed for federal income tax purposes under Section 1202 of the Internal Revenue Code. Although the Senate withdrew the proposal following significant criticism from the technology industry, the proposal reflects a heightened interest among state lawmakers to reexamine state conformity to the federal QSBS provisions.  Founders, investors, and employees with equity in startups who hold or plan to acquire QSBS should understand the implications and consider appropriate planning measures in the event that a similar proposal resurfaces.

State Conformity with Federal QSBS Provisions

Under federal tax law, the QSBS exclusion permits eligible founders, investors, and employees with equity in startups to exclude up to 100% of capital gains from the sale of certain company stock up to $15 million.  This exclusion was recently increased from $10 million as part of the “One Big Beautiful Bill Act” (OBBBA) signed into law by President Trump on July 5, 2025.  The New York Senate proposal came in direct response to the federal expansion of QSBS benefits and would have required taxpayers to include gains excluded under federal Section 1202 in their New York gross income effective retroactively to January 1, 2025, potentially leading to state and city tax rates of over 14% on previously exempt income. 

Other states have recently taken similar action. Oregon enacted legislation decoupling from the QSBS exclusion earlier in March 2026. Currently, a small number of states (including California, Alabama, Mississippi, and Pennsylvania) do not allow the QSBS exclusion. The vast majority of states with income taxes continue to conform to the federal exclusion. As state budgets face increasing pressure, however, additional jurisdictions may follow Oregon's lead and consider decoupling legislation.

Exempt Resident Trust Planning

Though immediate and substantial criticism from the technology and venture capital communities caused the New York proposal to be withdrawn for now, New York taxpayers with QSBS exposure should evaluate potential planning strategies in the event that similar legislation is reintroduced, particularly given the risk that any future enactment could be retroactive in nature.

If a future New York QSBS decoupling proposal is enacted, one potential avenue for mitigation involves the use of "exempt resident trusts" under New York law.  An exempt resident trust is generally not subject to New York state income tax on capital gains, including gains from the sale of QSBS.  Exempt resident trusts fall under a narrow exception in the tax laws that provides that New York resident trusts are not subject to state income tax if they have (1) no New York fiduciaries, (2) no New York source income, and (3) no New York real or tangible property.

The rules are complex and nuanced, however, and planning needs to be undertaken well in advance of any exit transaction. Taxpayers who are New York residents, or who were New York residents at the time they created irrevocable trusts holding QSBS, should consider whether their trusts qualify for this status or whether restructuring is appropriate.

Conclusion

The New York Senate's proposal to decouple from the federal QSBS exclusion, while ultimately withdrawn, reflects a broader trend among states reassessing the cost of conformity to federal Section 1202 in the wake of the OBBBA expansion. New York taxpayers who hold or expect to acquire QSBS should take this development as an important signal and consider evaluating their existing structures and planning options now, before any future legislative action narrows the available alternatives.

If you have questions about how these tax and trust strategies apply to your specific situation, professional guidance can make all the difference. The tax, trust and estate planning attorneys at Cullen and Dykman LLP provide tailored legal advice in New York, New Jersey and Florida to help you protect your assets, minimize tax exposure, and ensure your estate plan reflects your goals with clarity and confidence. We invite you to reach out to discuss your needs and explore how we can support you with thoughtful, personalized solutions.

Disclaimers

Please note this is a general overview of developments in the law and does not constitute legal advice. Nothing herein creates an attorney-client relationship between the sender and the recipient. Brittany L. Froning is admitted to practice law in Florida. Maureen R. Monaghan and Andrew P. Nitkewicz are not admitted to practice law in Florida.

If you have any questions, please feel free to contact Maureen R. Monaghan at (212) 701-4112 or via email at mmonaghan@cullenllp.com, Andrew P. Nitkewicz at (516) 357-3895 or via email at anitkewicz@cullenllp.com, or Brittany L. Froning at (516) 357-3788 or via email at bfroning@cullenllp.com.