California is the land of start-ups. From January to August 2026, venture capitalists invested about $366 billion in California businesses. This venture capital is over triple the amount received by the remaining 49 states combined. Yet most founders, investors, and key employees are likely unaware of two valuable opportunities available under the Internal Revenue Code for start-ups.
The first is qualified small business stock treatment provided by section 1202 of the Internal Revenue Code. A person who purchased stock in a small C corporation (not more than $75 million in gross assets) can potentially exclude up to $15 million of gain if held for more than 5 years. There are several technical requirements. One of the most significant limitations is the disqualification of service industries “where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”[1] Yet, there is flexibility facilitating gifts, inheritances, and indirect share ownership (such as through partnerships). There are relatively few regulations regarding qualified small business stock. Consequently, multiple advanced techniques remain viable, especially for the $15 million exclusion limitation.
The second overlooked opportunity lies in the regulations under Internal Revenue Code section 409A. The tax treatment of stock options is multifaceted. If part of a nonqualified deferred compensation plan, the stock option holder is taxed on that option’s value plus 20% of that value, along with interest. One means to avoid this outcome is to follow section 409A’s strict rules, which result in deferring the income inclusion until the option is struck. Another is to file an election under section 83(b) through Form 15620 if the option price is no less than the underlying stock’s fair market value as of the date the stock option was granted.[2] This requires a specific form of appraisal known as a section 409A valuation. If executed correctly, the option’s owner will not be taxed on the stock purchased through the option’s exercise (although any subsequent sale of that stock would still be taxed). Someone who received a stock option with a fair market value of $1 per share for 1,000 shares in 2026 would recognize $1,000 in income. The same person striking that option would not include any income from that exercise even if the fair market value grew to $100 per share.
Tax planning is usually circumstantial. If you receive a stock option for a corporation’s shares eligible under section 1202 for qualified small business stock treatment, you would probably benefit most by striking that option immediately because the 5-year holding period does not include stock options. However, if the corporation is ineligible under section 1202 and you want to wait to exercise your option, your best tax strategy may be to choose to be taxed on that option now, thereby avoiding the tax on the stock you purchase later. If you suspect that either opportunity is at hand, please call 916-822-8700 or email info@lawburton.com.
[1] IRC § 1202(e)(3).
[2] 26 CFR § 1.409A-1(b)(5).