Entrepreneurs who invested in California small businesses can breathe a sigh of relief because Governor Jerry Brown signed legislation (A.B. 1412) which fully relieves such investors from retroactive tax assessments from the sale of Qualified Small Business Stock (QSBS) between tax years 2008 and 2012. Without this legislation, investors would have been required to pay approximately $120 million in retroactive tax assessments, interest and penalties.
Culter decision and retroactive QSBS tax assessments
The legislation is aimed at reversing the actions of the Franchise Tax Board (FTB) in the wake of Cutler v. Franchise Tax Board, 208 Cal.App.4th 1247 (2012), which held that California’s law providing for 50 percent income tax exclusion on gains from the sale of QSBS in certain corporations discriminated against interstate commerce. The FTB interpreted Culter as invaliding the entire California QSBS law and determined that the only way it could remedy such discrimination was to require taxpayers who took the exclusion under the California QSBS law in years still open for assessment to pay tax and interest on those gains.
Two proposed legislative fixes
The California legislature has been working on a legislative fix to such retroactive tax assessments by proposing amendments to the QSBS law to remove the specific language in California’s QSBS law that Culter stated was discriminatory. These amendments would apply to sales of QSBS made before January 1, 2013. The legislature sent two bills (S.B. 209 and A.B. 1412) to Governor Jerry Brown providing a partial or full legislative fix for such retroactive tax assessments and left it to the governor to decide how much relief to provide to taxpayers, if any.
A.B. 1412 provided for a full legislative fix and would allow such California investors to exclude up to 50 percent of the gain from the sale of QSBS during tax years 2008 through 2012, which would eliminate the retroactive QSBS assessments. S.B. 209 provided for a partial legislative fix and would allow such California investors to exclude up to 38 percent of the gain from the sale of QSBS during tax years 2008 through 2012, which would have meant that taxpayers would be required to pay one-fourth of those retroactive QSBS assessments.
Governor Jerry Brown actually signed both bills, but because he signed A.B. 1412 second, the full 50 percent exclusion for sales of QSBS made before January 1, 2013 becomes law as of January 1, 2014.
Franchise Tax Board guidance
The FTB has posted guidance on its website regarding the changes in the California QSBS law.
For taxpayers who filed their 2008 to 2012 tax returns and were contacted by the FTB regarding their QSBS election, the FTB will notify taxpayers of the following:
- Pending Notices of Proposed Assessments based on the Cutler decision or FTB Notice 2012-3 will be withdrawn.
- Closing letters will be mailed to taxpayers who signed a limited QSBS waiver for 2008.
- Unpaid tax, interest or penalty assessed as a result of the Cutler decision/FTB Notice 2012-3 will be abated.
- Refunds for payments received related to the Cutler decision/FTB Notice 2012-3 will be issued. No action is needed by taxpayers to request refunds, unless they do not hear from the FTB by November 30, 2013, in which case such taxpayers should contact the FTB.
In addition, certain taxpayers who filed their 2008 to 2012 tax returns may now be able to claim a QSBS exclusion. A.B. 1412 amends the California QSBS law to eliminate the previous requirement that 80 percent of business activity occur in California during the five-year holding period. Therefore, as long as the corporation met the 80 percent California payroll requirement at the time of the taxpayer’s investment in the corporation, such taxpayer may claim the 50 percent gain exclusion from the sale of such QSBS between the years 2008 to 2012 if the four-year statute of limitations is open. A.B. 1412 permits taxpayers until June 30, 2014, to file a QSBS claim for refund for tax year 2008. The FTB website provides specific instructions to claim such refunds.
To read the information on the FTB website, click here.
Click here for the full text of A.B. 1412.
For a discussion of the state appellate court case and more background on S.B. 209, A.B. 1412 and the QSBS exclusion, view our previous Multistate Tax Updates.
Click here to read the Multistate Tax Update -- April 11, 2013
Click here to read the Multistate Tax Update -- June 13, 2013
Click here to read the Multistate Tax Update -- September 26, 2013