New California Tax Made Retroactive
Franchise Tax Board (FTB) changes rules going back 4 years and recommends taxpayers amend returns –
Business founders and early investors in high tech start-ups and other qualified small businesses (QSB) in California who sold the stock since January 1, 2008, taking a Qualified Small Business (QSB) exclusion, may soon receive a Notice of Proposed Assessment from the Franchise Tax Board for 50% of the capital gains they legally excluded under the California Tax Code. (California Revenue and Taxation Code, § 18152.5, subds. (c)(2)(A), (e)(1)(A) & (e)(9)). The FTB has retroactively disqualified all exclusions and deferrals for Qualified Small Businesses and recommends taxpayers amend their returns. Not only will the taxes be retroactively charged, going back to 2008, but interest and penalties may be added.
On December 21, 2012 the Legal Division of the California Franchise Tax Board issued FTB Notice 2012—13,*
“For taxable years beginning on or after January 1, 2008, the department will disallow all CR & TC section 18152.5 exclusions and CR & TC section 18038.5 deferrals.”
FTB recommendation for these small business founders or investors:
“For taxable years beginning January 1, 2008, or later, you should file amended tax returns for the years in which the exclusions or deferrals were reported. If you don’t file amended tax returns, you can expect to be contacted by FTB. ”
Question: · “Assume a taxpayer sold QSBS in 2012 and planned to either claim the 50 percent gain exclusion or purchase replacement stock within 60 days in anticipation of electing the QSBS gain deferral. The gain was not included in the estimated tax computation for 2012. Will the penalty for underpayment of estimated tax apply?”
FTB answer: “Yes. R&TC Section 19142(b)(1) only allows an exception to the estimated tax penalty when a change during the year is due to a provision of the law that is chaptered during the year. It does not apply to changes due to the application of court decisions.”
Proposition 30 also increased income taxes retroactively when it was approved by voters in November, 2012 and will affect the amounts due under FTB Notice 2012—03.
*In “Implementation of Court of Appeals Decision in Cutler v. Franchise Tax Board” the Court of Appeal Of The State Of California, Second Appellate District reversed and remanded judgment of the Superior Court for the County of Los Angeles in Cutler v. Franchise Tax Board.
“The trial court upheld, against a commerce clause challenge (U.S. Const., art. I, § 8, cl. 3), the constitutionality of Revenue and Taxation Code provisions allowing an individual California taxpayer to defer capital gains on the sale of stock in a qualified small business if the taxpayer used the gain to purchase stock in another qualified small business. The deferral was available, however, only if the stock sold and purchased was issued by corporations that used 80 percent of their assets in the conduct of business in California and that maintained 80 percent of their payrolls in California. (Rev. & Tax. Code, § 18152.5, subds. (c)(2)(A), (e)(1)(A) & (e)(9).)
The trial court upheld, against a commerce clause challenge (U.S. Const., art. I, § 8, cl. 3), the constitutionality of Revenue and Taxation Code provisions allowing an individual California taxpayer to defer capital gains on the sale of stock in a qualified small business if the taxpayer used the gain to purchase stock in another qualified small business. The deferral was available, however, only if the stock sold and purchased was issued by corporations that used 80 percent of their assets in the conduct of business in California and that maintained 80 percent of their payrolls in California. (Rev. & Tax. Code, § 18152.5, subds. (c)(2)(A), (e)(1)(A) & (e)(9).)
Because the statute affords taxpayers a deferral for income received from the sale of stock in corporations maintaining assets and payroll in California, while no deferral is afforded for income from the sale of stock in corporations that maintain assets and payroll elsewhere, the deferral provision discriminates on its face on the basis of an interstate element in violation of the commerce clause. We therefore reverse the judgment.
…classification as a qualified small business requires that “[a]t least 80 percent (by value) of the assets of the corporation [must be] used by the corporation in the active conduct of one or more qualified trades or businesses in California” (§ 18152.5, subd. (e)(1)(A)), and a corporation does not meet this requirement “for any period during which more than 20 percent of the corporation’s total payroll expense is attributable to employment located outside of California.” (Id., subd. (e)(9).)
In 1998, plaintiff Frank Cutler sold stock he had acquired in an internet start-up company (U.S. Web Corporation or US WEB) for $2,296,000. He used some of the proceeds to purchase stock in several other small businesses. However, the US WEB stock he sold did not meet the “active business requirements” of section 18152.5—that is, US WEB did not maintain 80 percent of its assets and payroll in California.
Plaintiff filed a protest, asserting the US WEB stock met the requirements of section 18152.5 and, even if it did not, the statute was unconstitutional under the commerce clause because it unfairly discriminates against investors in companies which conduct a portion of their business outside the State of California. Plaintiff also asserted he had substantiated or could substantiate the statutory requirements for the replacement stock.”
