Governor Signs Bill Providing Retroactive Tax Relief to Sellers of Qualified Small Business Stock

Authors: Matthew A. Portnoff | David Herbst

On October 4, 2013, Governor Brown signed into law California Assembly Bill 1412 (Stats. 2013, ch. 546) (AB 1412), which provides tax relief to those individual taxpayers affected by the decision in Cutler v. Franchise Tax Board, 208 Cal. App. 4th 1247 (2012). Under the new law, which is retroactive in application, individual taxpayers who previously sold qualified small business stock (QSBS) and deferred or excluded 50% of the gain for open tax years (generally, 2008 through 2012) will continue to qualify for such gain deferral or exclusion irrespective of the percentage of the QSBS issuer's assets used in the conduct of business in California or the percentage of its California payroll.

Earlier this year, we released guidance concerning the California Court of Appeal's decision in Cutler and the response by the Franchise Tax Board (FTB). (Please see FTB Announces Temporary Reprieve on Retroactive Assessment of Qualified Small Business Stock Taxes and FTB Retroactively Denies “Qualified Small Business Stock” Personal Income Tax Benefits.) By way of brief background, the Court of Appeal overturned then-existing state laws providing for gain deferral or 50% exclusion upon the sale of QSBS. The Court of Appeal held that such tax incentives, which required QSBS issuers to have 80% or more of their assets and payroll in California, discriminated against interstate commerce, and therefore, were unconstitutional. Consequently, in FTB Notice 2012-03, the FTB declared that California's QSBS statutes were invalid and also issued corresponding Notices of Proposed Assessment (the NPAs) to affected taxpayers.

With the enactment of AB 1412, taxpayers who previously filed their tax returns for open tax years and timely made a QSBS election to exclude or defer gain on the sale of QSBS will no longer be required to recompute their taxable incomes, file amended returns or pay retroactive taxes, interest or penalties for such tax years. In response to the passage of AB 1412, the FTB has recently released detailed guidance in the form of an updated FAQ on its website. For those taxpayers who filed their tax returns for open tax years and were contacted by the FTB regarding improper QSBS elections, the FTB indicates it will now take the following actions:

• The NPAs will be withdrawn.
• Closing letters will be mailed to taxpayers who signed a limited QSBS waiver for 2008.
• Unpaid taxes, interest, or penalties assessed as a result of Cutler or FTB Notice 2012-03 will be abated in full.
• Refunds for payments received by the FTB pursuant to Cutler or FTB Notice 2012-03 will be issued. No action is needed by taxpayers to request refunds, unless they do not hear from the FTB by November 30, 2013.

For those taxpayers who filed tax returns for open tax years but did not previously make a QSBS election, such taxpayers may file refund claims for gains realized that otherwise qualified for gain exclusion or deferral but for California's in-state property and payroll requirements for QSBS issuers. However, the FTB has stated that in accordance with AB 1412, the QSBS issuer must have met the 80% California payroll requirement at the time the taxpayer acquired the QSBS to claim the gain exclusion or partial deferral by filing an amended return(s) (claim for refund) for open tax years. Taxpayers have until June 30, 2014, to file a QSBS claim for refund for tax year 2008.

In summary, AB 1412 provides a significant retroactive remedy for those taxpayers who sold QSBS after January 1, 2008, and before January 1, 2013. Under AB 1412, QSBS treatment is available for gains realized from installment sales occurring during the foregoing period until January 1, 2016, at which time QSBS treatment is repealed. It should be noted that, for those in-state QSBS issuers that may have expanded to include out-of-state business operations, AB 1412 also removes the unconstitutional defect that had limited QSBS gain exclusion or deferral to only in-state businesses.

As discussed above, California taxpayers should consider filing refund claims for gains realized from the sale of QSBS for open tax years that may have otherwise qualified for gain exclusion or deferral but for the active in-state business requirement. If you have any questions concerning AB 1412 or require assistance with filing a claim for refund with the FTB, please do not hesitate to contact us.