BILL ANALYSIS Ó
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THIRD READING
Bill No: AB 1412
Author: Bocanegra (D) and Gatto (D) et al.
Amended: 9/6/13 in Senate
Vote: 21
PRIOR VOTES NOT RELEVANT
SUBJECT : Income taxes: exclusion: deferral: qualified small
business stock
SOURCE : Author
DIGEST : This bill reenacts recently stuck-down income
exclusion for gains when selling qualified small business stock
(QSBS), and provides that income does not include 50% of any
gain from the sale of QSBS, held for more than five years, for
taxable years beginning on or after January 1, 2008 and before
January 1, 2013; and requires the Franchise Tax Board (FTB) to
waive all penalties and interest for taxes assessed and
authorizes a taxpayer to enter into a written installment
payment agreement with the FTB for the payment of any taxes due,
as a result of the decision of Cutler v. FTB, for each taxable
year beginning on or after January 1, 2008, and before January
1, 2013.
Senate Floor Amendments of 9/6/13 delete prior version of bill,
and add provisions enacting an alternative version of SB 209
(Lieu), relating to qualified small business stock (QSBS).
ANALYSIS :
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Existing law:
The United States Constitution and Discriminatory Taxes . The
United States Constitution grants the power to Congress to
"regulate Commerce with foreign nations, and among the several
states" a provision widely known as the Commerce Clause (Article
I, Section 8). If Congress fails to regulate interstate
commerce wholly or in part, the United States Supreme Court has
asserted consistently that the Constitution still precludes
states from doing so, known as the "dormant" or "negative"
Commerce Clause.
Many states seek to shift burdens of tax from firms with most
business operations inside their states to ones that don't, and
the United States Supreme Court has decided several cases
applying the dormant commerce clause to affirm the power of
states to tax interstate business; however, the taxpayer must
have nexus, the tax must be fairly apportioned and
non-discriminatory, and a fair relationship between the tax and
the services provided must exist. Complete Auto Transit v.
Brady, 430 U.S. 274, 97 S.Ct. 1076 (1977). The Supreme Court
and others have struck down taxes and tax benefits that
legislatures have enacted to help instate businesses as
discriminatory against interstate commerce when it "tax[es] a
transaction or incident more heavily when it crosses state lines
than when it occurs entirely within the State." Complete Auto
Transit. The commerce clause protects taxpayers from
"regulatory measures designed to benefit instate economic
interests by burdening out-of-state competitors." Fulton Corp
v. Faulkner, 516 U.S. 325 (1996).
QSBS Exclusion . As originally enacted, the Internal Revenue
Code allowed taxpayers to defer the entire gain or exclude from
income 50% of the gain from the sale of QSBS in specified
circumstances, known as the "QSB exclusion." In 1993,
California enacted its own QSB exclusion, seeking to draw more
investment into California-based firms. Taxpayers could have
claimed a deferral or income exclusion on the gain on the sale
of the stock, subject to a cap, if: (1) at issuance, the
Corporation is a "C" Corporation with less than 50 million in
aggregate gross assets, (2) the taxpayer acquires stock at
original issue, either in exchange for money, other property, or
as compensation for services provided to the Corporation, (3)
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the taxpayer holds the stock for five years, and (4) at the date
of issuance, the Corporation is a qualified small business, and
during the holding period, meets the active business
requirements.
Among other requirements, to be a qualified small business, a
corporation must have 80% of its payroll located in California
at the time of issuance. To meet the active business
requirement during the holding period, a firm must continue to
have at least 80% of its payroll in California and 80% (by
value) of the assets of the corporation used in the active
conduct of a qualified trade or business in California for
substantially all of the holding period.
This bill:
1. Reenacts a recently stuck-down income exclusion for gains
when selling QSBS, and provides that income does not include
50% of any gain from the sale of QSBS, held for more than
five years, for taxable years beginning on or after January
1, 2008 and before January 1, 2013.
2. Requires the FTB to waive all penalties and interest for
taxes assessed and authorizes a taxpayer to enter into a
written installment payment agreement with the FTB for the
payment of any taxes due, as a result of the decision of
Cutler v. FTB, for each taxable year beginning on or after
January 1, 2008, and before January 1, 2013.
3. Requires the FTB to waive all penalties and interest for
taxes assessed and authorizes a taxpayer to enter into a
written installment payment agreement with the FTB for the
payment of any taxes due, if specified provisions of this
bill are held invalid, ineffective, or unconstitutional by a
court of competent jurisdiction for each taxable year
beginning on or after January 1, 2008, and before January 1,
2013.
4. Makes a legislative finding and declaration regarding the
public purpose served by this bill and states that its
provisions are severable.
Background
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Cutler v. FTB . Frank Cutler sued the FTB when it disallowed a
1998 gain deferral for one stock that it determined did not meet
the requirement to be treated as QSBS. Cutler argued that the
FTB was wrong and the stock did meet the requirements, but even
if it didn't, the requirement discriminated against interstate
commerce in violation of the dormant commerce clause of the
United States Constitution. The Board of Equalization decided
against Cutler, but he paid the tax and filed suit against FTB
in Superior Court in 2009, represented by noted tax attorney
Marty Dakessian.
The trial court sided with FTB because Cutler still could not
document that the corporation that issued the stock in question
met the active business requirement, and that Cutler didn't
prove the law was discriminatory. However, the Second District
Court of Appeal reversed, ruling the QSB law was discriminatory
on its face, citing Fulton:
"A regime that taxes stock only to the degree that its
issuing corporation participates in interstate commerce
favors domestic corporations over their foreign competitors
in raising capital among North Carolina residents and tends,
at least, to discourage corporations from plying their
trades in interstate commerce."
The Appeals Court added that a discriminatory tax benefit is no
different than a discriminatory tax. Cutler v. FTB. 208
Cal.App.4th 1247 (2012). The Court cited two cases where the
California Supreme Court invalidated California tax statutes as
discriminatory: Ceridian Corp. v. FTB 85 Cal.App.4th 875
(2000), that invalidated section 24410 of the Revenue and
Taxation Code, which provided for a dividend received deduction
for dividends paid by an 80% or more owned insurance corporation
to the extent that the insurance corporation was subject to the
California gross premiums tax, and Farmer Brothers v. FTB 108
Cal.App.4th 976 (2003), that allowed for a dividend received
deduction to the extent that the dividend payor was subject to
California corporate income or franchise tax. Similar to those
cases, the Court in Cutler found the statutory scheme
discriminatory on its face, and remanded the case to the trial
court to determine whether Cutler should receive a refund. The
Court also did not attempt to sever unconstitutional aspects of
the statute from the non-discriminatory ones. FTB did not
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petition for review.
On December 21, 2012, FTB issued notice 2012-03 stating that
because the Appeals Court held the statutory scheme of the QSB
exclusion discriminatory, the only possible remedy that FTB as
an administrative agency bound by California Constitution's
Article Three, Section 3.5 could issue that would treat all
taxpayers the same was to invalidate all QSB deferrals and
exclusions taxpayers claimed in each taxable year within the
statute of limitations, which is 2008, while allowing refund
claims for prior years. FTB updated its website to include new
FAQs in regards to the issue on February 28, 2013, directing
affected taxpayers to file amended returns without QSB deferrals
or exclusions back to 2008, and pay any tax due as a result.
FTB states that it started sending notices of proposed
assessment, which are essentially tax bills, on April 11th to
ensure collection before the statute of limitations expires for
the 2008 taxable year for taxpayers who did not voluntarily
waive the statute of limitations.
FISCAL EFFECT : Appropriation: No Fiscal Com.: Yes
Local: No
AB:d 9/11/13 Senate Floor Analyses
SUPPORT/OPPOSITION: NONE RECEIVED
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