BILL ANALYSIS Ó Senate Appropriations Committee Fiscal Summary Senator Kevin de León, Chair SB 209 (Lieu) - Income Taxes: Exclusions: Deferral: Qualified Small Business Stock Amended: April 3, 2013 Policy Vote: G&F 6-1 Urgency: No Mandate: No Hearing Date: May 23, 2013 Consultant: Robert Ingenito SUSPENSE FILE. Bill Summary: SB 209 would reenact a recently struck-down income exclusion for gains when selling qualified small business stock (QSBS). Under the measure, (1) taxpayers who did not already claim the QSBS exclusion between 2008 and 2012 could do so, (2) the Franchise Tax Board (FTB) would not issue notices of proposed assessments (NPAs, essentially tax bills) and seek interest for taxable years 2008 through 2011, (3) the QSBS exclusion would be suspended for taxable years 2013 through 2015, and (4) the QSBS exclusion (specifically the element not struck down by the court) would resume beginning January 1, 2016. Fiscal Impact: The bill would require changes to existing tax forms and instructions, as well as information systems, resulting in an unknown increase (greater than $50,000 General Fund) to the FTB's printing, processing and information technology costs. The calculation of revenue impact resulting from this measure depends entirely on the baseline revenue scenario selected to which this measure compares (see Staff Comments). From the perspective that all QSBS exclusions and deferrals are currently invalid dating back to 2008, this measure would result in annual revenue losses in the range of roughly $30 million to $50 million. Alternatively, using the methodology that QSBS exclusions and deferrals associated with the portion of the statute not struck down are valid, because it would suspend the QSPS exclusion for the period 2013 to 2015, this measure's net revenue loss in the aggregate (as currently drafted) would be greatly reduced, SB 209 (Lieu) Page 1 approaching revenue neutrality. Background: As originally enacted, federal law allowed taxpayers to defer the entire gain or exclude from income 50 percent of the gain from the sale of QSBS in specified circumstances. In 1993, the State enacted a statute that was generally identical to the federal version, with three exceptions: A requirement that when the stock was issued, at least 80 percent of the corporation's payroll was in the State. A requirement that, during substantially all of the taxpayer's holding period of the subject stock, at least 80 percent (by value) of the corporation's assets was used in the active conduct of one or more qualified trades or businesses in the State. A requirement that, during substantially all of the taxpayer's holding period of the subject stock, at least 80 percent of the corporation's payroll expense was attributable to employment in the State. A California Court of Appeal, hearing the case of a taxpayer who didn't meet one of these tests, ruled in August 2012 that two of the incentive's three requirements discriminated against the interstate commerce clause of the U.S. Constitution. In response, FTB invalidated all QSBS deferrals and exclusions taxpayers claimed in each taxable year within the statute of limitations (2008). FTB directed affected taxpayers to file amended returns without QSBS deferrals or exclusions back to 2008, and pay any resulting tax due, along with potential interest. Proposed Law: SB 209 would reenact California's QSBS deferral and 50 percent exclusion statutes with the requirement that the firm have 80 percent of its payroll in the state at issuance (the one requirement not struck down by the Court of Appeal). SB 209 reenactment applies to the 2008 through 2012 taxable years, thereby absolving taxpayers who claimed the deferral or exclusion and expect to soon receive NPAs from FTB. The measure then enacts the QSBS deferral and exclusion again beginning in the 2016 taxable year. SB 209 (Lieu) Page 2 Related Legislation: AB 901 (Wieckowski) would provide retroactive tax relief for taxpayers who claimed QSBS incentives. Staff Comments: From the perspective that the entire QSBS statute is invalid in the aftermath of the Court of Appeal ruling, SB 209 would lead to a revenue loss for the period 2008 through 2012, and ongoing beginning in 2016 (because the baseline under this scenario is that the QSBS exclusion is completely "off the table"). Specifically, FTB estimates the following General Fund revenue losses: $45 million in 2012-13, $34 million in 2013-14, $9 million in 2014-15, $58 million in 2015-16, and roughly $45 million annually thereafter. The revenue loss results from (1) allowing the QSBS exclusion to taxpayers who have not already claimed it previously for the period 2008 to 2012, and (2) not issuing NPAs (nor seeking interest) for the period 2008 to 2011. Alternatively, from the viewpoint that the portion of the QSBS exclusion statute that was not struck down by the Court of Appeal is current law, the bill's current calculated net revenue loss would be considerably smaller. Revenue losses would still result from (1) allowing taxpayers to claim the QSBS exclusion from 2008 to 2012 who did not do so previously, and (2) a larger number of taxpayers qualifying for the exclusion beginning in 2016. Both result from the bill only including the 80 percent payroll requirement, whereas the previous statute had the other two requirements that were struck down. However, these revenue losses would be nearly offset because under the bill, the QSBS exclusion "goes dark" from 2013 to 2015. Current calculations of the net impact of these two effects results in a small revenue loss. However, reducing the percentage of the exclusion, from 50 percent down closer to 38 percent, could result with the bill having no aggregate net impact on General Fund revenues.