BILL ANALYSIS                                                                                                                                                                                                    Ó


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                                    THIRD READING

          Bill No:  SB 209
          Author:   Lieu (D)
          Amended:  5/24/13
          Vote:     27

           SENATE GOVERNANCE & FINANCE COMMITTEE  :  6-1, 5/1/13
          AYES:  Knight, Beall, DeSaulnier, Emmerson, Hernandez, Liu
          NOES:  Wolk

           SENATE APPROPRIATIONS COMMITTEE  :  5-0, 5/23/13
          AYES:  De León, Hill, Lara, Padilla, Steinberg
          NO VOTE RECORDED:  Walters, Gaines

           SUBJECT :    Income taxes:  exclusion:  deferral:  qualified  
          small business stock

           SOURCE  :     Author

           DIGEST  :    This bill reenacts a recently stuck-down income  
          exclusion for gains when selling qualified small business stock  
          (QSBS), and provides that income does not include 38% 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.

           ANALYSIS  :    

          Existing law:

           1.The United States Constitution and discriminatory taxes  .  The  


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            U.S. 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 U.S. Supreme Court has asserted  
            consistently that the Constitution still precludes states from  
            doing so, known as the "dormant" or "negative" Commerce  

           2.The 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  As originally enacted, the Internal  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:

                 At issuance, the Corporation is a "C" Corporation with  
               less than 50 million in aggregate gross assets,

                 The taxpayer acquires stock at original issue, either in  
               exchange for money, other property, or as compensation for  
               services provided to the Corporation,

                 The taxpayer holds the stock for five years, and

                 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 QSBS deferral and 38% exclusion status with the  
             requirement that the firm have 80% of its payroll in the  



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             state at issuance.  Reenactment applies to the 2008-12  
             taxable years.

           2. Makes a continuous appropriation from the General Fund to  
             the Franchise Tax Board (FTB) in those amounts necessary to  
             make payments required by this bill.

           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, 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. 

           4. 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,  

           5. Makes a legislative finding and declaration regarding the  
             public purpose served by this bill and states that its  
             provisions are severable.


          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 U.S.  
          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 did not  
          prove the law was discriminatory.  However, the Second District  
          Court of Appeal reversed, ruling the QSB law was discriminatory  



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          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 Revenue and Taxation Code Section  
          24410, 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 calculate the refund, declining a refund request.  The  
          Court also did not attempt to sever unconstitutional aspects of  
          the statute from the non-discriminatory ones.  FTB did not  

          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 3, 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 Web site 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  



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          the 2008 taxable year for taxpayers who did not voluntarily  
          waive the statute of limitations. 

           FISCAL EFFECT  :    Appropriation:  No   Fiscal Com.:  Yes    
          Local:  No

          According to the Senate Appropriations Committee, this bill as  
          amended on May 24, 2013, could result with the bill having no  
          aggregate net impact on General Fund revenues.

          AB:nk  5/24/13   Senate Floor Analyses 

                         SUPPORT/OPPOSITION:  NONE RECEIVED

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