BILL ANALYSIS Ó
SB 209
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Date of Hearing: August 21, 2013
ASSEMBLY COMMITTEE ON APPROPRIATIONS
Mike Gatto, Chair
SB 209 (Lieu) - As Amended: May 24, 2013
Policy Committee: Revenue and
Taxation Vote: 9-0
Urgency: No State Mandated Local Program:
No Reimbursable:
SUMMARY
This bill partially reinstates the income exclusion and deferral
provisions for gain from the sale or exchange of qualified small
business stock (QSBS), as defined, for taxable years beginning
on or after January 1, 2008, and before January 1, 2013.
Specifically, this bill:
1)Provides that, for taxable years beginning on or after January
1, 2008, and before January 1, 2013, a taxpayer may exclude
from gross income, under the Personal Income Tax (PIT) Law,
38% of any gain attributable to the sale or exchange of QSBS
held by the taxpayer for more than five years, a reduction
from 50% in existing law.
2)Requires the FTB to waive all penalties and interest for taxes
assessed as a result of the court decision in Cutler v. FTB
(2012) 208 Cal.App.4th 1247, as specified, and allows
taxpayers to enter into a written installment payment
agreement with the FTB for the payment of those taxes due in
installments for a period of up to five years.
3)States, if for any reason the exclusion provisions of this
bill are held invalid, ineffective or unconstitutional by a
court of competent jurisdiction, the FTB will be required to
waive all penalties and interest imposed as a result of those
provisions for each taxable year beginning on or after January
1, 2008, and before January 1, 2013, and the affected
taxpayers may enter into written installment payments
agreements with the FTB for the payment of any tax due.
FISCAL EFFECT
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Following is a table of estimated fiscal impacts for SB 209
developed by FTB. This fiscal effect estimate is based on the
FTB's interpretation of existing law, which is the QSBS has been
eliminated by court decision.
FTB's interpretation is not accepted by some supporters of the
bill, who argue the FTB decision improperly voided a statute,
and that FTB could have continued implementing existing law.
This view has a significant impact on the fiscal effect of this
bill (see comment #9).
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SB 209 Estimated Loss of Revenues by Tax Year ($
Millions)
------------------------------------------------------------------
|Provisions of SB 209 | 2012-13 | 2013-14 | 2014-15 | 2015-16 |
|----------------------+----------+----------+----------+----------|
|Loss from allowing |$21.0 |$18.0 |$2.0 |$0.3 |
|38% exclusion to | | | | |
|taxpayers who have | | | | |
|not already claimed | | | | |
|the QSBS exclusion | | | | |
|between 2009 and 2012 | | | | |
|----------------------+----------+----------+----------+----------|
|Loss from issue |$16 |$12 |$12 |$12 |
|limited assessments | | | | |
|for tax years | | | | |
|2008-2011 | | | | |
|----------------------+----------+----------+----------+----------|
|Loss due to waiving |$2.2 |$1.5 |$1.6 |$1.5 |
|interest on | | | | |
|assessments for tax | | | | |
|years 2008-2011 | | | | |
|----------------------+----------+----------+----------+----------|
|Total |$39.2 |$31.5 |$15.6 |$13.8 |
------------------------------------------------------------------
Potential additional costs in the tens of millions if there is
subsequent litigation. The severability clause would allow FTB
to attempt to determine if a program could be continued in the
event of an adverse court ruling. This provision opens the door
to a potentially more expensive program. This more costly
result is what would have happened if FTB had agreed with the
legal argument of some supporters of SB 209.
COMMENTS
1)Purpose. The author states that retroactive changes in tax
law which trigger retroactive tax assessments are inherently
unfair. The author explains that the taxpayers the FTB would
assess under their proposed remedy followed the QSBS law
exactly as it was written by the Legislature and implemented
by FTB. According to the author, they also risked their
capital and poured their efforts into creating start-up
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businesses that are the heart of the California economy.
The author argues the taxpayers are entitled to rely on the
state's representations that in exchange for doing so, they
would receive a tax break. To allow the state to
retroactively move the goalposts would result in the state
receiving an unfair windfall of close to $200 million.
The author argues that issuing retroactive tax assessments
when a legal defect is found with a tax credit provision will
undermine confidence in California tax incentives. According
to the author, if taxpayers know that the state may send
multiple years of retroactive tax assessments anytime a tax
incentive provision is challenged, confidence in California's
economic development program is seriously undermined. To
stop the retroactive taxes, preserve the rule of law, and
implement a Cutler remedy, legislative action is necessary.
2)Arguments in Support . The proponents of this bill, including
the California Chamber of Commerce and BIOCOMM, state that SB
209 would protect small business investors who made a good
faith reliance on California's tax law. They argue
retroactive changes in tax law, which trigger retroactive tax
assessments, are inherently unfair. The proponents point out
that, according to the most recent studies, virtually all of
California's net job growth is attributable to start-up
ventures and that SB 209 is a reasonable solution to a unique
situation. The proponents assert that, unless SB 209 passes,
the loss of the QSBS exclusion/rollover would cause
fundamental damage to California's efforts to emerge from
recession and put Californians back to work.
3)Arguments in Opposition . The opponents, the California School
Employees Association, argue the state should not restore a
tax break that was shown to be discriminatory and
unconstitutional. The opponents assert the problem with many
state tax breaks is they either violate interstate commerce
laws, or provide tax benefits irrespective of any economic
activity to benefit California. The opponents conclude the
retroactive tax relief proposed by SB 209 amounts to a tax
refund, with no incentive to invest in California.
4)QSBS Background. In 1993, the California Legislature enacted
SB 671 (Alquist, Statutes of 1993), which among things,
conformed California tax law to the federal tax provisions
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relating to a partial capital gains exclusion for small
business stock. Specifically, it allowed a non-corporate
taxpayer to exclude from gross income 50% of the capital gain
(up to a lifetime limit of $10 million) recognized by the
taxpayer from the sale or exchange of a stock that met the
requirements of QSBS, provided the stock was held for five or
more years.
State law provided all of the following requirements had to be
met to qualify for the deferral or exclusion of gain:
a) At the time of issuance of QSBS, at least 80% of the
corporation's payroll had to be attributable to employment
located within California (a so-called "payroll at
issuance" requirement).
b) During the taxpayer's holding period of the QSBS, at
least 80% of the corporation's assets had to be used in the
active conduct of one or more qualified trades or
businesses in California.
c) During the taxpayer's holding period of the QSBS, no
more than 20% of the corporation's payroll expense could be
attributable to employment located outside of California.
5)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. This is known as the
"dormant" or "negative" Commerce Clause. The courts have
struck down taxes and tax benefits that legislatures have
enacted to help in-state businesses as discriminatory against
interstate commerce.
6)Cutler vs. FTB. On August 28, 2012, the Court of Appeal in
Cutler v. FTB determined that the active business requirements
of the QSBS statute were discriminatory on their face and,
thus, unconstitutional. This decision, along with the FTB's
position on how to implement it, has not only severely
impacted taxpayers, but also created confusion among tax
experts, spawned a host of decisions, articles and
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communications attempting to address what is without question
a complex and awkward situation.
As discussed above, the QSBS statute allowed taxpayers a
deferral or a partial exclusion for income received from the
sale of stock in qualified corporations maintaining assets and
payroll in California, while providing no such benefit for
income from the sale of stock in corporations maintaining
assets and payroll elsewhere. In Cutler v. FTB, Mr. Cutler
argued the active business requirements violated the Commerce
Clause of the United States Constitution. The trial court
sided with the FTB, however, the Court of Appeal reversed the
decision of the trial court, holding that the QSBS statute is
discriminatory on its face and cannot stand under the commerce
clause.
7)FTB response. As the result of the Court of Appeal's decision
in Cutler, FTB was faced with the challenges of implementing
that decision and fashioning the appropriate remedy. The
Court held that the 80% property and payroll requirements,
i.e., the "active business requirements," discriminated
against interstate commerce. However, the court did not opine
on whether the unconstitutional provisions could be severed
from the remainder of the QSBS statute or whether the
reformation of the statute was appropriate, leaving open a
question of could the remainder of the statute be legally
administered. To put it simply, FTB had to make a decision
whether the remainder of the statute is complete in itself,
and would have been adopted by the legislative body had it
foreseen the statute's partial invalidation, or whether the
remainder comprises a complete expression of legislative
intent.
FTB determined the QSBS statutes were invalid and the
appropriate remedy was to deny the exclusion/deferral to
taxpayers who benefited from either incentive. The FTB
decided that there was no evidence demonstrating the
Legislature would have enacted the remaining provisions of the
QSBS statute (without the "active business requirements"), had
it known the unconstitutional provisions would later be struck
down. By refusing to sever the offending requirements from
the remaining provisions of the QSBS statute, the FTB took a
position that the whole statute is unconstitutional and is
invalid under Cutler.
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8)Legislative response . SB 209 was introduced to address the
confusion and settle the claims and counterclaims.
Essentially, SB 209 helps two groups of taxpayers. One group
is comprised of taxpayers who claimed the exclusion or
deferral in the past taxable years, but are now required to
pay the tax, interest and penalties for those years. SB 209
would waive all penalties and interest for taxes assessed as
the result of the Cutler decision and the FTB notice.
However, SB 209 would provide only partial relief to those
taxpayers as they would be allowed an exclusion of only 38%,
not the full 50%, of the gain recognized on the sale of QSBS.
At the same time, SB 209 would reward taxpayers who did not
qualify for either tax exclusion or deferral under the old
statute because they could not meet the discriminatory "active
business" requirements. Essentially, SB 209 would provide a
windfall to those taxpayers for their past behavior.
9)Alternative view . Some disagree with the FTB's position that
the California payroll and property requirements could not be
severed from the QSBS statute. They contend that the
legislative intent of the QSBS statute, which was to spur
investment in California small businesses, is advanced by the
remainder of the statute, namely the payroll at issuance
requirement, which was not at issue in Cutler. They argue
that the payroll at issuance requirement encourages taxpayers
to seek out California-based businesses for investment and in
so doing clearly advances the legislative intent of spurring
investment in California.
If FTB's interpretation is incorrect, the fiscal impact of SB
209 is much different, with a much smaller revenue impact.
Revenue losses would still result from allowing taxpayers, who
did not do so previously, to claim the QSBS exclusion from
2008 to 2012. These are taxpayers who did not meet the
requirements of the now unconstitutional provisions of the
law, but with SB 209 could file and take advantage of the
exclusion. However, savings result from two provisions, the
reduced exclusion, 38% as compared to 50%, and the ending of
the program. With these provisions, SB 209 may not have an
aggregate net impact on General Fund revenues, again provided
the FTB interpretation is incorrect or reversed.
10) More QSBS litigation could follow. SB 209 eliminates the
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80% California payroll and assets requirements, but retains
the requirement that at issuance at least 80% of the payroll
had to be attributable to employment based in California.
This requirement can be seen as discriminatory, much like the
other two requirements invalidated by the court in Cutler.
Some argue it is not discriminatory because it is not coercive
and does not compel the qualified small business to avoid
interstate commerce, but is rather a constitutionally
permissible means of encouraging investment in small business
in California without encouraging or discouraging investment
in other states. However, the issues are not clear, creating
risk for the implementation of SB 209.
11) Taxation with Representation. It is a truth universally
acknowledged that if one group of taxpayers is helped by
legislation, they likely will not be the last group to request
assistance. Cutler may be the first time courts have
nullified a California personal income tax benefit as
discriminatory; it won't likely be the last. Attorneys are
likely to use Cutler to file suit against the state claiming
that other incentives, such as the Research and Development
Credit, the Enterprise Zone Credit, and the Motion Picture
Production Credit, discriminate against interstate commerce by
not allowing costs incurred by taxpayers outside the state to
qualify for credits when the same costs incurred inside the
state do. Enacting SB 209 sends the message the Legislature
may act to save those disadvantaged by litigation, including
perhaps the litigants as in Cutler.
In Ventas Finance I, LLC v. Franchise Tax Board, courts first
allowed attorneys' fees to be awarded prevailing parties in
tax cases under the richer Code of California Procedure
instead of the less generous Revenue and Taxation Code. Since
then, the state has seen an increase in lawsuits challenging
the constitutionality of its taxes, as attorneys see richer
fees as incentive to file suit and the state lacks an
erroneous claims for refund penalty which would provide some
disincentive for filing claims.
12) Proposed amendment . The committee should amend out the
severability clause if the bill passes. The severability
clause creates two potential issues.
a) In the event of an adverse court decision, it would
allow the FTB or the courts to determine if they could
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fashion a program with what law remains. This provision
increases the fiscal risks of this bill. The results of
Cutler bear this out. If FTB had done what many supporters
argue for, the state would have a much more expensive QSBS
program designed without input from the Legislature. The
severability clause could facilitate the same situation
occurring again. Although there is room for disagreement
about the interpretation of the law, the result of the FTB
decision was to preserve the Legislature's perquisites to
shape tax policy and make spending decisions.
b) FTB has been subject to a great deal of criticism and
threats of litigation from many of the supporters of SB
209. If these arguments are correct, it seems
contradictory to place FTB in the role of shaping this
policy in the future if there are additional court
decisions that could lead to the need for changes in the
QSBS program.
.
Analysis Prepared by : Roger Dunstan / APPR. / (916) 319-2081