BILL ANALYSIS                                                                                                                                                                                                    Ó


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                                 UNFINISHED BUSINESS

          Bill No:  SB 209
          Author:   Lieu (D), et al.
          Amended:  9/11/13
          Vote:     21

           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

           SENATE FLOOR  :  34-3, 5/30/13
          AYES:  Beall, Berryhill, Block, Calderon, Cannella, Corbett,  
            Correa, De León, DeSaulnier, Emmerson, Evans, Fuller, Gaines,  
            Galgiani, Hernandez, Hill, Hueso, Huff, Jackson, Lara, Leno,  
            Lieu, Liu, Monning, Nielsen, Padilla, Pavley, Price, Roth,  
            Steinberg, Torres, Walters, Wright, Yee
          NOES:  Anderson, Wolk, Wyland
          NO VOTE RECORDED:  Hancock, Knight, Vacancy

           ASSEMBLY FLOOR  :  Not available

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

          SOURCE  :     Author

           DIGEST  :    This bill partially reinstates the income exclusion  


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          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.

           Assembly Amendments  remove the continuous appropriation for the  
          General Fund, and set a sunset date of January 1, 2016.

           ANALYSIS  :    

          Existing law:

           1.The United States Constitution and discriminatory taxes  .  The  
            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,



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          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.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. 

          2.Limits the aggregate amount of eligible gain for the taxable  
            year, in the case of one or more dispositions of QSBS by a  
            taxpayer, to the greater of the following: 

             A.   Ten million dollars, reduced by the aggregate amount of  
               eligible gain taken into account by the taxpayer for prior  
               taxable years and attributable to dispositions of QSBS, as  

             B.   Ten times the aggregate adjusted basis of QSBS issued by  
               the corporation and disposed of by the taxpayer during the  
               taxable year. 

          1.Defines a QSBS as a stock in a "C" corporation that is  
            originally issued after August 10, 1993, if both of the  
            following requirements are met: 

             A.   As of the date of issuance, the corporation is a  
               qualified small business. 

             B.   The stock is acquired in exchange for money or property,  
               or as compensation for services provided to the  
               corporation, as specified. 

          1.Defines a "qualified small business" as a domestic "C"  
            corporation, provided all of the following apply: 



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             A.   The aggregate gross assets of the corporation at all  
               times on or after July 1, 1993, and before the issuance did  
               not exceed $50 million; 

             B.   The aggregate gross assets of the corporation  
               immediately after the issuance do not exceed $50 million; 

             C.   At least 80% of the corporation's payroll, as measured  
               by total dollar value, is attributable to employment  
               located within California; and, 

             D.   The corporation agrees to submit reports to the  
               Franchise Tax Board (FTB) and to shareholders as the FTB  
               may require to carry out the purposes of the QSBS statutes.  

          1.Specifies that a stock in a corporation shall not be treated  
            as a QSBS unless, among other requirements, during  
            substantially all of the taxpayer's holding period for the  
            stock, the corporation meets a new non-discriminatory active  
            business requirement, as provided. 

          2.Authorizes a taxpayer to elect to defer gain from the sale of  
            QSBS made after August 5, 1997, and before January 1, 2013,  
            provided that the taxpayer held the QSBS for more than six  
            months, the gain is not treated as ordinary income for  
            purposes of the PIT law, and the taxpayer acquires a  
            replacement QSBS within 60 days of the date of the sale. 

          3.Waives the imposition of penalties and accrual of interest  
            with respect to the additional taxes assessed as a result of  
            the court decision in Cutler v. FTB (2012) 208 Cal.App.4th  
            1247, for each taxable year beginning on or after January 1,  
            2008, and before January 1, 2013, and allows the affected  
            taxpayers to enter into a written installment payment  
            agreement with the FTB for the payment of those taxes over a  
            period not to exceed five years. 

          4.Allows taxpayers to file a claim for credit or refund,  
            resulting from this bill, for taxable years beginning on or  
            after January 1, 2008, and ending before January 1, 2009,  
            within 180 days of the effective date of this bill. 

          5.Makes legislative findings and declarations regarding the  



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            public purpose served by the bill. 

           6. States that the bill's provisions are not severable and, if  
             any provisions of this bill or its application are held  
             invalid, the invalidity shall apply to other provisions or  
             applications of this act, except for those provisions  
             relating to the waiver of penalties and interest. 


          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  
          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  



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

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

          AB:n:k  9/12/13   Senate Floor Analyses 

                         SUPPORT/OPPOSITION:  NONE RECEIVED

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