- California Court of Appeal Holds Unconstitutional California Exclusion of Gain from Sales of “Qualified Small Business Stock”
- February 1, 2013
- Law Firm: Loeb Loeb LLP - Los Angeles Office
California’s Revenue and Taxation Code Section 18152.5 includes a provision that is similar to IRC Section 1202, which allows a taxpayer to exclude a portion of the gain he recognizes upon the sale of “qualified small business stock.” Qualified small business stock is generally stock of a C corporation acquired by the taxpayer at its original issuance and held by the taxpayer for at least five years. The corporation must be engaged in an active trade or business and cannot have more than $50 million of gross assets. While California law generally follows federal law in determining what is qualified small business stock, California imposes additional requirements that at least 80 percent of the corporation’s payroll be attributable to employment in California and at least 80 percent of its assets be used in the conduct of an active business in California.
In a recent case, Cutler v. Commissioner (2012), the California Court of Appeal for the Second District held that the statute violates the commerce clause of the U. S. Constitution because it favors corporations doing most of their business in California over their competitors in attracting investment capital from California residents.
In FTB Notice 2012-03, the Franchise Tax Board provided information on how it will implement the Cutler decision. For tax years beginning before January 1, 2008, the FTB will allow claims for the exclusion if they meet the requirements of Section 18152.5, apart from the California payroll and property requirement. For taxpayers for whom the statute of limitations on a pre-2008 tax year is still open, the taxpayer may file an amended return to claim the credit if he meets all of the requirements apart from the California payroll and property requirements. The statute of limitations normally now would be closed for years before 2008 unless such statute has been extended due to a pending audit or appeal.
California adopted this position for pre-2008 years in order to provide the same treatment for taxpayers who are similarly situated. Some taxpayers claimed the exclusion for years prior to 2008 and the statute of limitations for those years has expired so the FTB cannot assess additional tax for those years. To be fair to all taxpayers, the FTB will permit other taxpayers for whom the statute of limitations is still open to now claim the exclusion if they have not previously done so.
For years beginning with 2008, the FTB will not allow the exclusion. For taxpayers who claimed it, the FTB will issue Notices of Proposed Assessment denying the exclusion of gain from qualified small business stock. Taxpayers who wish to minimize the interest that will be due on any additional tax can self-assess the tax by filing an amended return and paying the additional tax due.