New QSBS Law

On Friday, October 4, 2013, Governor Brown signed into law AB 1412, which reinstated the California tax break for Qualified Small Business Stock (QSBS) that had previously been ruled unconstitutional by the California Court of Appeals. The new legislation applies retroactively to the tax years 2008 to 2012 and is applicable going forward until at least January 1, 2016.

Background of California Tax Law AB 1412

Since 1993, the California tax code has contained a QSBS exclusion which provided for the exclusion or deferral of gain from the sale or exchange of qualifying stock. For the stock to qualify as QSBS, it must have been purchased when at least 80% of the company’s payroll was within California, and 80% of the assets and payroll must have been within California during the holding period of the stock.

In August 2012, the California Court of Appeals in Cutler v Franchise Tax Board found that the 80% asset and payroll tests were unconstitutional and the Franchise Tax Board (FTB) claimed that this made the entire Qualified Small Business Stock statute invalid. California taxpayers who had previously taken advantage of the QSBS rules within the statute of limitations period (generally 2008-2012) had to recalculate their taxable income and pay additional tax.

AB 1412: Modifies the Qualified Small Business Stock (QSBS) Law

AB 1412 reintroduces a modified form of the Qualified Small Business Stock law that eliminates the 80% requirement for assets and payroll during the holding period. The legislation retains the requirement that 80% of payroll be located in California on the date of acquisition of the stock. AB 1412 applies retroactively, so California taxpayers can rely on the new rules for tax years 2008-2012.

Next Steps for California Taxpayers

The next step depends on whether the taxpayer previously made a QSBS election in California tax returns from 2008-2012.

Taxpayers who made a QSBS election in their tax returns would have been contacted by the Franchise Tax Board with Notices of Proposed Assessments following the Cutler decision. Those notices will now be withdrawn and unpaid tax, interest, and penalties will be abated. Refunds for overpayments will be made automatically, although taxpayers may contact the Franchise Tax Board if they do not receive a refund by November 30, 2013.

Taxpayers who did not make a Qualified Small Business Stock election because of the 80% asset and payroll tests during the holding period may file amended returns with a QSBS election. However, it is important to note that the Qualified Small Business Stock must still meet the 80% payroll requirement at the time of acquisition of the stock. The statute of limitations for the 2008 and 2009 tax years has been extended to June 30, 2014 for the purposes of making a QSBS election.

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Roger Royse
rroyse@rroyselaw.com

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City. Read My Full Bio

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