California Okays Full and Partial Relief from Retroactive Taxes

Published September 18, 2013

The California Assembly Appropriations Committee may have recommended only partial relief from retroactive taxation of capital gains, but by nearly unanimous margins the state’s representatives and senators have sent Gov. Jerry Brown (D) a bill to provide full relief. But another bill to provide only partial relief also passed.

Late last year approximately 2,500 small business investors in California were threatened with collection of $120 million of taxes they were told they’d never have to pay. Since then Sen. Ted Lieu (D-Torrance) and private businessman Brian Overstreet have led an effort to block the retroactive taxation.

The measure to provide full relief was actually one of two bills passed by legislators to deal with the issue. AB1412 would provide full relief while SB209 would provide 76 percent relief, leaving the affected investors to pay approximately $30 million in retroactive taxes.

‘Pushing for Full Relief’

“We’re pushing hard for the governor to sign AB1412 into law and provide full relief,” said Overstreet, who was among 2,500 small business investors who participated in a tax incentive program California enacted 20 years ago to lure entrepreneurs and early-stage investors. The Qualified Small Business Stock incentive program allowed sales of stock of a qualified small business to be taxed at half of the regular state rate on capital gains or rolled over into a new qualified small business if reinvested within 60 days of the sale.

Last year, in a case known as Cutler v. Franchise Tax Board, the Second District Court of Appeal struck down the incentive program, ruling that it violated the Constitution’s Commerce Clause because of a requirement that a business must have 80 percent of its payroll and assets in California to qualify for the incentive.

The Franchise Tax Board then announced that it would demand the return of $120 million in incentive payments, with interest, going back to 2008, even though the court did not order the collection of taxes that had been forgiven under the program.

‘Lifeblood of Economy’

“Entrepreneurs and small businesses create the majority of new jobs in California and are the lifeblood of a healthy economy,” Overstreet said. He said the passage of a bill to provide full relief from retroactive taxation “will give business owners more faith in California’s leaders, will create more high income jobs throughout the state, and will bring more investment to new California ventures.” 

He said he and members of California Business Defense, which he co-founded to oppose the retroactive taxation, are grateful that legislators recognized the importance of small businesses and entrepreneurs.

“We want to first thank Senator Ted Lieu, whose leadership and guidance throughout this process has been invaluable. We also want to thank other major supporters including Assembly members [Jeff] Gorell, [Mike] Gatto), and [Raul] Bocanegra as well as the leadership in both houses. They all believed in our cause and now the governor has the tools to eliminate this retroactive tax.”

“This is about the rule of law,” said Lieu in a statement. “You simply cannot punish people for doing what we asked.”

Money Tied Up

Overstreet sounded the alarm to businesspeople across California after receiving a letter from his lawyers informing him he could be on the hook for capital gains taxes resulting from his sale of a company earlier in 2012. He used the money he saved through the incentive program to help start AdverseEvents, a company that compiles and provides safety and outcome information on all FDA-approved drugs. Most of the other participants in the incentive program also have money they saved tied up in other ventures, Overstreet said.

SB 209 was originally written to provide full relief of retroactive taxes, interest, and penalties. In May, the Senate Appropriations committee attached amendments over the objection of SB 209 author Senator Lieu. Those amendments reduced the incentive program benefit from the original 50 percent cut in the state’s capital gains tax rate to 38 percent retroactively (bringing the level of tax relief down from 100 percent to 76 percent) and eliminated the QSBS incentive program from now on. The amended SB 209 passed out of the Senate on a 34-3 vote. On the Assembly side, the bill passed out of the Assembly Revenue and Tax committee on a 9-0 vote.

Board Demands Legislative Fix

In a letter to the tax board, Senator Lieu wrote, “I recently spoke with a taxpayer who all of a sudden is faced with a new retroactive tax bill of over $200,000 plus interest even though he complied with the law. I am informed there are thousands of other taxpayers who will be faced with potentially even higher retroactive bills and penalties.”

Lieu asked the tax board to reverse its decision to collect taxes retroactively, but the tax board responded the solution must come legislatively.

The bills have until October 13 to become law. If one of the bills does not become law by then, the entrepreneurs would receive no tax relief. Governor Brown has not indicated if he supports full relief or partial relief – or if he opposes all relief, in which case he could veto the bills.