Taxable Talk

Two pieces of news out of California regarding the Qualified Small Business Stock situation. For those who aren’t aware, a court last year ruled that California couldn’t discriminate against out-of-state Qualified Small Business Stock (QSB). The Franchise Tax Board interpreted that ruling to mean that for any open tax year, the state would challenge the QSB deductions for anyone who took it. For 2012 on, the California deduction was eliminated, so this is an issue impacting entrepreneurs for tax years 2008 through 2011.

The FTB announced today that they will begin sending Notices of Proposed Assessment (NPAs) in early April. The FTB has also established a simplified procedure to protest the NPAs and it’s clearly noted in their FAQ web page on this issue.

(As much as I think the FTB’s implementation of the Cutter decision is wrong, I want to give the FTB kudos to them for an easily understood webpage and instructions on this issue. I also want to thank them, especially Susan Maples (the FTB’s Tax Practitioner Liaison), for reaching out to the tax professional community in communicating the issues.)

Meanwhile, the tech community remains extremely displeased with the FTB’s actions. Brian Overstreet, the man who began sounding the alarm, has set up a new website on this issue. There’s a very anti-California article on Forbes.com that highlights this issue. Legal action is almost a certainty; many of these entrepreneurs have the deep pockets necessary to fight the FTB.

Back in December, I reported on how the Franchise Tax Board (California’s income tax agency) would interpret the Cutter decision. I didn’t spend much time on it, as the subject of Qualified Small Business stock (QSB) doesn’t impact many of my blog readers. The FTB decided that since the appellate court ruled as aspect of California’s law on sale of QSB stock unconstitutional, one way around the issue was to void the law in its entirety. And send individuals who took the QSB deduction penalty and interest notices. Surprise!

That said, an entrepreneur named Brian Overstreet has written a column that is about as nasty as can be toward the FTB and California. (I recommend reading the entire column.) As Mr. Overstreet notes the impact:

1. If you are a business founder or early investor who sold stock since 2008 and took the QSB exclusion: Surprise! You are going to get a bill from the FTB for the 50 percent of the taxes you excluded plus interest plus possible penalties.

2. If you are a business founder or early investor and have not yet sold stock: Rethink your business and tax planning strategies. Consider whether it’s fiscally prudent to stay in California.

3. If you a contemplating starting or investing in a California business: Think long and hard. Consider out-of-state alternatives.

Of course, there’s definitely a constitutional issue here, too. Given that some of the impacted entrepreneurs have deep pockets, I expect this ruling to head to court. I suspect the FTB can do this for the current tax year (2012; the ruling was announced in December) but I doubt it will hold up for prior tax years.

The other issue is one any entrepreneur in California should consider. As Mr. Overstreet noted, “Why in the world would any smart business person start or invest in a new California company facing that kind of penalty?”