A California court recently found unconstitutional a business incentive law which many small businesses relied on to pare their tax bills over the last twenty years.
At issue in Cutler v. Franchise Tax Board was a law passed by California 20 years ago which created a tax incentive intended to lure entrepreneurs and early-stage investors to California. The incentive allowed stock sales 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.
The Second District Court of Appeal declared one part of the qualified small business stock exclusion unconstitutional because it required businesses to have 80 percent of their payroll and assets in California. According to the court, the 80 percent provision violated the U.S. Constitution’s Commerce Clause.
California’s Franchise Tax Board (FTB) must have recognized a potential windfall when the court issued its decision late last summer. They began recalculating tax returns and sending out retroactive tax bills – with interest – in December. They plan to collect taxes legally excluded on business tax returns back to 2008.
For 20 years, many small businesses took advantage of the lucrative tax incentive. The elimination of the tax credit is expected to negatively impact the number of small businesses formed in California going forward.
Though they still plan to collect back taxes, the FTB has decided to wait until the end of the tax year to send out more notices. In the meantime, small business owners are looking to the state legislature to take action to protect those who paid the taxes they owed under the law in effect at the time.
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