Small businesses got a bit of hope this past week as Governor Brown signed two bills, Senate Bill 209 (Lieu) and Assembly Bill 1412 (Bocanegra) to ensure that interest and penalties will not be assessed retroactively against taxpayers who complied in good faith with existing tax law when that law was later declared unconstitutional by a court.
Here’s a brief history lesson to explain why these two bills were desperately needed:
In August of 2012, a California Court of Appeal overturned a state law that provided a tax deferral or partial exclusion on returns to investors in certain qualified small businesses that had 80% or more of their assets and payroll in California (Cutler v. Franchise Tax Board). This law was passed to encourage investment in California-based small businesses, but the court ruled that it violated the Commerce Clause of the U.S. Constitution by treating California businesses differently. While these types of exclusions for investments in small business are allowed under federal law, the state went too far in only allowing them for small businesses based at least 80% in-state.
Consequently, the Franchise Tax Board (FTB) unilaterally declared that the Qualified Small Business Stock (QSBS) statutes were invalid in their entirety, instead of merely striking out the 80% requirement. Rather than simply granting the exclusion to all small business investors, the FTB instead chose to generate more revenue. The FTB announced that it would penalize taxpayers after the fact for previously legal actions by issuing notices of public assessment (NPAs) to retroactively assess taxes on all investors who previously benefitted from the QSBS. To make matters worse, FTB decided to apply interest on the claims, adding insult to injury in what cannot be described as anything other than blatant state money grab from small business. Though the court did order FTB to fix the problem, it did not order them to retroactively collect penalties.
Senator Ted Lieu introduced SB 209 to fix this problem by retroactively amending the exclusion to apply to anyone who invested in a qualified California small business, whether or not they remained here. The bill also eliminated all penalties and interest. Assembly Member Raul Bocanegra built upon this much-needed relief by introducing AB 1412, which had the same fix as SB 209, but kept the entire original 50% exclusion intact. Now, thanks to these two critically important bills and the Governor’s swift action in making them law, taxpayers will not be forced to forfeit money after the fact.
Small business owners and all taxpayers should be able to trust their government when acting in good faith. They shouldn’t be penalized when the rules are changed mid-game. Small businesses in California already face a mountain of uncertainty as they strive to create jobs, build the economy, and keep their doors open. Both of these bills are critical in restoring confidence and hope to our leading job creators.