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Qualified Small Business Stock (QSBS) and Cutler v. Franchise Tax Board

Purpose of Bulletin

To inform staff of FTB Notice 2012-03 regarding Qualified Small Business Stock (QSBS) and a recent court decision.

Background

Federal law provides for the exclusion or deferral of gain from the sale or exchange of QSBS. California adopted QSBS provisions in 1993, which generally mirrored existing federal law. However, California law required that at least 80 percent of a company’s assets and payroll are within California in order to qualify for a QSBS gain exclusion or deferral.

The provisions in California law regarding the 80 percent asset and payroll requirements were found to be unconstitutional by the California Court of Appeal in Cutler v. Franchise Tax Board. The court’s decision made California’s entire QSBS statute invalid and unenforceable. As a result, all QSBS gain exclusions and deferrals previously allowed under California law became invalid.

Taxpayer Inquiries

Taxpayers who previously took advantage of California’s treatment of QSBS in years still open for assessment under the four year statute of limitations rule (generally 2008 and later) must now recompute their taxable income for each affected year and file amended returns or file claims for refund without excluding or deferring gains from the disposition of QSBS.

For 2007 and prior tax years that are still open under the statute of limitations, a QSBS gain exclusion or deferral will be allowed if the taxpayer meets all requirements under California law, other than the unconstitutional California property and payroll requirements.

Additional Information

For additional information, taxpayers can go to ftb.ca.gov, and search for QSBS, or call us at 800.852.5711, weekdays, 7 a.m. to 5 p.m., except state holidays.