Policy

California’s $120 Million Retroactive Tax Saga Winds Down


California’s $120 Million Retroactive Tax Saga Winds Down

Photograph by David Ryle/Gallery Stock

It’s been a long, strange trip for California business owners and investors who face millions in back taxes after a 20-year-old tax exemption was struck down by an appeals court last year.

Since 1993, California law halved capital-gains taxes due on sales of stock in businesses with less than $50 million in gross assets, so long as the business kept at least 80 percent of payroll costs and assets in the state. In August 2012 the tax exemption was ruled unconstitutional on the grounds that it interfered with interstate commerce. Before long, the state’s Franchise Tax Board was signaling plans to collect retroactive taxes dating back to 2008 from more than 2,000 business owners. The expected take: $120 million.

Entrepreneurs pushed back, enlisting state lawmakers to seek a legislative solution. In February state tax collectors offered to hold off on sending out tax bills, as long as affected business owners signed waivers extending the statute of limitations. Meanwhile, the state Senate took up the issue, eventually passing a bill that reduced the total amount of retroactive tax due by 76 percent.

That number represented a compromise, says Brian Overstreet, a Santa Rosa (Calif.)-based software entrepreneur who has helped lead efforts to reverse the retroactive tax. Avoiding back taxes means expanding the scope of the original exemption. “That puts the state in the position of potentially having to issue refunds,” he says. So lawmakers proposed collecting some back taxes to pay for potential returns.

Now, the adventure appears to be winding down. California’s legislative session ends tomorrow, and the state Assembly is expected to approve two bills: One lets business owners entirely off the hook for back taxes, and the other would spare them from 76 percent of the expected cost. If all goes as planned, the legislature will send both bills to Governor Jerry Brown and let him decide.

Of course, there’s a third option: Brown could sign neither bill and let the retroactive tax take effect. “That would give people one more reason to look elsewhere before they start a business” in California, Overstreet says.

Clark is a reporter for Bloomberg Businessweek covering small business and entrepreneurship.

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