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Qualified Small Business Stock (QSBS) Gains – FAQs

October 7, 2013 update on QSBS gains

AB 1412 (Stats. 2013, ch. 546), signed by the Governor on October 4, 2013, retroactively allows the Qualified Small Business Stock (QSBS) deferral and 50 percent gain exclusion for tax years 2008 to 2012.

Although AB 1412 is effective January 1, 2014, FTB is providing the following information for taxpayers impacted by amendments made by AB 1412 to Revenue & Taxation Code Sections 18038.5, 18152.5, and 18153, Frank Cutler v. Franchise Tax Board, (2012) 208 Cal.App.4th 1247, or Franchise Tax Board Notice 2012-03.

Taxpayers who have not filed their 2012 tax return

IMPORTANT: We will publish revised 2008 to 2012 tax forms online starting in late January 2014. Use the instructions below if you file before we do this.

Taxpayers who are entitled to the retroactive QSBS provisions may claim the exclusion or deferral. To claim the exclusion or deferral for QSBS on Form 540 Schedule D, report the entire amount of gain from the sale of QSBS. Immediately underneath that line write “QSBS exclusion” and report the exclusion amount as a negative number (loss), or write “QSBS deferral” and report the deferral amount as a negative number (loss). Taxpayers claiming the exclusion should report 50 percent of the QSBS exclusion amount on Form 540 Schedule P, Line 10, Incentive stock options and California qualified stock options, as an alternative minimum tax (AMT) preference item.

Taxpayers who filed their 2008 – 2012 tax returns and were contacted by the FTB regarding their QSBS election

FTB will notify taxpayers of the following:

  • Pending Notices of Proposed Assessments based on the Cutler decision or FTB Notice 2012-3 will be withdrawn.
  • Closing letters will be mailed to taxpayers who signed a limited QSBS waiver for 2008.
  • Unpaid tax, interest, or penalty assessed as a result of the Cutler decision/FTB Notice 2012-3 will be abated.
  • Refunds for payments received related to the Cutler decision/FTB Notice 2012-3 will be issued. No action is needed by taxpayers to request refunds, unless they do not hear from the FTB by November 30, 2013. In these circumstances, taxpayers may contact the FTB at 916.845.3030.

Taxpayers who filed their 2008 – 2012 tax returns and did not claim the QSBS election may now do so

AB 1412 modifies the current QSBS statutes (Revenue and Taxation Code Section 18038.5, 18152.5) and eliminates the previous requirement that 80 percent of business activity occur in California during the holding period. However, the QSB must meet the 80 percent California payroll requirement at the time of acquisition for taxpayers to claim the 50 percent gain exclusion or deferral on an amended return (claim for refund) if the statute of limitations is open. Generally, the statute of limitations is four years from the date the return was filed (if filed within the extension period), or one year from the date of the overpayment, whichever is later. In addition, newly enacted Revenue and Taxation Code section 18135 allows taxpayers until June 30, 2014, to file a QSBS claim for refund for tax year 2008. See information entitled “Taxpayers who have not filed their 2012 return” above for instructions about how to claim the exclusion or deferral.

Amended returns should state in red “QSBS CLAIM FOR REFUND” at the top of the return, include the computed refund amount, and be mailed to the following address:

US Mail

Cutler Claim for Refund 347 MS F381
Franchise Tax Board
C/O FTB Notice 2012-03
P.O. Box 1779
Rancho Cordova, CA 95741-1779

Courier Service Delivery or Private Courier Mail:

Franchise Tax Board
Sacramento, CA 95827


FTB Notice 2012-3’s guidelines still apply to tax years 2007 and prior, with an open statute.

The governor signed Assembly Bill 1412 on October 4, 2013. This allows taxpayers to report QSBS exclusions and deferrals of gain for 2008-2012 tax years.

The information below is for historical purposes.

Background

Federal income tax law provides for the exclusion or deferral of gain from the sale or exchange of qualified small business stock (QSBS). Beginning in 1993, California adopted its own standalone QSBS provisions dealing with exclusions, which generally mirrored existing federal law. However, California law required that at least 80 percent of the company's payroll at the time the stock was purchased must be within California and 80 percent of assets and payroll must be within California during the taxpayer's holding period for the stock in order to qualify for a QSBS gain exclusion or deferral. In 1998, California adopted its own standalone QSBS provision dealing with deferrals.

The provisions in California law regarding the 80 percent asset and payroll requirements were found to be unconstitutional in August 2012 by the California Court of Appeal in Cutler v. Franchise Tax Board (FTB). 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. It is important to note that the court's decision in Cutler did not change the federal treatment of QSBS.

Because QSBS gain exclusions and deferrals are no longer valid for California purposes, taxpayers who previously took advantage of California's preferential treatment of QSBS in years still open for assessment under the four-year statute of limitations (generally 2008 and later) must now recompute their taxable income for each affected year without excluding or deferring gains from the disposition of QSBS. For 2007 (and prior) tax years still open under the statute of limitations, a QSBS gain exclusion or deferral will be allowed if the taxpayer meets all other requirements under California law, i.e., those other than the 80 percent asset and payroll requirements (See FTB Notice 2012-03).

FAQs

General | Interest and penalties | Audit, protest, and settlement issues | LLC issues | Payment issues

General questions


  1. Who does FTB Notice 2012-03 affect?

    This notice affects taxpayers who excluded or deferred gain from the sale of QSBS under California Revenue and Taxation Code (R&TC) Sections 18152.5 or 18038.5. If you claimed an exclusion or deferral for taxable years beginning January 1, 2008 or later, then those items must be corrected. For taxable years beginning prior to January 1, 2008, and earlier, some taxpayers may be entitled to file claims for refund.

  2. How does this impact my federal income tax return?

    Your federal QSBS exclusions and/or deferrals are not affected by the Cutler decision or FTB Notice 2012-03.

  3. What should I do now?

    For taxable years beginning January 1, 2008, or later, you should file amended tax returns for the years in which the exclusions or deferrals were reported. If you don't file amended tax returns, you can expect to be contacted by FTB. Also see interest and penalties FAQ 4 regarding the implications of interest suspension and a possible alternative to filing an amended return to report the corrections.

  4. What if I am contacted by FTB and believe I did not exclude or defer any QSBS gains?

    Review your returns and determine if you reported a QSBS gain exclusion or deferral. If there was no exclusion or deferral reported on your tax return, please contact us. We will review your return and take appropriate action.

  5. How did FTB determine the remedy?

    After the court found the statute was unconstitutional, the FTB carefully considered every administrative option possible. We found no lawful option for the FTB but to strike the provisions for tax years within the statute of limitations. The court found that the statute improperly discriminates against interstate commerce, which is a situation which must be remedied. The FTB has had to deal with statutes found to improperly discriminate against interstate commerce in the past and addressed such discrimination through a remedy which was substantially similar to the remedy described in Legal Notice 2012-03. The propriety of that remedy has been litigated and upheld by the California Court of Appeal.

    Legislative Intent is Clear and Cannot be Altered by Administrative Action – The Legislature’s creation of this tax benefit was intended to spur investment in California. The Legislature never intended to confer the QSBS benefits on all taxpayers, but rather clearly and unambiguously designed the provisions to favor investment in California businesses.

    Because the California Constitution expressly and exclusively vests the Legislature with lawmaking authority, modifying a legislative enactment so as to write a new law is beyond any administrative agency’s power, including the FTB’s.

  6. If FTB cannot change its remedy, who can relieve this unexpected tax burden?

    While the FTB has no discretion to administratively provide relief, the Legislature is not similarly constrained. The Legislature may wish to consider corrective actions to provide relief to adversely impacted taxpayers.

Interest and penalties


  1. Are there any penalties that I might be subject to as a result of the Cutler decision?

    Generally there will not be penalties assessed due to the correction of a reported gain exclusion or deferral relating to QSBS under the notice. However, if your original return was not filed timely, there may be a penalty for filing a delinquent return, which will be based on the additional tax due. Also see interest and penalties FAQ 5.

  2. Is there any interest due?

    Interest will accrue on a balance due as prescribed by California law. (See R&TC Section 19101.) The imposition of interest is mandatory, and FTB is not allowed to abate interest except where authorized by law (Appeal of Amy M. Yamachi, 77-SBE-095, June 28, 1977.).

  3. Would either interest abatement or suspension of interest be available?

    Generally neither interest abatement nor interest suspension will be available.

    Interest abatement — Under R&TC Section 19104, interest may be abated only in limited circumstances where a delay was caused by an unreasonable error or delay by FTB in performing a ministerial or managerial act. A change in law due to a California Court of Appeals decision is not a managerial or ministerial act by FTB.

    Interest suspension — Under R&TC Section 19116, interest may be suspended where a proposed deficiency notice is not issued within 36 months of the original due date of the return or the date the original or amended return was filed, whichever is later. FTB will automatically compute any applicable interest suspension amount on a proposed deficiency assessment. As explained below, because the due date of the 2008 return is more than 36 months ago, it may be to some taxpayers’ advantage for FTB to make the adjustment by Notice of Proposed Assessment (NPA) rather than by the taxpayer filing an amended return.

  4. If I claimed a QSBS exclusion or deferral on my 2008 California personal income tax return, and you have not yet contacted me, should I file an amended return, or wait for you to contact me?

    Because of the way the interest suspension rules under R&TC Section 19116 operate, if more than 36 months have elapsed since you timely filed your 2008 return, and you now file an amended return including the full amount of the gain previously excluded under R&TC Section 18152.5 or deferred under R&TC Section 18038.5, no interest suspension would be allowed by law.

    Instead, to qualify for interest suspension for 2008, you may compute the additional tax due (or contact us for help in computing the additional tax due) and pay this amount as a tax deposit without filing an amended return. The amount paid will be applied against the tax liability shown on the notice of proposed assessment (NPA) that we will issue for 2008. Interest suspension will then apply to the periods after the expiration of 36 months from the date the original return was filed and the date that the FTB issues its NPA (Note: Mandatory e-pay requirements may apply, see payment issues FAQ 2.).

  5. Assume a taxpayer sold QSBS in 2012 and planned to either claim the 50 percent gain exclusion or purchase replacement stock within 60 days in anticipation of electing the QSBS gain deferral. The gain was not included in the estimated tax computation for 2012. Will the penalty for underpayment of estimated tax apply?

    Yes. R&TC Section 19142(b)(1) only allows an exception to the estimated tax penalty when a change during the year is due to a provision of the law that is chaptered during the year. It does not apply to changes due to the application of court decisions.

Audit, protest, and settlement issues


  1. What if my tax return is currently under FTB audit or in protest for the QSBS issue?

    The auditor or hearing officer will resolve this issue as part of the audit or protest process in accordance with FTB Notice 2012-03.

  2. When will FTB issue proposed additional tax assessments on QSBS exclusions or
    deferrals? - Added February 28, 2013

    Notices of Proposed Assessment (NPAs) will be sent beginning in early April, 2013 and will continue to be issued before the applicable statute(s) of limitations expire.

  3. Can taxpayers request a waiver of the 2008 statute of limitations to postpone the issuance of an NPA? - Added February 28, 2013

    Yes. A waiver extends the time for FTB to issue an NPA, or for a taxpayer to receive a refund. Taxpayers can contact FTB to request a waiver to extend the expiration of the 2008 statute of limitations. Taxpayers interested in signing a waiver should contact the auditor on their letter (if they received one) or call FTB at 916.845.3030. If interest suspension applies, signing a waiver will extend the interest suspension period – see interest and penalties FAQ 3.

  4. If I disagree with FTB’s position on QSBS or the assessment of additional tax, can I protest or appeal the decision?

    Yes. The normal claim for refund, protest, and appeal time frames and procedures apply.

  5. How can I protest an NPA disallowing QSBS exclusions or deferrals? - Added February 28, 2013

    FTB has established procedures for taxpayers to easily protest the QSBS tax assessments. If you wish to protest the NPA:

    • Check the appropriate box on the notice.
    • Sign and date in the space provided.
    • Mail or fax a copy to the address or phone number given on the notice.

    You do not need to send additional documentation at this time.

  6. When protesting a proposed QSBS tax assessment, can a taxpayer request FTB to defer action on the protest pending 2013 legislative action that may impact the QSBS proposed assessment? - Added February 28, 2013

    Yes. The protest procedures include an option to request that the protest be held pending legislative action. Interest will continue to accrue during the deferral and any subsequent action on the protest, until payment is received.

  7. I had a QSBS audit that was resolved through FTB’s formal Settlement Program. Am I still subject to additional tax?

    No. The settlement resolves the issue for the tax year. No further action is required nor will any further action be taken by FTB.

  8. I was previously audited by FTB. Do I need to file an amended return for the QSBS issue or expect to be contacted by FTB with respect to the QSBS issue?

    While the FTB typically does not reopen an audit for a tax year after an audit has been completed, we will be issuing notices to taxpayers who claimed this exclusion or deferral for taxable years beginning on or after January 1, 2008, since the Cutler decision represented a "change of law."

LLC issues


  1. If an LLC now has higher total income because of the elimination of the QSBS benefits, will the LLC fee increase because of the reported sale?

    Yes, but only if the adjustment increases the total income of the LLC so as to require a higher LLC fee.

  2. Will the 10 percent LLC estimated fee penalty apply if the prior year exception is not met by virtue of including the QSBS gain under the Notice?

    Yes. Under R&TC Section 17942(d)(2), there is no provision in the law, which permits waiver of the LLC fee penalty.

Payment issues


  1. I am currently making installment payments for tax years prior to 2008. Can I file a claim for refund for those years?

    Yes, but the refund may be limited to recovery of payments made within one year of the date of filing the claim.

  2. If I am a mandatory e-pay taxpayer, do I have to e-pay a tax liability from an amended tax return?

    Yes. In order for your payment to be properly processed, you must check the "tax deposit" box. Please attach a copy of the e-pay receipt to the amended tax return.

  3. What if I cannot pay the tax?

    There are payment arrangements available. See payment options.

  4. If I need to make installment payments because of the Cutler decision, will FTB waive the payment arrangement fee?

    Currently, there is no provision in the law to waive the fees based on a situation like the Cutler decision.

Contact Us

For additional information, call us at 800.852.5711, weekdays, 7 a.m. to 5 p.m., except state holidays or email us at qsbs@ftb.ca.gov.