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California small business owners face end of partial capital gains exclusion

The word "taxes" is a very general one. In practice, there are many different types of taxes. In part, this is because there are so many levels of government: not only federal, but also state and local. It therefore isn't only the decisions of the IRS that can loom large over taxpayers. In California, the decisions of the Franchise Tax Board can do so as well.

This is definitely the case with a recent decision of the board that will greatly affect small business owners. The board has not only ended an income tax exclusion for those taxpayers on capital gains. It has also specified that the capital gains tax will be reinstated in a retroactive manner.

As a result of this decision, some small business owners may face tax bills for amounts that go all the way to 2008 - plus interest on the unpaid taxes.

Why the change?

The presence of a partial California state income tax exclusion for stock sales of certain small businesses dates back twenty years to 1993. The goal of the exclusion was to provide an incentive to business development in California by cutting in half the regular tax rate when a "qualified" business is sold. This would allow founders of new businesses to keep more of what they made upon selling the business.

In December 2012, however, the California Franchise Tax Board (FTB) ruled that the partial exclusion would no longer apply. The full tax rate is supposed to apply now to capital gains from the sale of an applicable business. In addition, the board intends to retroactively bill taxpayers who used the exclusion, dating back to 2008.

Understandably, entrepreneurs and advocates for the small business community are very concerned about the ruling. According to the FTB, it could affect more than 2,500 people. The FTB is seeking to obtain in the vicinity of $120 million in revenue by ending the income exclusion.

Source: "The California tax that terrifies tech," CNN Money, 2-21-13

Our firm handles situations similar to those discussed in this post. To learn more about our practice, please visit our California tax litigation page.

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