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California's Surreal Retroactive Tax On Tech Startup Investors 514

Posted by timothy
from the do-not-pass-go-remit-$200 dept.
waderoush writes "Engineers and hackers don't think much about tax policy, but there's a bizarre development in California that they should know about, since it could reduce the pool of angel-investment money available for tech startups. Under a tax break available since the 1990s, startup founders and other investors in California were allowed to exclude or defer their gains when they sold stock in California-based small businesses. Last year, a California appeals court ruled that the tax break was unconstitutional, since it discriminated against investors in out-of-state companies. Now the Franchise Tax Board, California's version of the IRS, has issued a notice saying how it intends to implement the ruling — and it's a doozie. Not only is the tax break gone, but anyone who claimed an exclusion or deferral on the sale of small-business stock since 2008 is about to get a big retroactive tax bill. Investors, entrepreneurs, and even the plaintiffs in the original lawsuit are up in arms about the FTB's notice, saying that it goes beyond the court's intent and that it will drive investors out of the state. This Xconomy article takes an in-depth look at the history of the court case, the FTB's ruling, and the reaction in the technology and investing communities."
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California's Surreal Retroactive Tax On Tech Startup Investors

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  • That's unpossible! /looks at "Fire Prevention Fee" bill

  • And you expected something else from a state run by "progressives"? They never have enough of other people's money!

    • by Xeranar (2029624) on Thursday January 24, 2013 @07:10PM (#42685093)

      Ironically in this case it was a tax break created by progressives that was ruled unconstitutional. So your joke/stupid remark falls flat. Really this is a situation where large investors are taking it on the nose. As a progressive liberal I'm actually not OK with charging them retroactively unless this was acknowledged as up for debate previously and even then it should be executed without penalties.

      Cash grab or otherwise this is more or less an administrative issue to be rectified amongst the elite.

    • Which is why generally Blue states pay out more in federal taxes than they take in, and Red states take in more federal funds than they pay in taxes?

      http://en.wikipedia.org/wiki/Federal_taxation_and_spending_by_state
  • "Surreal"? (Score:5, Insightful)

    by MrEricSir (398214) on Thursday January 24, 2013 @06:44PM (#42684827) Homepage

    Retroactive taxes aren't particularly surreal. An example of surreal taxes would be if you had to submit your check to a giant who was growing out of the floor in a building that's melting.

    So let's use the word correctly, please.

  • by eksith (2776419) on Thursday January 24, 2013 @06:44PM (#42684833) Homepage

    People have been up in arms over ex post facto law, so why do they think they can get away with taxes? Granted, not all retroactive laws are unconstitutional. The tax law shouldn't have been in the books in the first place if it was unconstitutional, but we're not talking slavery here. Repeal the law, if you must, and call it even.

    This is just a sad attempt at increasing state revenue

    • People have been up in arms over ex post facto law, so why do they think they can get away with taxes? Granted, not all retroactive laws are unconstitutional.

      And this isn't a retroactive law, its the implementation of the decision that an existing statute providing a tax break, to quote the court decision, "can not stand under the commerce clause".

      • by sjames (1099) on Thursday January 24, 2013 @07:21PM (#42685173) Homepage

        But it DOES create a tax liability that people had no reson to expect at the time it was (retroactively) incurred. So it is an ex post facto tax and it is unfair for the same reason an ex post facto law is.

        In a sense, it is an ex post facto law because it creates a legal obligation for actions in the past that did not carry such an obligation at the time.

        Otherwise, we accept that it is somehow Constitutionally OK to roll back a law that invalidated another law and so create a crime in the past where there was not one at the time (which is exactly when the prohibition on ex post facto laws is meant to prevent).

        • But it DOES create a tax liability that people had no reson to expect at the time it was (retroactively) incurred. So it is an ex post facto tax and it is unfair for the same reason an ex post facto law is.

          An ex post facto tax can't be "unfair for the same reason an ex post facto law" is, because the principle invalidating ex post facto laws is intimately tied to the punitive nature of criminal law and the kind of penalties associated with criminal offenses.

          In a sense, it is an ex post facto law because i

          • by afidel (530433)

            An ex post facto tax can't be "unfair for the same reason an ex post facto law" is, because the principle invalidating ex post facto laws is intimately tied to the punitive nature of criminal law and the kind of penalties associated with criminal offenses.

            Sure they can, let's say you cashed out of your small business investment in the spring of 2008, and reinvested it into the broader market (portfolio diversification, a very sound practice for a small business investor who has realized a gain), well in the

          • by sjames (1099)

            No, it is more broadly attached to the idea that it is patently unfair to change the rules once the play is in motion. More broadly, it is summed up as "no take backs".

            If you want to look at it another way, at the time of the transactions, the tax LAW said no tax was owed. Now, ex post facto, the tax LAW says the tax was owed.

            If they would like to ask for voluntary contributions, they are free to change the tax SUGGESTION all they want.

    • by Dahamma (304068) on Thursday January 24, 2013 @06:57PM (#42684949)

      A law wasn't passed ex post facto and wasn't applied retroactively. A law passed years ago was declared unconstitutional, and the FTB is now making people re-file their taxes without its benefit.

      I don't agree with the ruling, either, but if you are going to throw around all of those legal terms make sure they are used correctly...

      • by sjames (1099)

        The body of law was changed ex post facto by expanding a portion of it after the fact to cover a situation that was not covered at the time.

        If I don't not kill someone, I have still committed murder.

    • by ZombieBraintrust (1685608) on Thursday January 24, 2013 @07:02PM (#42685019)
      This isn't a retroactive law. This is invalidation of a law by a court. California basically created a tarrif to promote local buisnesses. States are not allow to create terrifs. California had two options. They could send money to every out of state buisness that was damage by the tarrif. Or they could undo the benifit the in state buisnesses recieved. California is broke so they did the second thing.
  • How far back are they permitted to go? What stops them from going back 20 years or more? I would think there would be some ex post facto equivalent for civil issues.

    • by Artraze (600366)

      My guess would be that it has to do with a statute of limitations...

      Apparently California has a limit of four years from the filing date to collect any unpaid taxes. So I would conclude that the FTB's logic here is that, because the tax break was unconstitutional, these people should have known that(?) and their returns were all filed incorrectly. Thus, the FTB can collect the last four years of these back taxes because the deductions that were claimed weren't valid.

      It's adorable the logic governments use

    • How far back are they permitted to go? What stops them from going back 20 years or more?

      They are going back exactly as far as they are allowed (and, in FTB's view, required) to go, applying the invalidation of the statute providing the tax break to all tax years for which the statute of limitations for tax collection has not expired.

      I would think there would be some ex post facto equivalent for civil issues.

      There isn't, really, because the reason for the prohibition of ex post facto laws -- which appli

  • I can't believe how any freedom-loving country can permit retroactive anything.

    How can anyone plan anything when the threat of a retroactive change takes place?

    • country can permit retroactive anything.

      You buy a slave legally. Country decides that is unconstitutional and decides all slaves must be free - retroactively.

      Maybe some retroactive decisions are good.

      • by gl4ss (559668)

        country can permit retroactive anything.

        You buy a slave legally. Country decides that is unconstitutional and decides all slaves must be free - retroactively.

        Maybe some retroactive decisions are good.

        that's not really retroactive. it's not like slave owners were forced to retroactively pay proper working mans wages to the slaves when they were freed...
        there's nothing retroactive about ending someones contract at a certain point in time. it just ends there and then.

        now, punishing concentration camp guards.. that's sort of retroactive, deciding their job was illegal after they had been at it for years.

        this retroactive tax sort of assumes that rich are still rich, though it might be true in most cases who

      • by Intropy (2009018)

        That merely freed them in the future. Had they been freed retroactively anyone who owned a slave within the previous years could have been imprisoned for kidnapping.

        Still, some retroactive decisions are good. I don't think this tax collection is one of them, though I do agree with the court's ruling.

  • "Deferred"? (Score:3, Interesting)

    by 14erCleaner (745600) <FourteenerCleaner@yahoo.com> on Thursday January 24, 2013 @06:52PM (#42684905) Homepage Journal
    If the tax is truly just deferred, then it's not "retroactive".

    Besides, it's only $150 million. A drop in the bucket, relative to the tech industry as a whole.

  • Ex post facto? (Score:5, Interesting)

    by fyngyrz (762201) on Thursday January 24, 2013 @06:52PM (#42684907) Homepage Journal

    So. Does this make a crime of not paying taxes out of a situation where it was not a crime?

    If so, it would seem to be ex post facto:

    1st. Every law that makes an action done before the passing of the law, and which was innocent when done, criminal; and punishes such action.

    2d. Every law that aggravates a crime, or makes it greater than it was, when committed.

    3d. Every law that changes the punishment, and inflicts a greater punishment, than the law annexed to the crime, when committed.

    4th. Every law that alters the legal rules of evidence, and receives less, or different, testimony, than the law required at the time of the commission of the offense, in order to convict the offender.

    Seems to me they should just not pay, because there's no legal way to punish them for not paying.

    Not that the supreme court has actually paid that much attention to ex post facto violations on either the federal or state level... real bunch of pants-shittingly stupid people in SCOTUS lately...

    • 1st. Every law that makes an action done before the passing of the law, and which was innocent when done, criminal; and punishes such action.

      Key words your ignoring: law, passing, and criminal. No law was passed. Instead a court invalidated a law. Thus when the people doing the action, they were not innocent. Second ex post facto only applies to criminal law. No tax payer is going to jail over this.

  • Hey let's push the state into exempting out of state companies so we can get the exemption too. Oh crap, we just screwed it up for everyone and wasted millions in legal fees for a ruling that will get us nothing. Who could have ever guessed California would take the money grab option?

  • by mmell (832646) <mike.mell@gmail.com> on Thursday January 24, 2013 @07:04PM (#42685027)
    I was taught (wa-a-a-y back in high school) that US laws couldn't be made retroactive. The case I heard about as an example was a guy who pissed in an unattended police vehicle. Turns out there wasn't a law against public urination and somehow this guy's lawyer convinced a judge that an unattended police car in an alley represented public property. The town this happened in passed a law PDQ, but couldn't apply that law to the fellow who triggered its inception.

    Oh, wait. This is TAX law. The IRS can do pretty much anything they want; even the state IRS.

    • I was taught (wa-a-a-y back in high school) that US laws couldn't be made retroactive.

      No low is being made retroactive.

      An old law is being declared unconstitutional, and therefore all the benefits and penalties under the old law were invalid in the first place.

  • by Marble68 (746305) on Thursday January 24, 2013 @07:05PM (#42685047) Homepage

    Ex post facto laws are expressly forbidden by the United States Constitution in Article 1, Section 9, Clause 3.

    People will sue - and this will go to federal courts... The question is will it make it to SCOTUS.

    • by gander666 (723553) *
      That seems to be a limit on congress. Does that apply to states? (just asking, my civic class was more than 30 years ago)
      • That seems to be a limit on congress. Does that apply to states?

        14th Amendment would have made it applicable to the individual States, even assuming CA didn't have such a provision in its own Constitution (which it does, Article 1, Section 9).

    • Ex post facto laws are expressly forbidden by the United States Constitution in Article 1, Section 9, Clause 3.

      So, where's the ex post facto law in this case?

      While I consider CA's behaviour slightly sleazy (though predictable), I can't see anything unconstitutional here.

  • As a Californian (Score:2, Interesting)

    by Spy Handler (822350)

    I am ashamed of my state government and the populace that elected it. As soon as I have enough money to be worthy of Franchise Tax Board's notice, I'm fleeing to a free state.

    • by Nimey (114278)

      Just like all those people who threaten to flee to Canada if an election doesn't go their way, right?

      Pfft.

      • Re:As a Californian (Score:4, Interesting)

        by Spy Handler (822350) on Thursday January 24, 2013 @07:57PM (#42685517) Homepage Journal

        no, my flight from California will have been motivated by economic reasons rather than ideological.

        My mother owns commercial real estate (a small strip mall) and she's been sued three times in the past three months by handicapped people under California ADA provisions. That's like... once a month.

        First two have been settled for $2500 and $3200, third suit is pending.

        Why did she get sued? First one was, the handicapped parking spot didn't have the words "Van Accessible" in the correct sized font. Second one, the towel rack/grab rail in the bathroom was 2 inches too high.

  • by AlienSexist (686923) on Thursday January 24, 2013 @07:10PM (#42685095)
    California (and New York) are hemorrhaging population and business. Often (but not only) heading to Texas according to numerous articles and analysis [manhattan-institute.org] over the past year as well as the last census.

    Texas appears to be the largest recipient of the migrations but so are Arizona and Florida. Coincidentally Texas was also named the 2012 Top State [yahoo.com] for business. Every few weeks I see more and more business headlines of companies (namely tech) moving to or starting a branch in Texas such as Apple [wired.com], Facebook [statesman.com], PayPal [austinnovation.com], Catepillar [msn.com] and so on

    There had been, however, some controversy over the years of TX Gov Perry's use of the Texas Enterprise Fund to woo companies to relocate. While the deal-landing results appear to be evident, some worry about the taxpayer cost, total incentive packages, and net gain of these deals. The fund seems to be perfectly suited to situations like this, where California tax laws cause some turmoil thereby increasing the opportunity to woo away industry. Recently Texas AG Greg Abbott has also been advertising to New Yorkers to move to Texas on account of gun control issues.

    I wonder how long Texas can remain "Texas" if it becomes stuffed with people who are accustomed to living like Californians and New Yorkers.
    • Re: (Score:2, Informative)

      by Darkness404 (1287218)
      And once the federal government starts making the entire country more business-unfriendly than it already is, expect to see massive off-shoring. Indeed if you were to start up a new online company and could base it anywhere in the world, the US and western Europe would be the last place where I'd host it.
    • by Maudib (223520)

      NYC has been gaining in population and business formation. Upstate is in decline, but whatever.

  • by PPH (736903)

    I'm moving to France!

  • by Iconoc (2646179) on Thursday January 24, 2013 @07:14PM (#42685135)
    Elections have consequences.
  • What is unconstitutional about a state providing state tax incentives for its residents to invest in companies within that state? There is no interstate commerce going on there. I know the federal government thinks absolutely everything is interstate commerce, but it doesn't make it true. It's allowing the federal government to regulate the tax policy of a state.
  • This is why most of the West is doomed. Why the hell would anyone start up a business in California if they pull stunts like this? Indeed, if you've got an online business with no geographical boundaries, why even host it in the US/Europe? Why not host it in a country that actually -wants- productive citizens?

    In economic terms, a tax is basically a government's way of saying, "we don't want you to do that". An income tax is basically saying, we don't want you to work. A payroll tax is basically saying,
    • Re:This is why... (Score:5, Insightful)

      by Todd Knarr (15451) on Thursday January 24, 2013 @07:50PM (#42685459) Homepage

      As an employee, why would I want to work in states like Texas or Arizona that provide much less in the way of protections for workers? One of the reasons I like working in California is the laws that give me some leverage when dealing with employers, and protections and safety nets when said employer folds due to dumb decisions by management.

      And as an employer, why would I want to set up business in a state where my pool of workers is limited to the kind who all they have to offer is their willingness to accept that lack of protection? One of the reasons tech companies locate in California is that that's where the people they need/want to hire are. If I set up business in Texas or Arizona, I do so knowing that the best employees, the ones I'd most want to have, aren't going to be willing to relocate there. I can't see that being a winning strategy long-term.

      • Because life is about risk and reward. Do I want to live in a nanny-state where people try to ban toys in happy meals? Where the cost of living is so high that you could make $100,000 a year and only live in a crappy apartment? Do I really need all these "protections" for workers? Or am I smart enough to always be learning and adopt a mind of an independent contractor and not a slave?
  • Nashville welcomes you with open arms.
  • The Opinion (Score:5, Informative)

    by jklovanc (1603149) on Thursday January 24, 2013 @08:00PM (#42685535)

    Here is the relevant part from the Appeal Court opinion:

    Plaintiff asks us to hold that a refund is the only proper remedy in this case, under the authority of McKesson Corp. v. Florida Alcohol & Tobacco Div. (1990) 496 U.S. 18 [110 L. Ed. 2d 17, 110 S. Ct. 2238] (McKesson). In McKesson, the high court held that “[i]f a State places a taxpayer under duress promptly to pay a tax when due and relegates him to a postpayment refund action in which he can challenge the tax's legality, the Due Process Clause of the Fourteenth Amendment obligates the State to provide meaningful backward-looking relief to rectify any unconstitutional deprivation.” (McKesson, supra, 496 U.S. at p. 31, fn. omitted.) McKesson identified three ways to provide the “‘clear and certain remedy’” required for an unlawful tax collection. (Id. at p. 39.) These were (1) “refunding to petitioner the difference between the tax it paid and the tax it would have been assessed were it extended the same rate reductions that its competitors actually received”; (2) “assess[ing] and collect[ing] back taxes from petitioner's competitors who benefited from the rate reductions during the contested tax period”; and (3) “a combination of a partial refund to petitioner and a partial retroactive assessment of tax increases on favored competitors, so long as the resultant tax actually assessed during the contested tax period reflects a scheme that does not discriminate against interstate commerce .” (Id. at pp. 40–41.) In this case the statute of limitations prevents the state from collecting additional taxes from other taxpayers who benefited from the unconstitutional deferral provision.

    Under this portion of the opinion the Franchise Tax Board can not do nothing. They are required by this opinion to level the playing field. The Franchise Tax Board has three options;
    1. Refund the tax to him and every other other person that was denied or didn't file because they did not qualify.
    2. Retroactively tax everyone
    3. A combination of partial refunds and partial taxes opening up even more litigation.

    Option 1 is bad because the state could loose a lot of revenue. Option 3 is bad because the state loses revenue and spends more on litigation. Option 2 is viable as it already falls under the process of filing and adjusted tax return. By requiring the Board to level the playing field the court threw a wrench in the works.

  • by LVSlushdat (854194) on Thursday January 24, 2013 @08:43PM (#42685969)

    This kind of shit is soooo FAR beyond merely shooting yourself in the foot, its more like pointing a gun at your foot, letting loose one round, blowing half your foot off, then blithly taking the gun, shooting the rest of the original foot off, taking a morphene shot to kill the pain, then turning the gun on your other foot, and doing the same thing again.. The old MontyPython skit with the guy getting his limbs shot off and continuing to taunt his attacker is kind of appropriate for California.. To keep ratcheting down on business like they're doing will ONLY work in a *completely* totalitarian country, one that includes barbed wire fences on the borders, landmines, tank traps, reminicient of the old "Iron Curtain".. When a business can weigh the pros-cons of staying/leaving and decides to pack it up and head for one of the states that are welcoming business, like Texas, f'instance, with no chance of being shot while going over the fence, the "geniuses" in Sacramento can only sit back and watch their tax-base leave the state.
    Of course, in the world that the California liberal bureaucrat lives in, they never see this.. Up until the reality of the situation jumps up and bites them on the ass.. namely when they have 20+ million mouths on the government feed trough and ZERO tax-paying businesses.. I was born in California many moons ago, in what is now "liberal-ville", better known as the "City By The Bay"... such a lovely town, gone to hell by the Nancy Pelosi-liberals.. The wife and I saw the handwriting on the wall back in the mid 90s and moved to Las Vegas Nevada.. Best move we ever made.. With that, we had to fight with the State Franchise Tax Board for nearly 3 years after moving to prove to them we no longer had any income from the State.. It finally took a tax attorney to rattle their cage and get their b.s. stopped. I hate to think about ALL the hassle any business will get today when they move out of California... My thoughts are with them...

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