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California's Surreal Retroactive Tax On Tech Startup Investors 514

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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  • Re:California (Score:2, Informative)

    by Shaterri ( 253660 ) on Thursday January 24, 2013 @07:00PM (#42684987)

    I'm not going to argue with 'severely over budget' (thank you, Prop 13) but the last information available for California suggests that federal spending in the state was substantially less (by roughly 25%) than federal revenues from the state; California is, on a per-capita basis and certainly on an overall basis, one of the largest net givers to the federal budget, not a taker. Do you have any specific reason to believe that that's changed in the last few years?

  • Re:California (Score:4, Informative)

    by DragonWriter ( 970822 ) on Thursday January 24, 2013 @07:01PM (#42685003)

    In other news, much of the national deficit is due to this pathetically disorganized, in the red, severely overbudget, bloated state.

    California is net contributor to the federal budget, so a negative percentage of the federal budget deficit is due to California. Leaving aside the other inaccuracies in that sentence.

  • 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.
  • 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.

  • Re:California (Score:3, Informative)

    by hguorbray ( 967940 ) on Thursday January 24, 2013 @07:09PM (#42685077)
    nice try -thanks to Governor Moonbeam, er Brown, the state is projected to break even this year after years of deficits.

    and like most Blue States, we pay more $ to the Feds than we get back in Benefits

    as does Minnesota.

    You don't have to live here, but we like it quite a bit.

    -I'm just sayin'
  • Re:California (Score:5, Informative)

    by ZombieBraintrust ( 1685608 ) on Thursday January 24, 2013 @07:09PM (#42685081)
    Californians pay more in federal taxes than they recieve from the federal goverment. The following map shows Federal Taxes minus spending on a state by state basis. []
    Texas and Minnesota both pay more taxes than they recieve. The biggest debtor state in the union is Virginia.
  • by Darkness404 ( 1287218 ) on Thursday January 24, 2013 @07:21PM (#42685181)
    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 Anonymous Coward on Thursday January 24, 2013 @07:23PM (#42685197)

    Texas has textbooks with mandated Christianity in them, pretty sure teaching the bible as fact ruins your education argument. That's one. Business climate is a toss up as Texas really isn't good at innovation, but it's really good for companies looking to cut costs by lowering how much they pay their workers. Infrastructure is the same, Texas has been working for a while to tackle it's serious traffic problems in the cities, taxes are lower sure, but in Texas you're on your own if something bad happens, which isn't as true in California. Really, not a great comparison either since California has been top of the food chain far longer than Texas. texas really couldn't survive without the government money it receives from the military, no necesarrily true of California.

  • 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.

  • Re:Obama effect (Score:4, Informative)

    by craigminah ( 1885846 ) on Thursday January 24, 2013 @08:03PM (#42685573)
    Owning a firearm is a right guaranteed under the Second Amendment. Call them "nuts" if it makes you feel better but the second you say it's OK to restrict one's gun rights they'll be restricting all your rights. I know this is a repost, but it's very relevant to my point (feel free to replace who "they're" coming for with items from our Bill of Rights):

    When the Nazis came for the communists,I remained silent;I was not a communist.
    When they locked up the social democrats,I remained silent;I was not a social democrat.
    When they came for the trade unionists,I did not speak out;I was not a trade unionist.
    When they came for the Jews,I remained silent;I wasn't a Jew.
    When they came for me, there was no one left to speak out.
  • Re:California (Score:4, Informative)

    by jfengel ( 409917 ) on Thursday January 24, 2013 @08:05PM (#42685591) Homepage Journal

    Virginia (and Maryland, the second biggest net recipient) are a little different from other states, in terms of this comparison. A lot of that money isn't state grants or welfare checks or other federal largesse. That's money spent on federal employees and facilities that were located outside DC. The Pentagon, for example, is just over the river in Arlington. These are facilities that need to be kinda close to DC, but don't really need to be right on top of the White House.

    The states definitely benefit from it. If the government were to pack up and move, the DC metro area would become a ghost town, and the whole economy would change. But it's not just a subsidy or pork-barrel make-work projects; it's the government actually doing what it does. MD and VA don't get that because of power. It's just geography.

  • by gazuga ( 128955 ) on Thursday January 24, 2013 @09:56PM (#42686725) Homepage

    Is Austin some Green paradise where everybody lives close to their work and the roads are clear? Nobody works downtown? How does a rail line like that fail so badly?

    Hah, quite the opposite. Traffic here is terrible. We've been the fastest growing area in the nation for a few years now, so things will only get worse. The biggest problem is that all of our major thoroughfares (at least in Austin proper) were built in such a way that it will be extremely difficult to expand them. Unfortunately that's meant that we've had toll roads crammed down our throats. Several pre-existing highways have been converted, with more slated to be converted over the next few years. In theory that should mean mass transit should be a great option, and I think that's why the city has chosen to take this route. In practice, however, it's not at all convenient to use public transport. Though extensive, the bus system is highly inefficient. Count on an hour bus ride to get somewhere when you could drive yourself in 30 minutes, or maybe less. Light rail could be better since it can bypass the traffic altogether, but it really only connects 2 main points in the city, and you have to use the bus from there.

    It's a bit of a chicken and egg problem: until they expand the number of routes for light rail, it's going to be of limited use. To be fair, the line was just completed a year or two ago and they do have plans to expand. However, expanding the routes is so expensive, its a tough pill to swallow when you see a train go by with only a couple of people onboard.

Never worry about theory as long as the machinery does what it's supposed to do. -- R. A. Heinlein