California’s Attempt to Retroactively Tax its Residents


In Cutler v. Franchise Tax Board, a case litigated by Reed Smith, a California Court of Appeal held that the California property and payroll requirements of California’s Qualified Small Business Stock provisions were invalid. These provisions provided a tax deferral or partial exclusion to investors if the companies they invested in had substantially all (80 percent) of their assets and employee costs in California. The court struck down this requirement because it violated the Commerce Clause of the U.S. Constitution.

In response to the court’s decision, the Franchise Tax Board (FTB) staff erroneously declared that the entire gain-deferral statute was invalidated—even the parts that were not unconstitutional. What’s worse, in an action that’s legally questionable and unquestionably bad policy, the FTB declared that it would retroactively tax investors who previously benefited from the Qualified Small Business Stock deferral provisions.*

California is the world leader in startup businesses, but losing this tax incentive would drive more businesses out of the state. Now, rather than expanding this benefit to keep California competitive, investors are receiving notices from the FTB stating that they owe additional taxes, plus interest going back to 2008.

Our lawyers have formed a coalition to reverse the FTB staff’s decision imposing retroactive taxes on California residents, in connection with the California property and payroll requirements of California’s Qualified Small Business Stock incentives. We are pursuing all available means—legislative, administrative and judicial—to overturn the aggressive FTB staff position, and are working to achieve an implementation of the Cutler decision that is sound from both a legal and a policy perspective (

Join Reed Smith February 12, for a teleseminar to discuss the Cutler decision and FTB actions, and their impact on California investors. The teleseminar will also be a call to action for all California taxpayers receiving wrongful assessments from the FTB. Register here.

For more information on the Cutler case or to join our pursuit, click here, or contact Marty Dakessian at 213 457 8310 or at  

About Reed Smith State Tax

Reed Smith’s state and local tax practice is comprised of lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues. Click here to view our State Tax team.

* FTB Notice No. 2012-03 (12/21/12).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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