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Tax Bulletin (February 2013)

Qualified Small Business
Stock Developments

By Breann E. Robowski, a tax associate in the Palo Alto office of Pillsbury Winthrop Shaw Pittman LLP, and Kerne H. O. Matsubara and Brian Wainwright, tax partners in the firm's San Francisco and Palo Alto offices.

If you have or can obtain the Acrobat Reader, or have an Acrobat-enabled web browser, you may wish to download or view our February 2013 Tax Bulletin (a 137K pdf file), containing a printed version of this article and also available via ftp at:


This bulletin concerning tax matters is part of the Tax Page, a World Wide Web demonstration project, no portion of which is intended and cannot be construed as legal or tax advice. Comments are welcome on the design or content of this material.


On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (P.L. 112-240, the "Relief Act") to address the looming "fiscal cliff." Section 324 of the Relief Act amended Internal Revenue Code section 1202 to reinstate the 100 percent exclusion for gain on the sale of qualified small business stock ("QSBS") held for more than five years.[fn. 1] That 100 percent exclusion now also applies to stock acquired in 2012 and 2013.[fn. 2] The Relief Act also eliminated the alternative minimum tax ("AMT") preference relating to excluded QSBS gain for QSBS acquired in 2012 and 2013.[fn. 3]

The Section 1202 exclusion is no stranger to Congressional revision. The exclusion has been amended several times, causing varying effective rates on eligible QSBS gain dependent solely upon the acquisition date as shown below for dispositions after December 31, 2012.

Acquisition Date
[fn. 4]
[fn. 5]
Effective Rate
[fn. 6]
AMT Effective
Rate [fn. 7]
August 11, 1993 –
February 17, 2009
[fn. 8]
50%14% [15.9%]14.98%
February 18, 2009 –
September 27, 2010
[fn. 9]
75%7% [7.95%]8.47%
September 28, 2010 –
December 31, 2013
[fn. 10]
January 1, 2014 –50%14% [15.9%]14.98%


California generally conformed to the federal QSBS 50 percent exclusion but added certain California-centric requirements (primarily that the issuing corporation maintain at least 80 percent of its assets and payroll in California).[fn. 11] On December 21, 2012, the Franchise Tax Board ("FTB") issued Notice 2012-03 to inform taxpayers that, for tax years beginning on or after January 1, 2008, the FTB will disallow all California QSBS exclusions.[fn. 12]

FTB Notice 2012-03 is in response to the California Court of Appeal's decision in Cutler v. Franchise Tax Board,[fn. 13] which involved a taxpayer's 1998 deferral of gain on the sale of QSBS. In Cutler, the Court invalidated the provisions of the California QSBS rules that require the corporation to maintain a California presence. The Court held that such provisions, which favor California corporations over their foreign competitors, are facially discriminatory in violation of the Commerce Clause. The Court did not address the issue of the proper remedy and remanded the case to trial court for further proceedings.

Although Cutler was a taxpayer victory, the FTB determined that because the Court held that the California QSBS provisions are unconstitutional, California's QSBS statutes are invalid and unenforceable. As such, the FTB believes that the appropriate remedy is to deny the California QSBS exclusion and deferral to all taxpayers beginning with the 2008 tax year, which remains open for deficiency assessments under California's four-year statute of limitations.[fn. 14] In Notice 2012-03, the FTB announced that it will individually notify taxpayers who reported a QSBS exclusion or deferral for tax years after 2007 and issue Notices of Proposed Assessments denying the exclusion or deferral.

In response to Notice 2012-03, several members of the California Legislature and at least one State Board of Equalization member have urged the FTB to change its remedy, on the basis that such remedy effects a retroactive change in the tax law and is unreasonable and unfair. The FTB continues to maintain that, in light of Cutler and in the absence of a legislative fix, the FTB must regard California's QSBS provisions as invalid. The FTB suggested that the Legislature could consider the following options: (1) waive interest and penalties for taxpayers who claimed the QSBS benefit in 2008-2011 or (2) extend the QSBS provisions to all taxpayers in 2008-2012 regardless of the extent to which the corporation conducted its business in California. Several lawmakers are considering legislation to address the QSBS remedy, but to date no bill has been introduced.


  1. See our September 1998 Tax Bulletin, Qualified Small Business Stock Update, for a discussion of the requirements and limitations applicable to QSBS and gain from its disposition.[return to text]

  2. Prior to the Relief Act, the exclusion for gain on QSBS held for more than five years had reverted to 50 percent for QSBS acquired after 2011.[return to text]

  3. By eliminating the general sunset provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27), the Relief Act also limits the AMT preference for QSBS gain to which the 50 or 75 percent exclusion applies to seven percent of the excluded QSBS gain. I.R.C. § 57(a)(7).[return to text]

  4. See Internal Revenue Code sections 1202(a)(3) and (4) for special rules regarding the acquisition date of stock for purposes of determining application of the 75 percent or 100 percent exclusion.[return to text]

  5. This article does not discuss the special exclusion for gain from the disposition of QSBS of an empowerment zone business. I.R.C. § 1202(a)(2).[return to text]

  6. The portion of QSBS gain that is not excluded from gross income because of a percentage limitation (i.e., 50 or 75 percent) is taxed at 28 percent. I.R.C. § 1(h)(4)(A)(ii). Effective January 1, 2013, that non-excluded gain is also potentially subject to the 3.8 percent unearned income Medicare contribution applicable to certain highincome individuals and certain estates and trusts. I.R.C. § 1411.[return to text]

  7. 28 percent (the maximum AMT rate) of the sum of the non-excluded gain plus 7 percent of the excluded gain. I.R.C. § 57(a)(7).[return to text]

  8. The QSBS exclusion was originally enacted as part of the Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66). [return to text]

  9. The exclusion for eligible QSBS gain was increased to 75 percent by the American Recovery and Reinvestment Tax Act of 2009 (P.L. 111-5).[return to text]

  10. The exclusion for eligible QSBS gain was increased to 100 percent by the Creating Small Business Jobs Act of 2010 (P.L. 111-240) and has been extended twice, first by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312), and then again by the Relief Act. [return to text]

  11. Cal.Rev.& Tax.Code §§ 18038.5, 18152.5.[return to text]

  12. Notice 2012-03 also invalidates California's rules conforming to the QSBS "rollover" provisions of Internal Revenue Code section 1045.[return to text]

  13. Cutler v. Franchise Tax Board, 208 Cal.App.4th 1247 (2012).[return to text]

  14. Cal.Rev.& Tax.Code § 19057(a).[return to text]

This material is not intended to constitute a complete analysis of all tax considerations. Internal Revenue Service regulations generally provide that, for the purpose of avoiding United States federal tax penalties, a taxpayer may rely only on formal written opinions meeting specific regulatory requirements. This material does not meet those requirements. Accordingly, this material was not intended or written to be used, and a taxpayer cannot use it, for the purpose of avoiding United States federal or other tax penalties or of promoting, marketing or recommending to another party any tax-related matters.

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