Again, these rules can be complex, and while the code appears to argue that a successful Rollover under Section 1045 offers a new set of opportunities and benefits for a new issuer under Section 1202, this combination of Sections 1202 and 1045 has not been addressed in any IRS settlement, litigation, or directive. The expansion of the federal profit exclusion to 100% is a welcome development, although the federal QSBS rules are complicated and vague in several critical points. With the increase in the maximum tax rates for long-term capital gains and the introduction of the 3.8% Medicare tax, QSBS` profit exclusion and deferral provisions are becoming increasingly attractive to eligible investors. Unfortunately, California, including Silicon Valley technology and its investment-rich environment, does not comply with federal QSBS rules or offer a tax benefit for the sale of QSBS. QSBS rules are designed to encourage investment in certain small businesses by giving investors the opportunity to exclude or defer some or all of the profits from the sale of QSBS. Many requirements must be met for the stock to qualify as a QSBS, including the following: Eligible investors in eligible small businesses are eligible for certain tax benefits that have become more attractive with recent federal legislative changes. Under a special provision of the Internal Revenue Code, certain holders of “qualifying small business shares” (“QSBS”) may exclude part or potentially up to all tax gains (depending on the circumstances and subject to restrictions) on the sale of QSBS, depending on the date of issue of the shares, if, among other things, the shares are held for more than five years.  For QSBS acquired on initial issuance by 17 February 2009, the profit exclusion is generally 50% (increased to 60% in certain circumstances); for QSBS acquired on the initial issue after 17 February 2009 and no later than 27 September 2010, the profit exclusion has been increased to 75 %; For QSBS, which was acquired on the initial issue after 27 September 2010 and before 1 January 2012, the profit exclusion was further increased to 100%. An accompanying federal provision allows QSBS holders to defer federal income tax on the QSBS disposition by “transferring” any profits to the purchase of shares of other eligible small businesses.
 Unlike many other states that have adopted an adapted version of the federal QSBS Act in state law, California has adopted a modified form of the QSBS Federal Rules, supplemented by certain California-specific requirements.  It is not easy to meet these criteria. You shouldn`t expect to get away with a fake train. If you`re not willing to make those efforts, you`d better follow the rules and pay California taxes, no matter how confiscatory they may be. If a sale of QSBS does not qualify for profit exclusion because the seller has not held the QSBS for more than five years, a taxpayer may still be able to defer the profit of such a sale in accordance with QSBS` profit deferral rules. Subject to certain restrictions, the profit from the sale of QSBS held for more than six months can be used to acquire new QSBS within 60 days of the sale. The “transfer” of profit to a new QSBS allows the taxpayer to defer tax on the initial sale. When QSBS are sold and reinvested in this way, the holding period of the old QSBS is usually added to the holding period of the new QSBS, making it easier for taxpayers to meet the five-year holding period requirement for the exclusion of QSBS profits.
The FTB has taken the position that California`s QSBS rules for tax years beginning on or after January 1, 2008 are invalid and unenforceable, although some lawmakers have promised to introduce taxpayer-friendly legislation. It is not clear at this stage whether such a law will ultimately be passed and, if so, what it will offer. In addition, existing operating companies currently treated as partnerships for income tax purposes (e.g. some limited liability companies) could examine the extent to which QSBS rules may be applicable to them. While QSBS` tax rules only apply to gains from the sale of shares, an LLC that is converted into a corporation can allow QSBS benefits to extend to its shareholders with surprising results. Consider this: The good news is that most states allow you to receive tax-free treatment, with a few exceptions, including California, Pennsylvania, Alabama, and Mississippi. Note that Massachusetts, New Jersey, and Hawaii only partially comply with federal QSBS rules. You must follow the rules of declaring a completed gift, valuing the shares at the time of the donation and the probable exhaustion of part of your gift for life and exemption from inheritance tax. California does not comply with the state`s QSBS rules, but has its own profit exclusion provision for the sale of California QSBS. Unfortunately, the validity of the California QSBS rules has been seriously challenged following a recent decision of the California Court of Appeals and subsequent positions taken by the FTB.
This is a simplified example and these rules can become complex. It is also important to note that while Article 1202 appears to allow this technique, the IRS has not yet commented on or provided formal guidance. Investments in convertible debentures, bridge loans with warrants or similar structures are expected to convert these investments into shares before the end of the year in order to benefit from the potential 100% federal tax exclusion applicable to shares issued before January 1, 2014. Although the QSBS tax rules have been expanded in the past (and whatever proposals are made to make these rules permanent), there is no guarantee that such extensions will continue in the future. FTB`s auditors are notoriously thorough and persistent. You often interview friends and neighbors, check phone and credit card records, and visit the organizations you`re supposed to join. Their mandate allows and encourages them to be intrusive, and standard rules of evidence don`t offer you protection. The exclusion of 100% of profits from federal income tax for QSBS is a potential tax benefit that remains significant despite the current uncertainty surrounding the situation in California. The benefit is bolstered by increasing long-term capital gains rates from 15% to 20% and introducing the Medicare contribution tax from 3.8% starting in 2013. Therefore, all unincorporated investors who are considering investing in one or more eligible small businesses in 2013 (or who may have already done so in 2012) should carefully review the requirements of the QSBS tax rules to determine the extent to which these rules may apply to their particular transaction.
18152.5(m) The amendments made to this section by law to add this subdivision apply to sales, including instalment sales, made in each taxation year dated or after the 1st. January 2008 and before January 1, 2013, and instalment payments received in taxation years beginning on or after January 1, 2008 for sales of eligible small business interests made in taxation years beginning before January 1. 2013. The State in which the taxpayer maintains or has commercial interests; The location of all of the taxpayer`s residential property and the approximate size and value of each residence; The Court of Appeal`s decision in Cutler v. Franchise Tax Vol., 208 Cal. App. 4th 1247 (2012) stems from a challenge by a taxpayer who sold shares in an internet startup that did not maintain 80% of its assets and payroll in California. In its tax returns, Cutler requested a deferral of profits from the sale of these shares. When the Franchise Tax Board (“FTB”) has not authorized the deferral. Cutler claimed the law discriminates against investors in companies that operate more than 20 percent of their business outside of California. The California Court of Appeals agreed and ruled that the discrimination in the law violated the trade clause of the U.S.
Constitution. California Qualified Small Business Equity Investment Incentives You may be able to achieve this in a variety of ways, such as determining your residency in a state that meets one of the following criteria: The starting point for the taxpayer`s current account and credit card transactions; Either way, be sure to work with a team of knowledgeable consultants to make sure you get accurate and up-to-date advice.