Tax Revolt by California Entrepreneurs Ends in Victory

Taxes aren’t usually the stuff of high drama. But a story that began last year when a California state appeals court unexpectedly struck down an old tax incentive for small-business investors—and that unfolded, in part, here in the pages of Xconomy—has, after numerous twists and turns, reached its end. On Friday California Governor Jerry Brown signed a bill quashing the state tax board’s move to levy up to $120 million in back taxes and penalties on entrepreneurs who’d taken advantage of the investment incentive in past tax years.

“The sense of relief is indescribable,” Brian Overstreet, co-founder of a group lobbying for the bill, said in a statement released Sunday. Members of Overstreet’s group, California Business Defense, spent much of 2013 in Sacramento, meeting with lawmakers to find a way to undo the Franchise Tax Board’s plan. “We thank the Governor for reassuring the state’s innovators and risk-takers that California is still the place where the companies of tomorrow should be built,” Overstreet said.

In a commentary published today on Xconomy, Overstreet says Governor Brown’s office called him at 1:15 pm on Friday to tell him Brown had signed Assembly Bill 1412, a bill hastily carved together to reverse the tax board’s plan after lawmakers introduced amendments that watered down a similar measure, Senate Bill 209. Brown had to choose which of the two bills to sign; in the end, he endorsed the one providing full relief.

In the commentary, Overstreet shares the behind-the-scenes story of the lobbying efforts leading up to the signing. “In short, we succeeded by doing what we do best: being entrepreneurial,” Overstreet writes.

California Business Defense organized a coalition of entrepreneurs, friendly lawmakers, and attorneys familiar with the ways of Sacramento, then approached the effort to reverse the tax ruling as a sales campaign, Overstreet says. “In countless trips to Sacramento, we met with over 50 legislators and other government officials. In each meeting, we identified the problem, presented our solution, elicited feedback, and overcame objections.”

It was Overstreet who first brought the retroactive tax plan to widespread notice, in an op-ed published on Xconomy on Jan. 15.

After selling his previous business in 2012, Overstreet had noticed a little-publicized announcement from the Franchise Tax Board, the state’s equivalent of the IRS. In a lawsuit decided last August, a state appeals court had ruled unconstitutional a portion of the state tax code that allowed investors selling stock in California-based small businesses such as startups to exclude 50 percent of their gains when computing their taxable income. The tax board’s interpretation of the ruling was that taxpayers who claimed the benefit would have to pay taxes on the formerly excluded income, retroactive to 2008. (Xconomy detailed the complex history of the tax board’s move in a Jan. 24 news analysis.)

That meant entrepreneurs and other investors who had sold their interest in small businesses in the state would soon get bills totaling an estimated $120 million. The tax board refused to revise its ruling, but said in February that it would delay collection of the back taxes, giving California Business Defense time to seek a legislative solution.

The group turned to lawmakers for help, notably Senator Ted Lieu, a Democrat from Torrance, CA. Lieu’s bill, SB209, temporarily restored the income exclusion in a way that wouldn’t run afoul of the Constitution. But after attracting early support, the bill ran into a snag this summer, when members of the Senate Appropriations Committee expressed concern that it might oblige the state to pay retroactive refunds to some taxpayers. To cover those potential costs, committee members introduced amendments to SB209 that reduced the 50 percent exclusion to 38 percent, meaning investors would still be on the hook for partial retroactive payments.

“With technical snafus and political pressure weighing down SB209, we worked with legislators [including Assembly member Raul Bocanegra, Democrat of Los Angeles] to gut an unrelated bill, AB1412, insert our desired language, and push that through both the Senate and Assembly,” Overstreet recounts in his commentary. Both bills passed by large margins in the Senate and the Assembly, leaving the Governor to decide which one to approve.

Brown’s office had remained silent on the issue throughout the year, leaving Overstreet and his coalition members uncertain about the governor’s intentions. But on Friday he signed AB1412, along with 17 other bills designed to boost economic development in the state.

Under AB1412, the restored 50 percent exclusion is only effective through 2016. So investors and legislators may have to revisit the issue within a few years, or find different ways to encourage investment in California small businesses. For now, Overstreet says he’s relieved to be able to get back to his real job, as CEO of drug safety startup AdverseEvents, and hopeful that the episode has demonstrated to entrepreneurs that they can have a voice in state politics.

“As entrepreneurs we’ve accumulated unique, transferable skills from starting and running successful businesses,” Overstreet writes today. “Let’s do more than just denigrate our government in clever 140-character missives. Let’s actually work to influence policy and re-craft the institutions and mindset of our government from within.”

Wade Roush is a freelance science and technology journalist and the producer and host of the podcast Soonish. Follow @soonishpodcast

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