Many state leaders agree that it is of essential importance for the stability of the state to attract, build, and keep businesses within the state.  For nearly two decades, California has offered small business owners tax incentives to prevent them from starting their businesses elsewhere.  This QSB program was developed to stimulate the economy in California, and for years it did.  This last year, however, legislation changed and thousands of small business owners are left with a hefty bill.

What is the QSB Program?

In attempts to stimulate the economy, California has offered small business owners a partial state income tax exclusion when selling stock of a Qualified Small Business (QSB).  Known as the QSB program, business owners were able to exclude 50% of taxable gain on the sale of their stock.  That resulted in the reduction of the capital gain tax to 4.5% from the original 9%.  It also resulted in an influx of new businesses starting up, in order to take advantage of the tax break.

As of August 2012 however, the QSB exclusion on state taxes has been extinguished.  It started when the California appellate court found one of the QSB program’s provisions unconstitutional.   In Cutler vs. Franchise Tax Board, it was decided that the program discriminated against those who invested in out-of-state businesses, and was virtually unenforceable.  From there the Franchise Tax Board made the decision to cancel the incentive.  Not only that, but they are demanding retroactive taxes back to 2008.  That means that the 50% of taxable gain that business owners saved on their taxes is now required to be paid in full.  Small business owners can expect to get a bill demanding these back taxes to be paid immediately.

Who is affected?

Although it is unclear exactly how many small business owners will be affected in the dissolution of the QSB tax exclusion, the Franchise Tax Board estimates that it may reach 2,500 taxpayers.  Cumulatively, these taxpayers will owe a whopping $150 million in back taxes plus interest.  Taxpayers and business banking experts are left wondering why they are held responsible for paying taxes that they were not legally required to pay.

If you benefited from the QSB program within the last five years, you are required to file amended tax returns for those years.  The California Franchise Tax Board will contact and may penalize any small business owners who fail to do so.  Banks in California encourage those small business owners to discuss their options with a tax professional to ensure they are taking the correct measures.

What affect will this have on California’s economy?

While California may have attempted to attract new business to their state, dissolving the QSB tax incentive has generally hurt their economy.  Many small businesses are seeking other, more business-friendly states to move into.  The emergence of new alternative technological epicenters, including New York, Denver, and Austin, has deterred many new businesses from calling California home.  Not to mention California’s increasingly difficult business regulatory process.

Unfortunately, many new small business owners have found locations in states other than California to start their companies.  With such an abrupt and dramatic change in the tax laws, business owners feel more comfortable opening their doors in another state.

Articel written by Charlie McCartney of the Marketing Robot. Follwo him on Twitter @robthemarketer for more industry updates and small business news.