California Nails Small Business Owners with Retroactive Tax

At the end of last year, California dealt another blow to state income tax payers.  Many wealthy individuals who had seen personal income taxes rise are now paying another tax increase in the form of a retroactive tax aimed squarely at small business owners to the tune of over $120 million.

Over the past few years, thousands of small businesses based in California claimed a tax break that was deemed legal at the time.  But the state has determined that the tax break is not in fact valid.  As a result, not only is this tax break no longer available to small businesses going forward, but those small business that previously claimed the tax break are being notified they need to repay the money.

“How would you feel if you made a decision, which was made four years ago, you absolutely knew was legally correct and four years later a governing body came in and said, ‘no, it’s not correct, now you owe us a bunch more money.  And we’re going to charge you interest on money you didn’t even know you owed’,” noted Brian Overstreet, one small business owner who was impacted by the tax change.

When Overstreet and his partners sold their small business four years ago, they paid the tax due based on the law in place at the time.  But a recent ruling by a California appeals court brought into question the constitutionality of the tax break.  As a result, California’s taxing authority determined that any small business who had claimed the tax break in the previous five years must pay the additional money.

“What [the money] translates into is tens of thousands, if not literally hundreds of thousands, of potential jobs,” Overstreet added.

“It’s going to cause not only significant financial hardship but real personal stress on a lot of people who shouldn’t be worried about this,” Overstreet continued.  “They did what is right.  They paid their taxes.  They should be off working away at their next business – instead they’re having to spend their time fighting this stuff.”

Overstreet noted that if the retroactive impact of the tax law change was allowed to stand then he would owe well over $100,000.

As a result, he and others like him are fighting to overturn the decision by California’s tax authority.  At least initially they are winning the fight, as the taxing authority has rebranded what were original deemed notices of payment as proposed assessments of payment.

The change in characterization of the notices mailed out to Overstreet and many others like him is believed to give state leaders time to change the law to address the concerns expressed by the appeals court without burdening small businesses with a retroactive tax.

Concern has been expressed at various levels that because of the state’s significant budget shortfalls in the end politicians may not be able to objectively reverse the decision and leave”Once the revenue is identified, those folks up in Sacramento will figure out how to spend it already,” noted former state Senator George Runner.  “And that’s what makes this so difficult.  Even though it has this great bipartisan support as being wrong.”

Lawmakers have introduced legislation that would undue the initial decision made by the taxing authority.

“Californians planned and based their actions on the language of the law as it existed,” added Democratic Senator Ted Lieu.  “Going backward in time and changing the rules innocent taxpayers relied upon violates the very essence of the rule of law.”

by Mark Johnston

Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.