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The founder of an integrated circuit startup company can’t exclude from income tax half of his $10 million gain on stock he sold when the company was acquired, the California State Board of Equalization said June 20.
The SBOE unanimously voted to uphold the California Franchise Tax Board’s determination that the stock Charles Harper held in Sierra Monolithics Inc. didn’t qualify for the small business stock exclusion intended to encourage investments in risky, startup companies ( In re Charles Harper , Cal. Board of Equalization, No. 942651, 6/20/17 ).
The SBOE will issue a letter decision within 30 days to make the vote officially final.
Harper and one co-founder started the company in Orange County, Calif, in 1986. It was restructured in 2000 under venture capital investors and acquired in December 2009 by Semtech Corp. Harper told the five-member elected board that the company designed and sold circuits to companies including Raytheon Corp., Deere & Co., and Cisco Systems Inc.
Harper’s case hinged on when he acquired his stock and the type of corporation. At issue was $486,316 in tax on the $5 million gain he claimed was excluded from tax on his 2009 California return.
The FTB argued that Harper’s shares lacked two necessary characteristics. His first acquisition of 100 shares at the company’s founding in 1986 was seven years before the 1993 date after which stock must be issued to qualify for the 50 percent tax exclusion under the law.
Also, the company was a C corporation for only 49 percent of the time that Harper held the stock, the FTB said. The law requires that companies must be C corporations for substantially all of the holding period to qualify for the exclusion—and the FTB interprets that to mean at least 85 percent of the holding period.
Harper argued the issue date should be in 2000, when Sierra Monolithics brought in venture capital investors who restructured the company. The restructuring included a stock split of 38,400 to 1, which gave Harper 3.84 million shares. He argued the restructuring created a new company and therefore a new issue date for the stock that meant it qualified for the exclusion.
Harper also argued that the FTB allowed the exclusion based on the same facts for one founder.
“It’s a matter of FTB auditors and attorneys having a different opinion under the same facts,” Denis Retoske, an attorney representing Harper, told the board.
FTB attorneys argued the agency isn’t bound “by a prior mistaken conclusion by an FTB auditor,” and the board must decide Harper’s appeal on its own merits.
The SBOE’s attorneys advising the board members on the appeal agreed with the FTB that the stock didn’t qualify for the 50 percent exclusion on the gain. Under the qualified small business stock rules, the stock must be acquired at its original issuance and the company must be a C corporation, SBOE Tax Counsel Grant Thompson told the board.
The 2000 restructuring “was not a taxable event akin to a new purchase,” Thompson said.
To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at LMahoney@bna.com
To contact the editor responsible for this story: Ryan C. Tuck at email@example.com
A summary of the case prepared for the SBOE is at http://src.bna.com/p2J.
Copyright © 2017 Tax Management Inc. All Rights Reserved.
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