Thursday, February 5, 2009
Court: Taxable Income Exclusion Inapplicable to Future Gains
By SHERRI M. OKAMOTO, Staff Writer
The Third District Court of Appeal yesterday clarified that deferred installment payments from a stock sale were not excluded from taxable income when the installments were paid, even though an exclusion applied at the time of the sale.
Affirming Sacramento Superior Court Judge Loren E. McMaster’s grant of summary judgment in favor of the Franchise Tax Board, the panel ruled the signatories on 58 state tax returns were not entitled to a refund for taxes they had paid on the balance of proceeds received in 1995 from a 1986 sale of stock.
The taxpayers had sold their shares in Norcal Solid Waste Systems Inc., a small business within the meaning of former Sec. 18162.5(e) of the Revenue and Taxation Code, to an employee stock ownership plan and trust. The ESOP paid the taxpayers approximately $417,000 in cash and gave a 14-year promissory note of $234,000 for the balance.
Sec. 18162.5, as then in effect, provided no percentage of the gain upon the sale of small business stock would be taken into account in computing taxable income, if the stock had been held for more than three years.
None of the plaintiffs elected to treat the proceeds from the stock sale as anything other than an installment sale, and all reported capital gains from the sale on their 1986 tax returns. All had held the stock for more than three years, and so the sale did not affect the calculation of their taxable income.
The ESOP subsequently defaulted on the promissory note and litigation ensued. To settle the litigation, the ESOP paid the plaintiffs approximately $215,000 each in 1995. The plaintiffs reported a capital gain of $197,000 on their tax returns that year. The parties did not address the $18,000 difference.
In 2002, the plaintiffs filed amended tax returns for 1995, seeking a refund of the taxes paid for the capital gains from the 1986 stock sale. Because the Legislature repealed Sec. 18162.5(e) in 1989, the Franchise Tax Board denied their claims, and the State Board of Equalization denied their administrative appeal.
Plaintiffs sought judicial review, but on cross-motions for summary judgment based on the undisputed facts, McMaster upheld the Franchise Tax Board’s ruling.
Writing for the appellate court, Justice Rodney Davis explained if the Legislature has determined the desired effects of a capital gains tax policy have not been achieved, and repeals certain favorable treatment, it would frustrate the legislative purpose to allow the exclusion to apply for future payments.
As there is no statutory guarantee that the manner in which a capital gain is treated at the outset of an installment sale will continue from one taxable year to another, Davis reasoned, the characterization of income in a particular year as a capital gain is determined as of that taxable year, not the original date of sale.
That the law regarding tax liability might be changed over the course of an installment sale is a risk that the taxpayer takes in deferring the realization of his gains, Davis wrote, concluding that the plaintiffs were not entitled to the benefit of the exception in force in 1986.
Presiding Justice Arthur G. Scotland and Justice Tani Cantil-Sakauye joined Davis in his opinion.
The case is Delucchi v. Franchise Tax Board, 09 S.O.S. 699.
Copyright 2009, Metropolitan News Company