BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |AB 154 |Hearing |7/8/15 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Ting |Tax Levy: |No | |----------+---------------------------------+-----------+---------| |Version: |6/30/15 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Grinnell | |: | | ----------------------------------------------------------------- TAXATION: FEDERAL CONFORMITY Conforms state law to federal law as of January 1, 2015; makes changes to the large corporate understatement penalty. Background and Existing Law I. Conformity. California law does not automatically conform to changes to federal tax law, except for specific retirement provisions. Instead, the Legislature must affirmatively conform to federal changes. Conformity legislation is introduced either as individual tax bills to conform to specific federal changes, like the Stephen Beck, Jr., Achieving a Better Life Experience Act of 2014 (AB 449, Irwin, and SB 324, Pavley) or as one omnibus bill that provides that state law conforms to federal law as of a specified date, currently January 1, 2009 (SB 401, Wolk, 2010). II. Large Corporate Understatement Penalty. Corporation taxpayers are subject to a penalty equal to 20% of any understatement that exceeds $1 million of the tax shown on an original return (or amended return filed on or before the extended due date of the original return) for taxable years beginning on or after January 1, 2003 (SBx1 28, Committee on Budget, 2008). The measure also applies to understatements on amended returns filed on or before May 31, 2009 for taxable years beginning before January 1, 2008. The penalty applies to AB 154 (Ting) 6/30/15 Page 2 of ? the total amount of the understatement for an entire combined report, and excludes any understatement attributable to a change in law under specified circumstances or when the taxpayer relied on written advice from the Franchise Tax Board (FTB). The penalty applies in addition to any other penalty, and is strict liability, meaning that the taxpayer has no appeal rights. In 2010, the Legislature modified the penalty for taxable years for the 2011 taxable year and thereafter to apply only to understatements that exceed the greater of $1 million, or 20% (SB 858, Committee on Budget and Fiscal Review, 2010). Proposed Law I. Conformity. Assembly Bill 154 conforms relevant sections of the Revenue and Taxation Code to the Internal Revenue Code as of January 1, 2015, with some modifications. Specifically, the measure conforms the federal net operating loss (NOL) rules that allow corporations expecting an NOL carryback to extend the time for payment of taxes for the preceding taxable year; the exclusion from gross income qualified military base realignment and closure fringe from the Worker, Homeowner, and Business Assistance Act of 2009; the disclosure of information with respect to foreign financial assets in the Hiring Incentives to Restore Employment Act; not treating certain swaps as Section 1256 contracts under the Dodd-Frank Wall Street Reform and Consumer Protection Act; the special rule with respect to certain redemptions by foreign subsidiaries in the State Fiscal Relief and Other Provisions Revenue Offsets; the modification of control definition for purposes of Section 249 in the FAA Modernization and Reform Act of 2012; the transfers of excess pension assets in the Moving Ahead for Progress in the 21st Century Act; modifications to acquisitions, dispositions, and aggregation of expenditures in the research and development credit in the American Taxpayer Relief Act of 2012; Indian general welfare benefits in the Tribal General Welfare Act of 2014, various technical changes in the Tax Technical Corrections Act of 2014; the Investment Direction Rule for 529 accounts in the Achieving a Better Life Experience Act. In the Small Business Jobs Act of 2010, AB 154 conforms to: The limitation on penalty for failure to disclose AB 154 (Ting) 6/30/15 Page 3 of ? reportable transactions based on resulting tax benefits, Removal of cell phones and similar technology from listed property, Increase in information return penalties, Special rules for annuities received from only a portion of a contract. AB 154 makes the following modifications for state purposes: Conform to lower state excise tax of 12.5% on nonqualified Archer Medical Savings Account distribution, instead of 20% at federal. Generally disconnects inflation adjustments to penalty amounts. AB 154 doesn't conform to: The higher threshold of 10% of adjusted gross income to claim unreimbursed medical expense deductions, maintaining California current 7.5% threshold. Deferral and ratable inclusion of income arising from business indebtedness discharged by reacquisition of debt. Requirement for certain tax preparers to file returns electronically. Inflation indexing of many penalty amounts. Increase in penalty for failing to file partnership or S-Corporation returns Exempting limitation on net unrealized built-in losses resulting from bank reorganizations. Expansion of work opportunity tax credit, which would have reduced the value of enterprise zone and other geographically targeted economic development area credits. As part of conformity, the measure repeals sections added by AB AB 154 (Ting) 6/30/15 Page 4 of ? 1423, AB 36 (Perea, 2010), AB 242 (Committee on Revenue and Taxation, 2011) as the January 1, 2015 general conformity date incorporates subsequent changes made by Congress. Additionally, AB 154 makes legislative findings and declarations stating that SB 401 (Wolk, 2010) is valid. II. Large Corporate Understatement Penalty. AB 154 makes the following changes to the Large Corporate Understatement Penalty: Provides that any amount of tax reflecting a proper 338 election doesn't count towards the understatement amount for purposes of the penalty, which can generally be made up to one year after an acquisition, are treated as shown on an original return, States that no penalty shall apply when FTB imposes an alternative apportionment formula under Revenue and Taxation Code §25137, or as a result of a change in the taxpayer's federal accounting method where the due date of the return is before the Secretary of the Treasury's determination to change the accounting method. State Revenue Impact According to FTB, AB 154's conformity provisions result in net revenue gains of $3.1 million in 2015-16, $8 million in 2016-17, and $14.2 million in 2017-18. An estimate of the measure's changes to the Large Corporate Understatement Penalty is pending. Comments 1. Purpose of the bill . According to the author, "AB 154 is a vital measure conforming state tax law to federal tax, easing tax preparation for taxpayers and tax preparers alike. This measure is intended to narrow differences between state and federal law and provide relief to members of the United States Armed Forces, businesses, and individual taxpayers." 2. Odd couple . AB 154 is the state's first omnibus tax conformity measure in five years, and would move ahead the state's conformity date by six years, picking up changes that AB 154 (Ting) 6/30/15 Page 5 of ? will more closely align state and federal personal income and corporation tax statutes, easing compliance headaches for taxpayers as well as administrative difficulties for FTB. However, the measure also contains changes to the state's Large Corporate Understatement Penalty, which only applies to large corporate taxpayers that significantly understate tax on their original returns, and doesn't have a federal counterpart. While the measure's changes to the penalty simply account for changes where federal law affords taxpayers time to choose between two transaction structures, or have their tax due changed by decisions made by either IRS or FTB, putting the two together is an odd match. The Committee may wish to consider whether AB 154's changes to the understatement penalty should be in a separate bill. 3. Doomsday machine . SB 401 was the last tax conformity bill the Legislature enacted by majority vote because Proposition 26 (2010) changed the standard that Legislative Counsel uses to determine whether a legislative bill is a tax increase, and therefore must be approved by 2/3 vote of each house of the Legislature. Instead of "changes in state taxes enacted for the purpose of increasing revenues collected pursuant thereto whether by increased rates or changes in the method of computation," Proposition 26 amended Section 3 of Article XIIIA of the California Constitution to provide that the 2/3 vote applied to any "change in state statute that leads any taxpayer to pay a higher tax." As such, measures like SB 401 that contained some provisions that increased taxes, and others that decreased them, but resulted in a net revenue loss, were majority vote bills before Proposition 26, but 2/3 vote bills today. Additionally, the initiative provided that the Legislature must reenact any bill that was enacted one year before its enactment by majority vote or else such measure would be "void," which captured two such bills, the gas tax swap (ABx8 6, Assembly Committee on Budget, 2010) and SB 401. While the Legislature subsequently reauthorized the gas tax swap by 2/3 vote, it did not do the same for SB 401. While no one has yet challenged the bill in court, should the measure be invalidated, an adverse decision could theoretically change the calculation of tax for every return filed for the last five years. AB 154 restates SB 401's validity in the hopes of eliminating any uncertainty regarding SB 401's legality. 4. Urgency . AB 154 contains an urgency clause, which states AB 154 (Ting) 6/30/15 Page 6 of ? that the measure's provisions must take effect immediately to grant needed tax relief to taxpayers in conformity with federal tax relief enacted in the last four years and to alleviate administrative burdens on state tax agencies. As such, Legislative Counsel has assigned the measure a 2/3 vote. However, the urgency clause isn't necessary as the measure is keyed a tax levy, which means that its changes affect the current 2015 taxable year. 5. Tax Increase . Because the measure would result in an increase in tax on any taxpayer according to Section 3 of Article XIIIA of the California Constitution, Legislative Counsel has keyed the measure a 2/3 vote. Assembly Actions Assembly Floor 75-0 Assembly Appropriations 15-0 Assembly Revenue and Taxation 6-0 AB 154 (Ting) 6/30/15 Page 7 of ? Support and Opposition (7/2/15) Support : California Asian Chamber of Commerce, California Bankers Association, California Chamber of Commerce, California Manufacturers and Technology Association, California Society of Enrolled Agents, California Taxpayers Association, Computing Technology Industry Association, Hewlett Packard Company, National Federation of Independent Business, Spidell Publishing, Inc. Opposition : None received. -- END --