BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |SB 38 |Hearing |4/29/15 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Liu |Tax Levy: |No | |----------+---------------------------------+-----------+---------| |Version: |3/23/15 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Bouaziz | |: | | ----------------------------------------------------------------- PERSONAL INCOME; CREDIT: EARNED INCOME: TAX PREPARER EDUCATION Allows a refundable Earned Income Tax Credit (EITC), upon appropriation of the Legislature, equal to 30% or 100% of the federal EITC. Background and Existing Law Federal law allows eligible individuals a refundable EITC, which allows the taxpayer to obtain a refund for the excess of the credit over the taxpayer's liability. As the name implies, the credit is based on a percentage of the taxpayer's earned income, and phases out as income increases. The percentage varies depending on whether the taxpayer has qualifying children. Married individuals are eligible for only one credit on their combined earned income and must file a joint return to claim the credit. Federal law specifies that if the federal EITC is denied, and the Internal Revenue Service (IRS) determined that the taxpayer's error was due to reckless or intentional disregard of EITC rules, the EITC would be denied for the next two years. If the error was due to fraud, the denial period would be ten years. State law provides various tax credits designed to provide tax SB 38 (Liu) 3/23/15 Page 2 of ? relief for tax-payers who incur certain expenses or to influence behavior, including business practices. State law allows individuals with income below a certain threshold to not file a return, when the standard deduction and personal exemption credit eliminate any tax liability. For 2014, these thresholds are $16,047 in gross income or $12,838 in adjusted gross income (AGI) for single taxpayers and $33,097 in gross income or $25,678 in AGI for married individuals filing jointly. These thresholds are increased based on the number of dependents claimed, and are increased annually for inflation. State law does not provide an EITC. Proposed Law Senate Bill 38 allows a refundable tax credit, upon appropriation by the Legislature, equal to 30% of the federal EITC for eligible individuals with qualifying children or 100% for individuals with no qualifying children. In a year when an appropriation is not made by the Legislature, the credit becomes nonrefundable, but can be carried over to succeeding taxable years until exhausted. An "eligible individual" would have the same meaning as in Section 32(c)(1) of the Internal Revenue Code (IRC), except that an individual without a qualifying child would qualify for the credit at age 21 instead of 25. Any amounts refunded to a taxpayer under SB 38 would not be included in income. For an individual who is a nonresident or is a part-year resident of this state, the amount of the credit or refund allowed under this bill would be determined based on the part of the earned income credit that is attributable to California. SB 38 also requires FTB to establish a pilot program to allow eligible individuals to secure advance payments of the EITC through their employers and requires FTB to report findings on the program. The pilot program applies to taxable years beginning on or after January 1, 2017 and before January 1, 2019. SB 38 requires FTB to report to the legislature information on SB 38 (Liu) 3/23/15 Page 3 of ? the effectiveness of the credit. Additionally, the bill requires providers of basic and continuing education to tax preparers to include instruction for preparing taxes for a taxpayer who is eligible for the state earned income tax credit SB 38 takes effect immediately as a tax levy and applies to taxable years beginning on or after January 1, 2016 and before January 1, 2027. State Revenue Impact FTB estimates that this bill would reduce General Fund revenues by $60 million in fiscal year 2015-16, $300 million in 2016-17, and $350 million in 2017-18 if there is no appropriation made by the Legislature. If there is a yearly appropriation made by the Legislature, FTB estimates that this bill would reduce General Fund revenues by $600 million in 2015-16, $2.9 billion in 2016-17, and $3 billion in 2017-18 Comments 1. Purpose of the bill. According to the author, "SB 38 will create a refundable state Earned Income Tax Credit (EITC) equal to 30% of the federal EITC for eligible individuals with qualifying dependents and 100% of the federal rate for eligible individuals with no qualifying dependents. Further, it calls upon the Franchise Tax Board (FTB) to establish a pilot advance pay program for the credit. The state EITC will help thousands of low- and middle-income working Californians and is an excellent complement to the federal tax credit. The federal EITC lifts 6.6 million Americans, including 3.3 million children, out of poverty each year, making it the nation's largest and most successful anti-poverty program. Research shows that the credit does more than reduce poverty and provide a short-term safety net for low-income working families The EITC, which benefits between 25 and 30 million low- and moderate-income families, stimulates the local economy by increasing their spending power. That is in addition to the income, employment, educational, and health benefits to children that can extend into adulthood. Nearly 70% of families living SB 38 (Liu) 3/23/15 Page 4 of ? in poverty in 2013 had at least one working adult. Further, according to the PPIC 61% of all of our state's impoverished children live in working families. The state Earned Income Tax Credit will help struggling families while increasing the take up rate of the federal EITC, bringing more federal dollars into our state. With the economy improving this is an ideal time to make an investment in those that have yet to recover from the Great Recession. The state EITC is an effective anti-poverty policy and will help working Californians and our state's children." 2. What is an EITC? The EITC is a federal tax credit for low-to-moderate income individuals and families. Congress originally approved the tax credit legislation in 1975, in part to offset the burden of social security taxes and to provide an incentive to work. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. In order for a taxpayer to qualify for the credit, an individual's AGI in the 2014 taxable year must be less than: $46,997 ($52,427 filing jointly) with three or more qualifying children. $43,756 ($49,186 filing jointly) with two qualifying children. $38,511 ($43,941 filing jointly) with one qualifying child. $14,590 ($20,020 filing jointly) without a qualifying child. The 2014 maximum credit for taxpayers is as follows: $6,143 with three or more qualifying children. $5,460 with two qualifying children. $3,305 with one qualifying child. $496 with no qualifying children. SB 38 (Liu) 3/23/15 Page 5 of ? Taxpayers cannot claim the federal EITC if their 2014 investment income (from interests and dividends) is more than $3,350. The amount of the federal EITC is reduced by the alternative minimum tax (AMT), if any. In 2009, 800,000 eligible Californians failed to claim over $1.2 billion worth of federal EITC dollars. According to the New America Foundation study Left on the Table, if these refunds were claimed, they would spur over $1.2 billion in business sales, pay $311 million in wages, and add nearly 7,500 jobs to the California economy, which would result in $88 million in taxes coming back to the state. According to the Internal Revenue Service (IRS), currently, 25 states and the District of Columbia offer state-level EITC for their residents. 3. A Note on Fraud. Although the federal EITC lifts families and individuals out of poverty, the refundable credit is highly susceptible to fraud. The Treasury Inspector General for Tax Administration estimates that improper EITC claims total over $10 billion a year. The payments paid out improperly for 2012 were at least 21-25% of all payments, according to the latest report from the IRS inspector general. 4. Another way? As stated in SB 38's legislative findings, the federal EITC is a proven antipoverty measure, but there are other programs we can invest in to help working families. The state can invest in increasing TANF grants, restore CalWORKs childcare subsidies that were cut during the recession, and increase funding for food stamps, to name a few. 5. Let's get clear. SB 38 lays out the framework for a California EITC, and a pilot program to secure advance payment of an EITC, but leaves out many critical details needed to implement both components of the bill. For example, the credit is refundable upon appropriation of the legislature, thus if there is no appropriation in the first two years, but an appropriation in the third, can individuals who would have received a refund amend their last two returns? Would individuals who are amending returns be entitled to payment first or would FTB prioritize individuals filing original returns? The simple solution would be to amend the bill to include a continuous appropriation; however this would likely result in the bill requiring a 2/3 vote for passage. Additionally, the pilot program does not specify an application SB 38 (Liu) 3/23/15 Page 6 of ? process for participating or an entity that would process applications and determine eligibility. Also the pilot program does not contain a funding mechanism so employers can make advance payments. The Committee may wish to consider amending the bill to provide the infrastructure needed to implement the pilot program and to clarify the mechanics of who is eligible for a refund when an appropriation is made by the Legislature. 6. Related legislation. SB 152 (Vidak) creates a refundable EITC equal to 15 percent of the federal EITC. SB 152 is set to be heard on April 29, 2015 in this Committee. AB 43 (Stone) creates a refundable EITC equal to 15 to 60 percent of the federal EITC. AB 43 is set to be heard in the Assembly Revenue and Taxation Committee. 7. FTB's Implementation Concerns. FTB notes the following implementation concerns in its analysis of this bill: Many taxpayers eligible for the federal EITC have no California income tax return filing requirement. These non-filers would be required to file a California income tax return to claim the proposed state EITC, which could impact the department's programs and costs. Typically, refund returns are filed early in the filing season. If taxpayers claiming the California EITC file late in the filing season, after they receive their federal EITC, that behavior could have a major impact on the processing of returns and possibly cause delays in the issuance of refunds. The taxpayer error rate on the federal EITC and the fraud concerns cause the IRS to adjust many returns. Consequently, the correct federal EITC amount may be unknown until after the taxpayer has filed the state return, claimed the proposed California credit, and received a refund. FTB could be required to issue an assessment to retrieve incorrect refunds and incur costs to do so. Relying on the EITC under federal law may present implementation problems for Registered Domestic Partners (RDPs). RDPs are required to file California income tax returns using the rules applicable to married individuals. If the author's intent is to allow EITCs for RDPs, a rule should be included in the bill to address the difference SB 38 (Liu) 3/23/15 Page 7 of ? between federal and state law. Historically, the department has had significant problems with refundable credits and fraud. These problems are aggravated because if a refund is made that is later determined to be fraudulent, the refund commonly cannot be recovered. Striking the refund provision from this credit would substantially reduce the department's concerns regarding fraud. 8. Let's get technical. FTB has proposed the following clarifying amendment: On page 6, line 19, after 17052.1, add "for taxable years beginning" On page 6, line 19, after "on or after" strike out "taxable years" and add "January 1, 2017" Support and Opposition (4/23/15) Support : Alameda County Board of Supervisors; American Academy of Pediatrics, California; American Association of University Women (AAUW); California Association of Food Banks; California Catholic Conference of Bishops; California Food Policy Advocates (CFPA); California Hunger Action Coalition (CHAC); California Partnership; California Reinvestment Coalition; Children's Defense Fund - California (CDF-CA); Coalition of California Welfare Rights Organization; Community Action Partnership of Kern (CAPK); Community Action Partnership of Riverside County (CAP); Courage Campaign; Friends Committee on Legislation of California; Lutheran Office of Public Policy - California; National Association of Social Workers, California Chapter (NASW-CA); Pacoima Beautiful; PolicyLink; Ventura County Board of Supervisors; Western Center on Law and Poverty. Opposition : California Taxpayers Association (CalTax) SB 38 (Liu) 3/23/15 Page 8 of ? -- END --