BILL ANALYSIS
AB 1936
Page 1
Date of Hearing: May 3, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
AB 1936 (De Leon) - As Introduced: February 17, 2010
2/3 vote. Tax levy. Fiscal committee.
SUBJECT : Income taxation: deductions: repeal of the net
operating loss carrybacks.
SUMMARY : Disallows the use of net operating loss (NOL)
carrybacks by individual and corporate taxpayers. Specifically,
this bill :
1)Repeals the provisions allowing NOL incurred on or after
January 1, 2011 to be carried back to offset the taxpayer's
income during the two prior tax years, under both the personal
income tax (PIT) and the corporation tax (CT).
2)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW :
1)Allows a taxpayer to carry an NOL back two years and forward
20 years.
2)Provides special rules for the carryback of NOLs relating to
specified liability losses, casualty or theft losses, disaster
losses of a small business, and farming losses.
3)Allows an eligible small business to elect to increase the NOL
carryback period from two years to three, four, or five years
for NOLs arising in tax years ending after December 31, 2007
or beginning in 2008. An "eligible small business" is one
that meets a $15 million (or less) gross receipts test for the
taxable year in which the loss arose.
EXISTING STATE LAW :
1)Allows a California taxpayer to calculate its NOL in
accordance with federal rules. Limits, for NOLs attributable
to taxable years beginning before January 1, 2008, the
carryforward period to 10 years in circumstances where federal
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law allows 20 years. However, for NOLs attributable to
taxable years beginning on or after January 1, 2008, the
applicable carryforward period is 20 years.
2)Conforms to the federal law allowing NOL carryback for NOLs
attributable to taxable years beginning on or after January 1,
2011, with the following modifications:
a) An NOL may be carried back only two years.
b) The amount of NOL carryback attributable to taxable year
2011 is limited to 50% of the NOL.
c) The amount of NOL carryback attributable to taxable year
2012 is limited to 75% of the NOL.
3)Conforms to federal law disallowing carryback of NOLs for a
Real Estate Investment Trust (REIT) and to a corporate equity
reduction interest loss, which is zero.
FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates
that this bill would result in an annual gain of $25 million in
fiscal year (FY) 2010-11, $250 million in FY 2011-12, and $145
million in FY 2012-13.
COMMENTS :
1)Author's Statement . The author states that, "Due to our
ongoing state budget deficit, I believe we need to reassess
the corporate tax giveaways that have been enacted over the
last few years and repeal those that neither generate economic
activity nor assist in the economic recovery of our state.
"In 2008, as part of the state budget, corporations were given
authorization for net operating loss (NOL) carrybacks. For
the first time in California's history, starting in the 2011
tax year, corporations will be permitted to write-off their
losses to offset income in the prior two tax years. This
corporate tax giveaway should be repealed before it takes
effect - it will cost our state over $500 million/year in
desperately-needed tax revenue and interject substantial new
volatility into our budget process."
2)Arguments in Support . The proponents of this bill state that
eliminating NOL carrybacks would close the tax loophole for
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businesses and individuals that the state cannot afford.
Allowing NOL carrybacks gives taxpayers a refund for taxes
previously paid, which destabilizes the budget process. The
proponents also argue that as a matter of tax policy, there is
no economic justification for allowing NOL carrybacks; rather,
it is a pure tax giveaway.
3)Arguments in Opposition . The opponents of this bill state
that the NOL deduction resolves an inequity in our tax
structure. They state that the NOL carryback is particularly
important for keeping struggling businesses afloat, but it
also "critical for start-up businesses that are often
inconsistently profitable during their first few years and
need help to get off the ground." Finally, the opponents
contend that rescinding the NOL carryback deduction would
"undermine employers' faith in the [state's] commitment to
keeping employers in the state, and would "hinder the state's
economic recovery by discouraging investment and growth."
4)Background . On September 30, 2008, the Governor signed into
law AB 1452 (Budget Committee), Chapter 763, Statutes of 2008,
to implement provisions of the 2008-09 Budget Agreement.
Among other things, AB 1452 suspended the NOL deduction for
the 2008 and 2009 tax years, except for taxpayers with net
business income of less than $500,000 in either year,
authorized NOL carrybacks for losses incurred in 2011 or later
tax years, and expanded the NOL carryforward period from 10
years to 20 years for losses incurred after January 1, 2008.
Under AB 1452, taxpayers are able to use carrybacks to offset
their income during the two prior tax years. The carryback
provisions are scheduled to phase in, with 50% of any 2011
NOLs available for carryback, 75% of any 2012 NOLs, and full
carryback for NOLs in subsequent years. This bill would
repeal the NOL carryback provisions enacted by AB 1452.
5)What is a NOL ? An NOL is the excess of allowable deductions
over gross income, computed under the law in effect for the
loss year, with certain adjustments. The NOL carryback is
generally that portion of the NOL that has not been previously
applied against income for other years. Under federal law,
nearly every taxpayer is allowed to carry back an NOL from a
trade or business to apply as a deduction against income in
prior taxable years. Generally, NOLs can be carried back to
the two years preceding the loss year and then forward to the
20 years following the loss year.
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6)Carryback, is it good policy? The basic rationale for
allowing losses to be carried back flows from a recognition
that businesses are established with the goal of making a
profit over a business cycle rather than in any particular
year. A 12-month period is not always best suited for
measuring a firm's net income for tax accounting purposes.
This is especially true for businesses with a long business
cycle. For example, if a business receives most of its income
in the first year of a three-year contract and then spreads
most of its costs over the remaining two years, tax liability
will be incurred in its first year of operation even if the
company turns out to be unprofitable over the course of the
three year business cycle. In this example, the company pays
a higher effective tax rate because of its longer business
cycle. Therefore, economic theory demonstrates that a
suitably long carryback period for NOL deductions helps to
smooth out income and taxes paid over a business cycle,
thereby allowing a business to make efficient decisions
regarding financing and investment. According to the
Congressional Research Service (CRS), the average business
cycle is approximately six years. This, of course, is an
average; other industries may have a much shorter business
cycle. Therefore, arguably, the time period within which an
NOL is allowed to be carried back should be tailored to the
particular business cycle of a particular industry.
According to the CRS report Net Operating Losses: Proposed
Extension of Carryback Period, the majority of the tax burden
falls on risky investments. As a way of easing this burden,
NOLs are allowed to be carried back, effectively creating a
partnership between the taxpayer and the government. This
allows the government to share both the return on investment
(tax revenue) and the risk of investment (revenue loss). A
refund, as a means of sharing investment risk, provides a firm
with cash flow, which helps pay for business expenses during
tough economic times. The ability to carryback an NOL is
particularly important for businesses that have historically
generated taxable income, but may currently be experiencing
losses. Additionally, an NOL carryback may provide for a
cheap source of funds in an economy with restrictive credit.
Although there is strong justification for a carryback
provision as a method of averaging business income over time
and as a way of reducing investment risk, there is
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disagreement over its ability to stimulate the economy. As
reported by the CRS, a dollar of NOL carryback translates into
a gross domestic product (GDP) increase between $0 and $0.40;
whereas a dollar increase in Federal government purchases
increases GDP by between $1.00 and $2.50. (Id. at 5). In
terms of economic stimulus, it is important to understand the
differences between the state and federal governments. The
federal government, unlike the state government, is able to
stimulate the economy because of its ability to run deficits.
Because of this, the federal government is able to provide for
a carryback deduction without having to offset the cost. The
state, on the other hand, is required to fund a carryback
deduction by eliminating government spending in other areas.
The ability to run deficits allows the federal government to
maintain or increase spending, whereas the state government
simply shifts funds from one program to another. Therefore,
the stimulating effect that a carryback provision would have
at the federal level does not apply at the state level.
Businesses may argue that repealing NOL carryback deductions
would be especially difficult during tough economic times
since refunds provide a valuable and predictable source of
revenue. According to the Center on Budget and Policy
Priorities analysis in Minority of States Still Granting Net
Operating Loss "Carryback" Deductions Should Eliminate Them
Now, business profits drop more sharply relative to a drop in
economic activity because of the slow reaction time during
economic downturns. When business profits decline sharply
during economic downturns, state tax revenue from business
profits also drop sharply. Without ignoring the rationale for
NOL carryback deductions, the state can still provide some
economic benefits by continuing to allow NOLs to be carried
forward.
Furthermore, under the "benefits received principle," it has
been argued that a business benefits from state programs,
infrastructure, protection of property and other activities
that facilitate the operation of business, and therefore,
should compensate the government for services rendered.
Allowing NOLs to be carried forward and backwards may be good
tax policy, but should unprofitable businesses be able to
enjoy the services without compensating the state for, at
least a portion of, those services? The sharp drop in state
tax revenue has made it difficult for California to fund the
programs and services needed for the operation of business.
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Thus, it may be impossible for the state to maintain basic
government services while providing refunds to businesses.
7)Related Legislation .
SB 76 (Committee on Budget), introduced in the current
legislative session, would have repealed the NOL carryback
provisions and the assignment of tax credits among the
affiliated members of a combined group. SB 76 was placed on
inactive file.
AB 1452 (Committee on Budget), Chapter 763, Statutes of 2008,
among other tax benefits, expanded the NOL carry forward
period from 10 years to 20 years for loses incurred after
January 1, 2008, and authorized two-year NOL carrybacks for
losses incurred in 2011 or later tax years.
REGISTERED SUPPORT / OPPOSITION :
Support
American Federation of State, County and Municipal Employees,
AFL-CIO
California Immigration Policy Center
California Tax Reform Association
National Association of Social Workers
Opposition
California Chamber of Commerce
California Hospital Association
California Manufacturers and Technology Association
California Taxpayers' Association
Analysis Prepared by : Carlos Anguiano / Oksana Jaffe / REV. &
TAX. / (916) 319-2098