BILL ANALYSIS ------------------------------------------------------------ |SENATE RULES COMMITTEE | AB 2671| |Office of Senate Floor Analyses | | |1020 N Street, Suite 524 | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ------------------------------------------------------------ THIRD READING Bill No: AB 2671 Author: Cook (R), et al Amended: 7/15/10 in Senate Vote: 21 SENATE REVENUE & TAXATION COMMITTEE : 3-0, 6/23/10 AYES: Wolk, Alquist, Padilla NO VOTE RECORDED: Walters, Ashburn SENATE APPROPRIATIONS COMMITTEE : 11-0, 8/12/10 AYES: Kehoe, Ashburn, Alquist, Corbett, Emmerson, Leno, Price, Walters, Wolk, Wyland, Yee ASSEMBLY FLOOR : 72-0, 5/20/10 (Consent) - See last page for vote SUBJECT : Corporation taxes: minimum franchise tax: Armed Forces SOURCE : Author DIGEST : This bill exempts, until taxable years beginning on or after January 1, 2018, a corporation and a limited liability company that are small businesses solely owned by a deployed member of the United States Armed Forces, as specified, from paying the minimum franchise tax, or the annual tax, for the privilege of doing business in this state if the corporation ceases operation or operates at a loss, as defined. CONTINUED AB 2671 Page 2 ANALYSIS : Corporations and limited liability companies (LLCs) must annually pay to the state a minimum franchise tax of $800. This liability exists regardless of whether the corporation is earning income. Businesses incorporating after January 1, 2000 are not subject to the minimum franchise tax for their first taxable year. This bill exempts corporations and LLCs that are small businesses solely owned by a deployed member of the United States Armed Forces from the minimum franchise tax and the annual LLC tax, respectively, if the corporation or LLC ceases operation or operates at a loss. This bill requires the Franchise Tax Board (FTB) to promulgate regulations to provide for a definition of "ceases operation" for purposes of this bill. This bill provides the following definitions: "Deployed" means being called to active duty or active service during a period when a Presidential Executive order specifies that the United Sates in engaged in combat or homeland defense. "Deployed" does not include temporary duty for the sole purpose of training or processing or a permanent change of station. "Operates at a loss" means negative net income as defined in Section 24341 of the Revenue and Taxation Code. "Small business" means a corporation or LLC with total income of $250,000 or less. Background The minimum franchise tax was enacted to ensure that all corporations pay at least a minimum amount of franchise tax for the privilege of doing business in this state, regardless of the corporation's income or loss. Thus, the minimum franchise tax is not technically an "income tax", but rather it is a tax on the right to exercise the powers granted to a corporation doing business in California. Even when a corporation earns no income, it still receives the benefits of its corporate status, including the limited liability protection under the laws of this state. AB 2671 Page 3 California's minimum tax was increased from $100 to $200 in 1972. It was increased to $300 in 1987, to $600 in 1989, and to $800 in 1990. Limited exceptions exist with respect to imposition of the minimum franchise tax. For instance, credit unions and nonprofit organizations are not subject to the minimum franchise tax and a corporation is not subject to the minimum franchise tax for its first taxable year. However, even though a corporation is not subject to the minimum tax in its first taxable year, it will be subject to franchise tax in its first taxable year based on its taxable income. Limited partnerships and limited liability partnerships that are doing business in California, registered or qualified to do business in California, or formed in this state are also subject to the $800 annual tax. Like LLCs and S-corporations, these are "pass-through" entities and are not subject to any tax based on their taxable income. Rather, the items of income, gain, loss, deduction and credit are passed-through to the owners and reported on their respective income or franchise tax returns. However, by definition, partnerships cannot be "solely owned" small businesses and subsequently are excluded from this bill. Comments The purpose of this bill is to provide tax relief to members of the United States Armed Forces called to service to defend the nation. Minimum tax in other states . According to the Franchise Tax Board, the following states currently impose a minimum franchise tax: 1. Illinois has a minimum one percent tax based on "paid-in" capital (calculated using the shares of stock issued by the corporation as disclosed in the annual statement reported to the Illinois Secretary of State). The tax ranges from a minimum of $25 to a maximum of $1 million. 2. Massachusetts imposes the greater of a corporate excise tax of 9.5 percent based on taxable income or a minimum tax equal to $456. AB 2671 Page 4 3. Beginning January 1, 2008, Michigan taxpayers are subject to the Michigan Business Tax. The Michigan Business Tax is composed of two taxes: a business income tax of 4.9 percent on every taxpayer with business activity in the state, and a modified gross receipts tax of 0.80 percent on every taxpayer having nexus with Michigan. 4. Minnesota imposes a franchise tax on a corporation's taxable income at the rate of 9.8 percent. In addition, a minimum franchise tax, ranging from $0 to $5,000, is imposed based on the sum of the property determined by property, payroll, and sales in the state. 5. New York imposes a franchise tax of 7.1 percent based on net income plus a fixed dollar minimum tax based on gross payroll. The fixed dollar minimum tax ranges from $100 to $1,500. The author states, "The Franchise Tax Board's minimum annual tax for all corporations, including S-corps, C-corps, partnerships, and LLC's is set at $800 per fiscal year. Regardless of the profitability of the business entity, this annual tax is a 'cost of doing business in California' fee, no matter the circumstance. Present law does not account for the unique situations that arise from deployments of service members answering the call of duty to country. Military service members on active or reserve duty who are either major share holders of these business entities, are self employed by the corporation but are deployed and cease to do business, or operate in the negative during the span of their deployment, or any combination thereof, are equally (and unfairly) required to pay the $800 minimum franchise tax fee. " FISCAL EFFECT : Appropriation: No Fiscal Com.: Yes Local: No Senate Appropriations Committee staff notes that the fiscal impact of this bill depends upon the number of small business owners who are deployed in a given year, and whose business either operates at a loss or ceases operation in a taxable year. FTB estimates that approximately 60 small AB 2671 Page 5 corporations and LLCs owned by deployed United States Armed Forces members would either cease operation or operate at a loss in a given year, which would result in an annual revenue loss of $48,000. Actual losses are indeterminable, based on available data, and could be somewhat higher. SUPPORT : (Verified 8/17/10) American Legion, Department of California AMVETS, Department of California Vietnam Veterans of America, California State Council ASSEMBLY FLOOR : AYES: Adams, Ammiano, Anderson, Arambula, Bass, Beall, Bill Berryhill, Tom Berryhill, Blakeslee, Block, Blumenfield, Bradford, Brownley, Buchanan, Caballero, Charles Calderon, Carter, Chesbro, Conway, Cook, Coto, Davis, De Leon, DeVore, Emmerson, Eng, Feuer, Fong, Fuentes, Fuller, Furutani, Gaines, Galgiani, Garrick, Gilmore, Hagman, Hall, Hayashi, Hernandez, Hill, Huber, Huffman, Jeffries, Jones, Knight, Lieu, Logue, Bonnie Lowenthal, Ma, Mendoza, Miller, Monning, Nestande, Niello, Nielsen, Norby, V. Manuel Perez, Portantino, Ruskin, Salas, Saldana, Silva, Skinner, Smyth, Solorio, Audra Strickland, Swanson, Torlakson, Torres, Torrico, Tran, Yamada NO VOTE RECORDED: De La Torre, Evans, Fletcher, Harkey, Nava, Villines, John A. Perez, Vacancy DLW:mw 8/17/10 Senate Floor Analyses SUPPORT/OPPOSITION: SEE ABOVE **** END ****