BILL ANALYSIS
SB 32 x8
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REPLACE : March 8, 2010 per consultant
SENATE THIRD READING
SB 32 x8 (Wolk)
As Amended March 4, 2010
Majority vote
SENATE VOTE :21-14
REVENUE & TAXATION 6-1 APPROPRIATIONS 10-5
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|Ayes:|Charles Calderon, |Ayes:|De Leon, Ammiano, |
| |Furutani, Coto, Ma, | |Bradford, Charles |
| |Portantino, Chesbro | |Calderon, Coto, Fuentes, |
| | | |John A. Perez, Skinner, |
| | | |Solorio, Torlakson |
| | | | |
|-----+--------------------------+-----+--------------------------|
|Nays:|Hagman |Nays:|Conway, Harkey, Miller, |
| | | |Nielsen, Norby |
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SUMMARY : Changes California's specified date of conformity to
federal income tax law from January 1, 2005, to January 1, 2009,
and thereby, generally conforms to numerous changes made to
federal income tax law during that four-year period.
FISCAL EFFECT : According to the Franchise Tax Board (FTB)
staff, SB 32 x8 has the following revenue effect:
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| Summary Revenue Estimates for SB 32 x8, as Amended February 11, |
| 2010 |
|-----------------------------------------------------------------|
| |
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|------------------------+----------+---------+---------+---------|
|Conformity Provisions | 2009-10 | 2010-11 | 2011-12 | 2012-13 |
|------------------------+----------+---------+---------+---------|
|Tax Revenue Totals | |-$20,600,0|-$21,600,|-$12,600,|
| | -$23,400,000| 00 | 000 | 000 |
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|Penalty and Interest | |$13,000,0| |$18,000,0|
SB 32 x8
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|Totals | $3,400,000| 00 |$16,300,000|00 |
|------------------------+----------+---------+---------+---------|
| Totals of |-$20,000,0|-$7,600,00|-$5,300,0| |
|Conformity Provisions | 00 | 0 | 00 |$5,400,000|
| | | | | |
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COMMENTS : According to the author's office, "SBx8 32 is a
vital measure conforming state tax law to federal tax, and
includes provisions that provide needed relief to struggling
homeowners, ensure that renewable energy projects are not unduly
taxed on federal grants, and provides needed conformity to
federal tax law, easing tax preparation for taxpayers and tax
preparers alike. This measure works to prevent onerous taxation
of distressed Californians who are already struggling to protect
their homes, their largest investment, as many Californians face
foreclosure and are forced to walk away from their homes; the
last thing they should have to think about is paying taxes on
debt they couldn't repay. This measure puts an end to this
onerous application of tax law. Additionally, since tax credits
are never considered income, taxing renewable energy production
grants would treat the renewable energy production industry
inequitably and would add additional costs onto these projects
need for job creation and energy sustainability. It is
important that we avoid this kind of unnecessary roadblock to
economic growth as our state works to rebuild its financial
prosperity."
The importance (and conundrum) of conformity. When changes are
made to the federal income tax law, California does not
automatically adopt such provisions. Instead, state legislation
is needed to conform to most of those changes. Conformity
legislation is introduced either as individual tax bills to
conform to specific federal changes or as one omnibus bill to
conform to the federal law as of a certain date with specified
exceptions, a so-called "conformity" bill.
The last California-federal conformity bill was enacted in 2005
[AB 115 (Klehs), Chapter 691, Statutes of 2005], and for the
last three years, businesses, tax practitioners and state tax
agencies have been advocating for a new bill to conform state
tax laws to ever-changing federal tax laws. Businesses,
generally, prefer conformity to federal tax laws because it
reduces their state tax compliance costs. The tax practitioners
have argued that there are significant costs associated with
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federal non-conformity. Failure to conform to federal law in
some areas may lead to improper tax reporting to California and
extra costs to the taxpayers. As an example, a taxpayer may
roll-over balances in an Archer Medical Savings Account to a new
Health Savings Account without triggering liability at the
federal level, but will unknowingly face penalties for the
transfer since it constitutes a disqualified distribution for
state purposes. Finally, conformity legislation is also
important to state agencies. Conformity eases the burden, and
reduces the costs, of tax administration because the state may
rely on federal audits, federal case law, and regulations.
While state conformity to federal income tax provisions offers
certain advantages and reduces tax compliance costs, it can also
significantly impact state revenues. Thus, it would be
difficult to achieve complete conformity with federal income tax
rules. Often, the Legislature needs to increase tax rates to
find funding to adopt a new or expand an existing credit or
deduction allowed for federal income tax purposes. Tax credits,
deductions, and exemptions are designed to provide incentives
for taxpayers that incur certain expenses or to influence
behavior, including business practices and decisions. Both the
federal and state governments often use tax policy to influence
taxpayers' behavior. However, federal tax incentives may not
necessarily produce the same effect on the taxpayer's behavior
at the state level, if adopted by the state government, as they
do on the federal level. Furthermore, unlike the federal
government, California cannot print money to subsidize its
budget. Therefore, the Legislature must be mindful of fiscal
effects of conforming to federal tax laws, even if those may not
trigger significant fiscal concerns in Congress.
In 2008, AB 1561 (Calderon), required a 2/3 vote of the
membership in each house. AB 1561 did not advance from the
Senate Floor because it failed to secure 27 Senate votes. Last
year, the Legislature approved AB 1580 (Calderon), but the
Governor vetoed it because of a "single provision inserted at
the last minute" that he could not support. The Legislature
continues to struggle with tax conformity and SB 32 x8
represents the most recent attempt to ease the hardship on
taxpayers and tax practitioners by bringing the two tax codes
closer together.
Mortgage Debt Forgiveness. The Legislature approved SB 1055
(Machado), Chapter 282, Statutes of 2008, which provided
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modified conformity to the MFDRA for discharge of mortgage
indebtedness in the 2007 and 2008 tax years. Last year, the
Senate Revenue and Taxation Committee held SB 97 (Calderon),
which extended modified conformity to discharge of mortgage
indebtedness in the 2009 and 2010 tax years, and the Assembly
Revenue and Taxation Committee held AB 111 (Niello), which
provided full conformity to MFDRA. AB 1580, which was vetoed by
the Governor in 2009, would have provided homeowners greater
assistance, not only by extending the mortgage debt forgiveness
provisions until January 1, 2013, but also by increasing the
amount of forgiven mortgage indebtedness excludable from
taxpayer's gross income from $250,000 ($125,000 in the case of a
married individual filing a separate return) to $500,000
($250,000 in case of a married individual filing a separate
return). The same mortgage debt forgiveness provisions are
included in SB 32 x8, tying California law to federal law until
2013. In addition, SB 32 x8 provides for a retroactive
application of those provisions for cancellation of debt income
arising from mortgage debt forgiveness until the 2012 tax year.
Erroneous Refund Penalty. Recently, Congress decided that on
and after May 25, 2007, taxpayers filing an erroneous claim for
refund should face a penalty equal to 20% of the disallowed
amount of the claim, unless the taxpayer shows a reasonable
basis for the refund. The penalty does not apply to any part
of the disallowed amount of the claim that relates to the earned
income credit or on which the accuracy-related or fraud
penalties are charged. The purpose of penalties is to encourage
voluntary compliance. Taxpayers often take aggressive tax
positions, and with taxpayers petitioning FTB for hundreds of
millions of dollars in refund claims each year, failing to
conform to the erroneous refund penalty may encourage California
taxpayers to continue to make tenuous refund claims, especially,
since the Internal Revenue Service (IRS) and many other states
apply the penalty.
When Congress was debating whether or not to enact the erroneous
refund penalty, the Treasury Assistant Secretary for Tax Policy,
Eric Solomon, was asked to testify regarding the penalty before
the Senate Finance Committee on Ways to Reduce the Tax Gap in
2007. In his testimony, he explained that, under current law,
the accuracy-related penalty that a taxpayer might pay,
generally, depends on the amount of underpayment of tax. If a
taxpayer wrongfully claims a refund, however, there is no
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penalty as long as no additional tax liability is attributable
to the wrongful claim, as often happens when there has been
over-withholding. Mr. Solomon stated that "the IRS has observed
aggressive behavior that is undeterred by the tax code's current
accuracy-related penalty framework, which is geared toward
deterrence of reported tax deficiencies. As a practical matter,
some taxpayers and their advisors may be taking advantage of the
existing penalty structure by aggressively claiming credits that
generate refunds, in an effectively risk-free gamble." To
address this problem, the IRS suggested an imposition of a
penalty on an unreasonable claim for refund or credit. As
emphasized by Mr. Solomon, the erroneous refund penalty creates
"a parallel system of deterrence applicable even if the taxpayer
is in a refund, rather than a deficiency, procedural posture,
thus stemming the tide of aggressive claims that are made
without reasonable basis or reasonable cause, regardless of the
procedural context." (Testimony of Treasury Assistant Secretary
for Tax Policy, Eric Solomon, Before the Senate Finance
Committee on Ways to Reduce the Tax Gap,
http://www.treas.gov/press/releases/hp360.htm ).
SB 32 x8 seeks to implement a similar penalty to deter taxpayers
from filing aggressive claims for refund. Opponents of the
erroneous refund penalty, however, assert that the terms of the
penalty, such as "reasonable basis" and "excessive amount" are
undefined, that the penalty disproportionately punishes
taxpayers compared to the amount of noncompliance, and that the
penalty will whipsaw taxpayers that have overstated their
liability in order to avoid the understatement penalty for
understatements in excess of $1 million, among other arguments.
To alleviate the burden of this penalty on individuals who,
generally, are not sophisticated in complicated tax matters, SB
32 x8 (similarly to AB 1580 from last year) provides an
exemption for the vast majority of individuals. Thus,
individuals with adjusted gross income of less than $10 million
(in the case of single/married filing separately taxpayers) or
$20 million (married filing jointly) are not subject to the
erroneous refund penalty under this bill.
Grants for qualified energy property. Federal law allows a
renewable electricity income tax credit for the production of
electricity from qualified energy resources at qualified
facilities. Qualified energy resources generally include wind,
biomass, solar energy, geothermal energy, small irrigation
power, municipal solid waste, qualified hydropower production
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and marine and hydrokinetic renewable energy. To be eligible
for this credit, electricity produced from the qualified energy
resources at qualified facilities must be sold by the taxpayer
to an unrelated person. The production tax credit for
electricity produced from renewable resources is generally
claimed over a 10-year period and is not refundable.
In addition to the renewable electricity production tax credit,
under federal tax law, a taxpayer is allowed to claim a credit
for the investment in certain property. The investment tax
credit includes an energy credit that is allowed for certain
qualifying energy property placed in service. The qualifying
energy property includes certain fuel cell, solar, geothermal
power production, small wind energy property, combined heat and
power system, and geothermal heat pump property. The energy
credit is generally equal to 30% of the taxpayer's basis in
qualified fuel cell property, certain solar energy property, and
wind energy property. It is 10% of the taxpayer's basis in all
other types of qualifying energy property. The investment tax
credit may be claimed entirely in the year the facility is
placed in service.
In February of 2009, Congress enacted, and the President signed,
the American Recovery and Reinvestment Act (ARRA), which, among
other things, allows taxpayers to make an irrevocable election
to treat certain qualified property that is part of a qualified
investment credit facility placed in service in 2009 through
2013 as energy property eligible for a 30% investment credit.
The investment tax credit option may be attractive to tax
investors that are not sure of their tax liability in the future
(the 10-year period). Furthermore, the ARRA authorizes the
Secretary of Treasury to provide a grant to each person who
places in service during 2009 or 2010 energy property that is
either: 1) an electricity production facility otherwise
eligible for the renewable electricity production credit; or, 2)
qualifying property otherwise eligible for the energy investment
tax credit. The grant amount is up to 30% of the basis of the
qualified property. In other words, a taxpayer that elects to
receive the investment tax credit can also elect to receive a
30% grant rather than the 30% tax credit. The ability to
receive the credit or grant in the year in which property is
placed in service helps owners to finance the project.
Congress excluded the grant proceeds from a taxpayer's income
but required that the basis of the property be reduced by 50% of
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the amount of the grant. In addition, some or all of each grant
is subject to recapture if the grant eligible property is
disposed of by the grant recipient within five years of being
placed in service. The provision also permits taxpayers to
claim the credit with respect to otherwise eligible property
that is not placed in service in 2009 and 2010 so long as
construction begins in either of those years and is completed
prior to 2013 (in the case of wind facility property), 2014 (in
the case of other renewable power facility property eligible for
credit under IRC Section 45), or 2017 (in the case of any
specified energy property described in IRC Section 48). Under
the program, if a grant is paid, no renewable electricity credit
or energy credit may be claimed with respect to the grant
eligible property.
The grant program was created to help developers of renewable
energy projects to finance these projects. Often, developers
seek investors that are usually allocated 99% of the income,
gains, losses, deductions and tax credits of the project.
However, in the current economic environment the potential
investors may not have enough tax liability to utilize those
deductions and credits. The creation of the grant program
allows developers to receive a federal subsidy to continue with
the renewable energy projects. Committee staff notes, however,
that it is unclear how a grant paid after the project is placed
in service, i.e. after it is completed, helps taxpayer with
obtaining financing for the project, given the current state of
the financial markets.
In absence of an authorized statute, taxpayers must include the
grant proceeds as income for state purposes. SB 32 x8 excludes
these grants from income because an unexpected tax could cause
project developers to terminate or delay the projects, causing
job losses and less renewable power for the state. SB 32 x8
also conforms to federal law by excluding these grants from
taxpayer's income, requiring the 50% basis adjustment, and
incorporating the recapture provisions of Section 1603(f) of the
ARRA.
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098
FN: 0003742
SB 32 x8
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