BILL ANALYSIS Senate Appropriations Committee Fiscal Summary Senator Christine Kehoe, Chair 401 (Wolk) Hearing Date: 05/28/2009 Amended: 04/28/2009 Consultant: Mark McKenzie Policy Vote: Rev&Tax 5-2 _________________________________________________________________ ____ BILL SUMMARY: SB 401 would discourage tax avoidance and the use of abusive tax shelters by defining a "potentially abusive tax avoidance transaction" as: (1) a tax shelter; (2) an undisclosed reportable transaction; (3) a listed transaction; (4) an entity, investment plan or arrangement, or other plan or arrangement that has the potential for tax avoidance or evasion, as identified by the Secretary of the Treasury or the Franchise Tax Board; (5) a gross misstatement; or (6) a transaction subject to the noneconomic substance transaction understatement penalty, as specified. _________________________________________________________________ ____ Fiscal Impact (in thousands) Major Provisions 2008-09 2009-10 2010-11 Fund ATS definition consolidation ($2,500) ($6,300) ($8,800)General (penalty revenue gain) ATS-use penalty reduction ($1,000) $9,900 $10,500General and avoidance Staff notes that the fiscal impact does not account for potential increases in tax collections by preventing the use of abusive tax shelters. _________________________________________________________________ ____ STAFF COMMENTS: SUSPENSE FILE. AS PROPOSED TO BE AMENDED. The consolidated definition of "potentially abusive tax avoidance transactions" would apply to the eight-year statute of limitations for filing deficiency assessments related to tax avoidance schemes, the specified abusive-tax-shelter (ATS) use penalty, interest suspension rules that apply to certain taxpayers that have been contacted regarding an ATS, and the authority to issue subpoenas to prevent the marketing of an ATS. The Franchise Tax Board (FTB) estimates that modification of the definition of a "potentially abusive tax avoidance transaction" and its application in various provisions that limit tax avoidance would increase penalty assessments by $10 million annually, based on a workload of 250 cases each year. These penalties would likely be collected over a three-year period because of delays due to the protest process. FTB estimates that half of this amount would be collected in the first calendar year. Staff notes that providing a single, consistent definition for abusive tax shelters would also create administrative efficiencies, enabling FTB staff to pursue additional tax shelter caseload. Under current law, the ATS-use penalty applies if FTB contacts a taxpayer regarding a deficiency that results from the use of an undisclosed reportable transaction, a listed transaction, or a gross misstatement. The penalty is 100 percent of the interest payable up to the date that a notice of proposed deficiency is mailed by FTB. Because the ATS-use penalty is based on the amount of interest on a deficiency, a taxpayer may avoid the penalty by filing an amended return prior to FTB issuing a deficiency notice. SB 401 Page 2 SB 401 (Wolk) would modify the ATS-use penalty by imposing 50 percent of the penalty on taxpayers who file an amended return prior to the issuance of a deficiency notice. FTB currently receives approximately $17 million annually in accelerated revenues from taxpayers that file amended returns to specifically avoid the ATS-use penalty. FTB estimates that some taxpayers would not voluntarily file an amended return because SB 401 allows 50 percent reduction in the penalty. The ATS-use penalty reduction would result in collection of only half of what is currently collected, and a delay in revenue collections of approximately $8.5 million beginning in 2010-11. The full amounts would eventually be collected upon completion of audits in future years. FTB anticipates that some taxpayers currently under audit would file an amended return in the period between the enactment of the bill and the January 1, 2010 operative date in order to avoid the ATS-use penalty. This would accelerate approximately $5 million from audits that would have been completed over the next few years into the first year. This bill would also specify that a legal tax structure of an LLC or an S corporation shall not by itself be "potentially abusive" solely because of the choice of entity. Finally, SB 401 would adopt the federal reportable transaction category for "transactions of interest" for California purposes, and provide similar authority to FTB for determining transactions of interest for California income or franchise tax purposes. Proposed amendments would: Revise the definition of a California transaction of interest to conform to the federal definition. Make clarifying changes to remove the term "potential" from references to "abusive tax avoidance transactions."