BILL ANALYSIS                                                                                                                                                                                                    



                                                                       



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          |SENATE RULES COMMITTEE            |                   SB 401|
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                              UNFINISHED BUSINESS


          Bill No:  SB 401
          Author:   Wolk (D), et al
          Amended:  4/6/10
          Vote:     21

           
          PRIOR VOTE NOT RELEVANT


           SUBJECT :    Tax conformity

           SOURCE  :     Author


           DIGEST  :     Assembly Amendments  delete the Senate version of  
          the bill which provided a single, consistent definition for  
          abusive tax shelters, which will be referred to as an  
          abusive tax avoidance transaction, and adopts the federal  
          reportable transaction category for "transactions for  
          interest.

          This bill generally conforms California personal income  
          tax, corporation tax, and administration of franchise and  
          income tax laws to federal income tax laws as set forth in  
          the Internal Revenue Code (IRC) as of January 1, 2009.  The  
          bill also conforms to one provision of federal tax law  
          enacted in 2009, from the Recovery and Reinvestment Act of  
          2009 by excluding income grants made-in-lieu of federal  
          renewable energy tax credits.  [This bill is substantially  
          similar to SB 32 X8, which was vetoed], SB 401 does not  
          contain the erroneous refund penalty provision of SB 32 X8  
          which the Governor objected in his veto message.

                                                           CONTINUED





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           ANALYSIS :    

          I.  Tax Conformity  

             Although there are many exceptions, California's  
             personal income tax and corporation tax laws are  
             generally patterned after federal law.  In most cases,  
             state legislation is needed to conform to federal law  
             changes.  Over the past five years since the Legislature  
             passed the last conformity bill, significant differences  
             have emerged between state and federal law.  The lack of  
             conformity can be attributed to several factors, some  
             involving fiscal concerns, and others involving policy  
             related issues.

          Specifically this bill:

          1. Conforms or partially conforms to, among other  
             provisions, the following federal provisions relating to  
             the:

             A.    Federal tax treatment of certain disaster  
                mitigation payments.  The Disaster Mitigation  
                Payments Act.

             B.    Federal treatment of electric transmission  
                property, certain atmospheric pollution control  
                facilities, nuclear decommissioning cost, natural gas  
                distribution lines, natural gas gathering lines, and  
                amortizable Internal Revenue Code (IRC) Section 197  
                intangibles. The Energy Tax Incentives Act of 2005.

             C.    Effective date of exception from suspension rules  
                for certain listed and reportable transactions and  
                tax technical provisions of the Gulf Opportunity Zone  
                Act of 2005.

             D.    Modification of active business definition under  
                IRC Section 355, treatment of loans to qualified  
                continuing care facilities, distributions involving  
                disqualified investment companies, taxation of  
                certain settlement funds, capital gains treatment for  
                certain self-created musical works, amortization of  
                expenses incurred in creating or acquiring music or  







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                music copyrights, and the application of earnings  
                stripping rules to partners that are corporations.   
                The Tax Increase Prevention and Reconciliation Act of  
                2005 and the Tax Relief and Health Care Act of 2006.

             E.    Clarification of treatment of self-employment for  
                purposes of the limitation on state taxation of  
                retirement income.  The Clarification of Treatment of  
                Self-Employment for Purposes of the Limitation on  
                State Taxation of Retirement Income.

             F.    Reform of funding for self-employed defined  
                benefit pension plans, funding rules for  
                multiemployer defined benefit pension plans, and  
                general reforms of charitable contribution reporting.  
                 The Pension Protection Act of 2006 (PPA).

             G.    Inflation indexing of gross income limitations on  
                certain retirement savings incentives and allowance  
                of additional Individual Retirement Account (IRA)  
                payments in certain bankruptcy cases.

             H.    Waiver of the early withdrawal penalty for  
                distributions made from a governmental plan to a  
                qualified public safety employee and penalty-free  
                withdrawals from retirement plans for individuals  
                called to active duty. 

             I.    Modified treatment of certain charitable  
                contributions and reporting by exempt organizations.

             J.    Frivolous tax submissions, sale of property by  
                judicial officers, and exclusion of gain from sale of  
                principal residence by certain employees of the  
                intelligence community.

                 (1)       Federal extension of mortgage debt  
                    forgiveness until January 1, 2013, modified to  
                    increase the state's limitation on the amount  
                    that can be excluded from gross income from  
                    $250,000 (or $125,000 in the case of a married  
                    individual/RDP filing a separate return) to  
                    $500,000 (or $250,000 in the case of a married  
                    individual/RDP filing a separate return).  The  







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                    Mortgage Forgiveness Debt Relief Act (MFDRA),  
                    P.L. 110-343, Division A, Title III, Section  
                    303 and the Emergency Economic Stabilization  
                    Act of 2008 (EESA).

                 (2)       Exclusion from income for benefits  
                    provided to Emergency Medical Services  
                    volunteers and firefighters.

                 (3)       Increase in age of minor children whose  
                    unearned income is taxed as if it is parents'  
                    income.

                 (4)       Federal penalty on understatement of a  
                    taxpayer's liability by a tax return preparer,  
                    in modified conformity, to incorporate the  
                    federal rule that the penalty will be the  
                    greater of a base amount ($250 for the  
                    first-tier penalty and $5,000 for the  
                    second-tier penalty) or 50 percent of the  
                    income derived (or to be derived) by the tax  
                    return preparer.

                 (5)       Special rule encouraging contribution of  
                    capital gain real property for conservation  
                    purposes, dedication of endangered species  
                    recovery expenditures, depreciation schedule  
                    for race horses, and information reporting for  
                    commodity credit corporation transactions.   
                    Heartland, Habitat, Harvest, and Horticulture  
                    Act of 2008.

                 (6)       Special tax treatment of distributions,  
                    contributions, exclusions, and disposition of  
                    amounts paid to, or made by, individuals called  
                    to active duty, other service members, and  
                    employees of the Intelligence Community.  The  
                    Heroes Earnings Assistance and Relief Tax Act  
                    of 2008.

                 (7)       Various tax incentives related to the  
                    low-income housing tax credit.  The Housing and  
                    Economic Recovery Act of 2008.








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                 (8)       Special rules for tax treatment of  
                    executive compensation of employers  
                    participating in the Troubled Assets Relief  
                    Program, modified tax treatment of certain  
                    payments to controlling exempt organizations,  
                    and charitable contributions of property.

                 (9)       Treatment of certain reimbursements from  
                    governmental plans for medical care and  
                    modification of penalty for failure to file  
                    partnership and "S" corporation returns.  The  
                    Worker, Retiree, and Employer Recovery Act of  
                    2008.

                 (10)      Exclusion from gross income for energy  
                    property grants provided to a taxpayer by the  
                    Secretary of Treasury for qualified property  
                    placed in service during either 2009 or 2010  
                    year. 

          2. Provides that the state shall not conform to certain  
             federal provisions, including, among others:

             A.    The seven-year recovery period for motor sports  
                racing track facilities.

             B.    The five-year recovery period for certain farming  
                business machinery and equipment.

             C.    The enhanced charitable deductions for  
                contributions of food inventory.

             D.    The enhanced charitable deductions for  
                contributions of book inventory.

             E.    The federal changes made to the determination of a  
                small refiner for purposes of the depletion  
                deduction. 

          3. Takes effect on or after January 1, 2011.

          II.  Renewable Energy Grants  

             Federal law allows an income tax credit for the  







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             production of electricity from qualified energy  
             resources at qualified facilities.  Congress enacted and  
             the President signed the American Recovery and  
             Reinvestment Act (ARRA), which 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 credit.  In lieu of the tax credits, ARRA allows  
             for the exclusion of the grant proceeds from a  
             taxpayer's federal income.  However, the basis of the  
             property is reduced by fifty percent of 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 provision, if a grant is paid, no renewable  
             electricity credit or energy credit may be claimed with  
             respect to the grant eligible property.  However, in  
             absence of an authorized statute, taxpayers must include  
             the grant proceeds as income for state purposes.  This  
             bill excludes these grants from income for 2009-2010 tax  
             year, because an unexpected tax could cause project  
             developers to terminate or delay the projects, causing  
             job losses and less renewable power for the state.  This  
             bill additionally conforms to federal law by excluding  
             these grants from state income and requiring the 50  
             percent basis adjustment.

          III.  Mortgage Debt Forgiveness  .

             The Legislature approved SB 1055 (Machado), Chapter 282,  
             Statutes of 2008, which provided modified conformity to  
             the MFDRA for discharge of mortgage indebtedness in the  
             2007 and 2008 tax years.  Last year, the Senate Revenue  







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             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.

           Similar/Prior Legislation
           
          AB 115 (Klehs), Chapter 691, Statutes of 2005, was  
          California's last federal conformity bill.

          AB 1561 (Calderon), which would have conformed state law to  
          federal income tax law changes up through December 31,  
          2007, failed passage on the Senate Floor in 2008 on a vote  
          of 24-16.  That bill would have resulted in an increase in  
          state tax revenue, triggering the 2/3 vote requirement in  
          Article XIIIA of the State Constitution.

          AB 1580 (Calderon), which was vetoed by the Governor last  
          year, was the most recent attempt to ease the hardship on  
          taxpayers and practitioners by bringing the federal and  
          state tax codes closer together.  The Governor's veto  
          message indicated an unwillingness to sign a conformity  
          bill that does not reflect consensus, while noting a  
          specific objection to a conformity provision related to  
          penalties on erroneously claimed tax refunds.  

          SB 32 x8 (Wolk), 2009-10 introduced in the 8th  
          Extraordinary Session, is identical to SB 401 but for one  
          provision - an erroneous refund claim penalty.  SB 32 x8  







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          was passed by both the Assembly and the Senate but was  
          vetoed by the Governor on March 25, 2010.

           FISCAL EFFECT  :    Appropriation:  No   Fiscal Com.:  Yes    
          Local:  Yes

          According to the Franchise Tax Board (FTB) Analyses, the  
          bill will result in a decrease in tax revenues and  
          offsetting increases in interest and penalties.  The net  
          impact is estimated by FTB to be revenue losses of $28  
          million in 2009-10; 14.0 million in 2010-11, and $15.0  
          million 2011-12, and a loss of $5.5 million in 2012-13.

           SUPPORT  :   (Verified  4/7/10)

          American Federation of State, County and Municipal  
          Employees, AFL-CIO
          BrightSource Energy
          California Bankers Association
          California Chamber of Commerce
          California Conference Board of Amalgamated Transit Union
          California Conference of Machinists
          California Manufacturers and Technology Association
          California School Employees Association
          California Society of Enrolled Agents
          California Tax Reform Association
          California Taxpayers' Association
          California Teamsters Public Affairs Council
          California Wind Energy Association
          Calpine Corporation
          Center for Responsible Lending
          Coast Longshore Division
          Engineers and Scientists of California, Local 20,  
          IFPTFL-CIO &CLC
          Independent Energy Producers
          Western States Petroleum Association
          International Longshore and Warehouse Union
           Laborers International Union of North America, AFL-CIO 
          Professional and Technical Engineers, Local 21IFPTEAFL-CIO
          Service Employees International Union
          Strategic Committee of Public Employees, Pacific Southwest  
          Region
          Tech America
          Terra-Gen Power







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          Unite Here International Union, AFL-CIO, United Food and  
          Commercial Workers Western States Council

           OPPOSITION  :    (Verified  4/7/10)

          Howard Jarvis Taxpayers Association

           ARGUMENTS IN SUPPORT  :    According to the author's office,  
          "SB 401 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."


          DLW:do  4/7/10   Senate Floor Analyses 

                         SUPPORT/OPPOSITION:  SEE ABOVE

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