BILL ANALYSIS ------------------------------------------------------------ |SENATE RULES COMMITTEE | SB 401| |Office of Senate Floor Analyses | | |1020 N Street, Suite 524 | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ------------------------------------------------------------ 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 SB 401 Page 2 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 SB 401 Page 3 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 SB 401 Page 4 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. SB 401 Page 5 (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 SB 401 Page 6 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 SB 401 Page 7 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 SB 401 Page 8 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 SB 401 Page 9 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 **** END ****