BILL ANALYSIS                                                                                                                                                                                                    




            SENATE REVENUE & TAXATION COMMITTEE

            Senator Lois Wolk, Chair

                                                      SB 876 - Florez

                                              Amended: January 10, 2010

                                                                       

            Hearing: May 12, 2010      Tax Levy         Fiscal: Yes




            SUMMARY:  Conforms California Law to Federal Law to Allow  
                      Taxpayers to Carry Back and Carry Forward Net  
                      Operating Losses from Investment Fraud Schemes.


                      

                 EXISTING LAW authorizes net operating loss deductions,  
            where taxpayers that generate a loss in one taxable year  
            may use that loss to deduct income from another taxable  
            year.  Current law allows limited net operating loss (NOL)  
            carrybacks to the preceding two taxable years, and extended  
            carry-forwards to 20 years for net operating losses  
            attributable to 2010 and later (AB 1452, Committee on  
            Budget, 2008).  Also, that measure limited a taxpayer with  
            net business income greater than $500,000 from applying  
            deductions for net operating loss carryforwards and tax  
            credits to 50% of liability for the 2008 and 2009 taxable  
            years.  

                 EXISTING FEDERAL LAW provides, in general, that a NOL  
            can be carried back 2 years and forward 20 years and  
            deducted.  Special rules are provided for the carryback of  
            NOLs relating to issues such as specified liability losses,  
            casualty or theft losses, disaster losses of a small  
            business, and farming losses.











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                 Recent changes in federal law extend the carryback  
            period up to five years for specified losses. The American  
            Recovery and Reinvestment Act allows certain taxpayers to  
            make an irrevocable election to carry back applicable 2008  
            losses for up to 5 years.  The Worker, Homeownership, and  
            Business Assistance Act of 2009 allows taxpayers, other  
            than taxpayers that received benefits under the Troubled  
            Asset Relief Program, with business losses to make an  
            irrevocable election to carry back losses incurred in one  
            year (ending after 2007 and beginning before 2010) for up  
            to 5 years. 



                 In March, 2009 the Internal Revenue Service (IRS)  
            issued Revenue Ruling 2009-9 and Revenue Procedure 2009-20.  
             Revenue Ruling 2009-9 defines losses on fraudulent  
            investment schemes as business losses; a NOL resulting from  
            a fraudulent investment loss is eligible for the extended  
            NOL carryback period.  Revenue Procedure 2009-20 provides a  
            safe-harbor method of computing and reporting the losses. 

                 


                 

                 THIS BILL would conform California to federal law with  
            respect to the net operating loss carryback and  
            carryforward treatment currently allowed under the Internal  
            Revenue Code for Ponzi-like scheme investment fraud. 

                 Specifically, this bill: 


                   Allows the "safe harbor" treatment for determining  
                 a fraudulent investment loss as set forth in the IRS's  
                 Revenue Procedure 2009-20, when the same procedures  
                 are applied for both state and federal purposes. 
                   Allows a state NOL resulting from the application  
                 of the terms of the Revenue Procedure the same  
                 carryback and carryforward periods as would be allowed  








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                 by federal law for the same tax year and would conform  
                 by reference to the federal statute of limitations  
                 rules with respect to NOL carrybacks for losses  
                 attributable to application of the Revenue Procedure.

                   Exempts NOLs arising from a fraudulent investment  
                 loss from the existing suspension period.

                    Precludes the Franchise Tax Board (FTB) from  
                 challenging the treatment of a loss determined under  
                 the terms of the Revenue Procedure.




            FISCAL EFFECT:  
                 The Franchise Tax Board (FTB) estimates that this bill  
            would result in a revenue loss of $9.9 million in fiscal  
            year (FY) 2009-10, $8.7 million in FY 2010-11, $500,000 in  
            FY 2011-12 and $30,000 in FY 2012-13. 




            COMMENTS:

            A. Purpose of Bill 

                 The author provides the following statement: 

                 "SB 876 is a tax relief measure that will return  
            erroneously paid tax dollars back to victims of Ponzi  
            schemes.  

                 During these tough economic times, several people have  
            fallen victim to fraudulent money schemes.  The most  
            prevalent being the Bernard Madoff Ponzi scheme.  While  
            there has been much attention given to the prominent names  
            of investors who were hurt by the Madoff scandal, there are  
            many people of average means in California who invested  
            with Bernard Madoff Investment Securities and are now  
            facing devastating financial futures.  








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                 The other untold story is that several of these  
            victims paid taxes on income they never received.  

                 The IRS has recognized the additional losses suffered  
            by these victims and has provided major tax relief to  
            qualified investors that paid taxes on phantom income -  
            income they never received due to fraud.   Unfortunately,  
            California's tax code does not afford similar relief.   

                 SB 876 would conform California's tax code to the  
            federal rulings and procedures so that victims in  
            California will be treated similarly on their state tax  
            returns as they would on their federal returns.  In  
            essence, this tax relief measure will ensure that the State  
            does not victimize these folks once again."



            B.  Background


                 On March 17, 2009, in response to the losses  
            resulting from the collapse of Bernard Madoff's  
            decades-long Ponzi scheme, the IRS issued Revenue Ruling  
            2009-9 and Revenue Procedure 2009-20 to provide guidance  
            to taxpayers who are victims of fraudulent investment  
            schemes.


                 The Revenue Ruling clarifies the income tax law  
            governing the treatment of losses from such schemes,  
            including the nature of such losses (theft losses), the  
            amount of such losses to be allowed, and the year of  
            deductibility.  The Revenue Procedure simplifies  
            compliance procedures for taxpayers by providing an  
            optional safe-harbor means of determining the year in  
            which the losses are deemed to occur, and a simplified  
            method of computing the amount of the loss.

                 Federal and state laws are generally the same with  
            respect to the deduction of theft losses.  In general,  








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            where state law is in substantial conformity with the  
            Internal Revenue Code, federal regulations, rulings and  
            procedures are applicable for state purposes.   
            Accordingly, Revenue Ruling 2009-9 and Revenue Procedure  
            2009-20 are applicable for state purposes to the extent  
            federal and state laws are the same.

                 However, California law does not currently allow  
            carrybacks of NOLs generated prior to the 2010 tax year,  
            and carryforwards of such losses have been suspended  
            until the 2010 tax year. (NOL carrybacks to the  
            preceding two taxable years will be allowed for  
            operating losses attributable to 2010 and later.)  
            Consequently, victims of Ponzi schemes that claim net  
            operating loss carrybacks on their federal returns in  
            accordance with Revenue Ruling 2009-9 and Revenue  
            Procedure 2009-20 cannot claim comparable carrybacks for  
            California purposes, and may be unable to use  
            carryforwards as allowed under Federal law until 2010. 

                 SB 876 would conform California to Federal law with  
            respect to the NOL carryback and carryforward treatment  
            currently allowed under the Internal Revenue Code.



            C.  Slippery Slope?

                  Under the recently issued IRS rules, victims of the  
            Madoff Ponzi scheme are receiving some favorable federal  
            tax treatment that is allowing them to recover at least  
            some of their losses.  This kind of relief is unusual, as  
            in most cases where people lose property in a casualty or  
            theft-related loss there aren't special exceptions and new  
            rules that apply under the tax code.  There have been many  
            Ponzi schemes, including the eponymous Charles Ponzi and  
            the match-king of Sweden, Ivar Krueger, before which  
            cheated many people out of money, reporting fake income,  
            and now have nothing to show but their losses.  Also,  
            ordinary taxpayers who haven't necessarily invested in a  
            Ponzi scheme, but have lost money in cases like AIG,  
            suffered capital losses that appeared theft-like. It is a  








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            slippery slope to pass laws and rules intended to protect  
            just one class of taxpayers. The committee may wish to  
            consider if SB 876 amends the California tax code to favor  
            one group of taxpayers over another, thereby making the tax  
            code less fair overall.  

            


            Support and Opposition

                 Support:            None received.



                 Oppose:None received.



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            Consultant: Meg Svoboda