BILL ANALYSIS Senate Appropriations Committee Fiscal Summary Senator Christine Kehoe, Chair 1316 (Romero) Hearing Date: 08/12/2010 Amended: 08/02/2010 Consultant: Mark McKenzie Policy Vote: Rev&Tax 3-0 _________________________________________________________________ ____ BILL SUMMARY: SB 1316 would eliminate state tax benefits related to any "like-kind exchange" of California property for out-of-state property for the 2011 calendar year that would otherwise qualify for deferral of capital gains taxes. This bill would also enact a New Markets Tax Credit for qualified investments made in low income communities in the 2011 calendar year. The State Treasurer's Office (STO) would administer the new credit program and allocate credits in an amount equal to the estimated revenue gains resulting from the temporary elimination of specified like-kind property exchanges. _________________________________________________________________ ____ Fiscal Impact (in thousands) Major Provisions 2010-11 2011-12 2012-13 Fund Denial of tax benefits ($2,500) ($3,900) ($600) General (estimated revenue gains) New tax credit revenue loss $2,500 $3,900 $600General CTAC regulations/admin__ $150 ongoing costs offset by fees Special* * California Tax Credit Allocation Fee Account _________________________________________________________________ ____ STAFF COMMENTS: SUSPENSE FILE. AS PROPOSED TO BE AMENDED. Existing federal law, the Internal Revenue Code (IRC) Section 1031, to which California conforms, generally allows taxpayers to defer the payment of capital gains taxes when a qualifying property is exchanged for property of a "like-kind" that is to be held for productive use in a trade or business or for investment. For example, if a taxpayer sells a store and purchases another store or property of the same nature and character any gains or losses from the sale of the store are not realized for taxation purposes until the purchased property is sold or otherwise ultimately disposed of. Like-kind tax treatment does not apply to exchanges of stocks, bonds, or other financial instruments. SB 1316 would prohibit the application of tax deferrals related to like-kind exchanges in which out-of-state property is received in exchange for real property located in California in the 2011 taxable year. The Franchise Tax Board (FTB) estimates that a one-year elimination of like-kind exchange treatment for out-of-state property would result in revenue gains of approximately $7 million. Staff notes that FTB indicates this provision is likely to be subject to a constitutional challenge and could be interpreted by the courts as unlawful discrimination against out-of-state taxpayers under the commerce clause of the U.S. Constitution. Existing federal law provides for a new markets tax credit for taxpayers' qualified equity investments in community development entities, the primary mission of which must be serving, or providing investment capital for low-income communities or low-income persons, as specified. The federal credit is equal to 39% of the qualified equity Page 2, SB 1316 (Romero) investment, and is spread over seven years. The Department of the Treasury administers the program and provides allocations of the federal credits to eligible community development entities through a competitive grant process when Congress makes the credits available. Existing California law provides for a Community Development Financial Institution credit until January 1, 2012, which allows taxpayers to claim a credit equal to 20% of qualified investments in specified financial institutions that have community development as their primary mission. The credit is subject to a 60-month recapture period if the investment is reduced or withdrawn. AB 1316 would enact a new California New Markets Tax Credit Program for the 2011 taxable year, which would allow taxpayers to claim a credit against the personal income tax and the corporation tax equal to 39% of a qualified equity investment in a qualified community development entity (QCDE) that serves low income communities or persons, as specified. This provision is modeled after the federal new markets tax credit. The bill would require the STO to prescribe regulations, guidelines, or procedures to administer the tax credit program, and to allocate the credits to qualifying applicants with priority given to applicant entities that either have a record of successfully providing capital or technical assistance to disadvantaged businesses or communities, or entities that make qualified investments in one or more businesses in which persons unrelated to the entity hold the majority equity interest. AB 1316 provides for recapture of the tax credits within seven years of the investment if the QCDE redeems the investment, the investment ceases to be used in the required manner, or the entity ceases to be a QCDE. The bill also requires FTB to estimate the aggregate revenue increase attributable to the one-year elimination of like-kind exchange treatment for out-of-state property, and limits the amount of tax credits available for allocation by the STO in any calendar year to the amount estimated by FTB. This bill would require the STO to promulgate regulations pursuant to the requirements of the Administrative Procedures Act within a short timeframe. The STO would also be required to certify that applicants qualify as QCDEs, rate and rank applications, and award and allocate grants. STO staff would also monitor projects and investments over nine years to ensure ongoing compliance and to enforce recapture provisions. The STO indicates the bill would require the addition of two AGPA-level staff positions at a cost of $232,000, and significant assistance and time from STO legal and administrative staff, particularly through the regulatory process. Staff estimates that ongoing monitoring would require one PY of dedicated STO staff time. Staff notes that the revenue impact noted in the above table is based upon FTB estimates of the revenues generated as a result of denying like-kind exchange treatment for non-California property in the 2011 calendar year. To the extent that actual revenue generated differs from the estimate, AB 1316 could result in net General Fund revenue gains or losses. The margin of error is unknown, but if actual revenues are 5% less than or greater than estimated revenues, the bill would result in a revenue loss or gain of approximately $350,000 over three years. Proposed author amendments would: (1) specify that the California Tax Credit Allocation Committee (CTAC) would administer the program; (2) authorize CTAC to implementation through guidelines rather than regulations; (3) appropriate $150,000 from CTAC revenues to cover startup costs; and (4) add double-jointing language.