BILL ANALYSIS Ó
AB 1369
Page 1
Date of Hearing: May 9, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 1369 (Gatto) - As Introduced: February 18, 2011
REVISED
2/3 vote. Tax levy. Fiscal committee.
SUBJECT : Personal income and corporation taxes: deductions:
illegal activities.
SUMMARY : Disallows deductions for expenses attributable to
income derived by a taxpayer from specified illegal activities.
Specifically, this bill :
1)Expands existing law by additionally denying deductions for
expenses, including deductions for costs of goods sold,
attributable to the taxpayer's gross income directly derived
from certain criminal profiteering activities. Specifically:
a) Describes the criminal profiteering activities to
include any act or omission punishable under the
"California Control of Profits of Organized Crime Act" of
Penal Code (PC) Section 186.2, dealing with a controlled
substance enumerated in the Health and Safety Code, and
unlawful referrals (insurance fraud) specified in the
Insurance Code.
b) Denies deductions to any taxpayer from gross income
earned from any activity that directly tends to promote or
to further, or are directly connected or associated with,
those specified acts or omissions of criminal profiteering
activity.
2)Specifies that a prior, final determination by a court of
competent jurisdiction in any criminal proceedings, or any
proceeding in which the state, county, city, or other
political subdivision was a party on the merits of the
legality of the taxpayer's activities, is required in order
for this bill's provisions to apply.
3)Applies to any taxable year that has not been closed by a
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statute of limitations, res judicata, or otherwise.
4)Repeals existing law that denied a taxpayer deductions related
to illegal activities, as described by reference to certain
crimes.
5)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW:
1)Provides that all income, from whatever source derived, is
included in a taxpayer's gross income, including income
obtained from illegal business activities, actual crimes or
unethical or immoral business practices.
2)Allows a taxpayer to deduct from the gross income all ordinary
and necessary business expenses, including expenses
attributable to an illegal business. Notwithstanding the
general rule, illegal payments such as bribes and kickbacks
are not deductible, nor are losses from illegal activities
allowed if there is a clear public policy that supports
denying the deductions. Special rules apply in the case of
business activities involving drug trafficking. In those
cases, all deductions are expressly disallowed.
EXISTING STATE LAW is similar to federal law but further denies
deductions from gross income if the income is directly derived
from or directly tends to promote or further illegal activities
relating to lotteries, gaming, or horse racing. Similar
restrictions apply to disallow deductions, including cost of
goods sold, from gross income for other specified illegal
activities including pimping or pandering, larceny, obscene
matter, robbery, burglary, illegal sales of controlled
substances, embezzlement, and indecent exposure.
FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates
that this bill would result in an annual gain of $50,000 in
fiscal year (FY) 2010-11, $150,000 in FY 2011-12, $250,000 in FY
2012-13, $350,000 in FY 2013-14, and $450,000 in FY 2014-15.
COMMENTS :
1)Author's Statement . The author states that, "This legislation
would amend Sections 17282 and 24436.1 and repeal Sections
17281 and 24436 of the Revenue and Taxation ÝC]ode to allow
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the Franchise Tax Board to deny a deduction for expenses,
including costs of goods sold, derived from criminal
profiteering activity or illegal profits against insured
property and insurers. This bill expands the definition of
illegal activities subject to the disallowance of claimed
expenses or the cost of goods sold. This bill would ensure
public expenditures provided through the state tax system are
reserved for legitimate business expenses and remove loopholes
that allow criminals to avoid paying taxes for "business"
conducted while engaged in illegal activities.
"The purpose of this bill is to prohibit taxpayers that
perpetrate crimes from claiming deductions on their tax return
for expenses incurred in criminal behavior. Although existing
law denies deductions for certain criminal activities, recent
tax evasion cases prosecuted on behalf of the Franchise Tax
Board highlighted the need to expand the list of covered
activities."
2)The Purpose of this Bill . This bill is sponsored by FTB, as
approved on December 4, 2002 when FTB voted 2-0 to sponsor
this bill, with the Director of Finance abstaining. FTB
states the purpose of this bill is to prohibit a taxpayer that
perpetrates specified crimes from claiming deductions on their
tax return for expenses incurred in their criminal behavior.
Existing law already denies deductions for certain criminal
activities; however, recent tax evasion cases prosecuted on
behalf of the FTB highlighted the need to expand the denial of
deduction to other criminal activities. In cases involving
crimes against the elderly and insurance fraud, FTB
investigators were required to allow deductions for expenses
directly related to the income from the illegal activity to
determine taxable income. State attorneys prosecuting the
cases were frustrated and concerned about the limited nature
of California's existing disallowance provisions. Absent
specific inclusion of the crime charged in the list of crimes
for which deductions are denied, the penalties available to
prosecutors with respect to the tax due from the criminal
endeavors might be limited.
3)Arguments in Support . The proponents of this bill argue that
fraudulent claims "account for a significant portion of all
claims received by insurers, and cost billions of dollars
annually," and that those who commit insurance fraud "should
not be able to profit from a tax deduction for expenses
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attributed to income derived from their criminal activities."
4)The Scope of this Bill . Existing state law provides an
inconsistent tax treatment of income derived from, or related
to, illegal activities. Thus, the law specifically prohibits
a taxpayer from deducting expenses, including the costs of
goods sold, from income derived from certain criminal
activities, such as pimping or pandering, larceny, obscene
matter, robbery, illegal sales of controlled substances,
embezzlement and indecent exposure. Similarly, a deduction of
ordinary and necessary business expenses is disallowed if it
is claimed to offset income derived from illegal activities
related to lotteries, gaming, gambling or horse racing.
However, a taxpayer is entitled to claim a deduction for the
costs of goods sold in an illegal business related to
lotteries, gaming, gambling and horse racing. Furthermore, a
taxpayer may claim deductions for expenses attributable to
other illegal activities, not specifically enumerated in the
statute.
AB 1369 would expand current rules disallowing deductions for
expenses attributable to certain crimes or criminal activities
to include all crimes punishable under the "California Control
of Profits of Organized Crime Act (PC Section 186.2) as well
as illegal activities involving insurance fraud. Crimes
enumerated in the California Control of Profits or Organized
Crime Act include arson, child pornography, kidnapping,
murder, corporate securities violations, money laundering,
human trafficking, theft of personal identifying information,
theft of motor vehicles, and abduction or procurement by
fraudulent inducement for prostitution, among others. By
providing the same consistent tax treatment to taxpayers
involved in all types of criminal profiteering activities,
this bill would further the legislative intent of punishing
and deterring crimes and would reserve state funds to help
legitimate businesses and/or various state programs.
5)FTB's Suggested Amendments . The FTB staff suggested technical
amendments to clarify the taxable years to which this bill's
provision would apply.
6)Related Legislation .
AB 1746 (Revenue and Taxation Committee), introduced in the
2007-08 legislative session, is almost identical to this bill.
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AB 1746 failed passage on the Assembly Floor.
REGISTERED SUPPORT / OPPOSITION :
Support
Liberty Mutual Group
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098