BILL ANALYSIS                                                                                                                                                                                                    

                            Senator Lois Wolk, Chair

          BILL NO:  AB 1369                     HEARING:  7/6/11
          AUTHOR:  Gatto                        FISCAL:  Yes
          VERSION:  5/18/11                     TAX LEVY:  Yes
          CONSULTANT:  Miller                   

                               ILLEGAL ACTIVITIES

              Denies deductions for expenses incurred from illegal 

                           Background and Existing Law  

          Existing federal law 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.  Federal law 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.

                                   Proposed Law  


          AB 1369 -- 5/18/11 -- Page 2

          Assembly Bill 1369 disallows deductions for income derived 
          by a taxpayer from specified illegal activities.  This bill 
          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.  

          This bill 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. 

          The bill also 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. 

          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. 

          AB 1369 takes effect immediately and applies to any taxable 
          year that has not been closed by a statute of limitations, 
          res judicata, or otherwise. 

                               State Revenue Impact
          The Franchise Tax Board (FTB) staff estimates that this 
          bill would result in an annual gain of $50,000 in 2010-11, 
          $150,000 in 2011-12, $250,000 in 2012-13, $350,000 in 
          2013-14, and $450,000 in 2014-15.


          1.   Purpose of the bill  .  According to the author, this 
          bill expands the definition of illegal activates subject to 
          the disallowance of claimed expenses or the cost of goods 


          AB 1369 -- 5/18/11 -- Page 3

          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.
           2.   Insurance Fraud  .  According to the proponents of this 
          measure, insurance fraud is a $5 billion business in this 
          state and the Department of Insurance estimates that fraud 
          adds an additional $500 to the cost of an insurance policy. 
           Insurance fraud is deliberate and seriously undermines the 
          insurance business.  The proponents claim that this bill 
          will act as a disincentive to these criminals and mitigate 
          some of the costs associated with fraud.


          AB 1369 -- 5/18/11 -- Page 4

                                 Assembly Actions  

          Assembly Revenue & Taxation Committee:  8-0
          Assembly Appropriations Committee:17-0
          Assembly Floor:                    75-0

                         Support and Opposition  (6/30/11)

           Support  :  Association of California Insurance Companies; 
          Liberty Mutual Group.

           Opposition  :  Unknown.