BILL ANALYSIS �
AB 132
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Date of Hearing: May 13, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 132 (Holden) - As Amended: March 21, 2013
REVISED
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Taxation: retirement plans: early distribution
penalties.
SUMMARY : Temporarily waives the 2 % penalty otherwise imposed
on early distributions from qualified retirement plans, provided
that the distributions are received by an individual who uses
the funds to pay the mortgage interest or principal on his/her
principal residence, as provided. Specifically, this bill :
1)Waives the 2 % penalty for early distribution from a
qualified retirement plan made to an individual to the extent
such distributions do not exceed the aggregate amount of
qualified principal residence payment distributions.
2)Defines "qualified principal residence payment distribution"
as any payment or distribution received and used by an
individual within 60 days of the receipt to pay qualified
costs with respect to a principal residence of the individual
or his/her spouse.
3)Defines the "qualified costs" as amounts paid as:
a) Principal or interest on acquisition indebtedness, or
b) Part of a loan modification that either reduces the
principal or interest of acquisition indebtedness.
4)Defines "acquisition indebtedness" pursuant to Internal
Revenue Code (IRC) Section 162(h)(3)(B) as any indebtedness
that is incurred in acquiring, constructing, or substantially
improving any qualified residence of the taxpayer and is
secured by such residence, without taking into account the
dollar limitation imposed by that section.
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5)Provides that all of the following additional conditions must
be satisfied in order for an individual to receive a tax-free
distribution from his/her retirement account:
a) The individual and, if married, his/her spouse, may not
collectively own more than one residence and must use that
residence as a principal residence within the meaning of
IRC Section 121.
b) The principal residence must have a market value that is
less than the unpaid balance of acquisition indebtedness on
that residence.
6)Limits the aggregate amount of qualified principal residence
payment distributions to $6,000 for all taxable years.
7)Applies to distributions made in taxable years beginning on or
after January 1, 2014, and before January 1, 2017.
8)Takes effect immediately as a tax levy.
EXISTING LAW :
1)Provides that federal changes to Part I of Subchapter D of
Chapter 1 of IRC Sections 401 through 420, inclusive, relating
to pension, profit-sharing, stock bonus plans, other employee
benefit plans, and IRC Section 457, relating to deferred
compensation plans of state and local governments and
tax-exempt organizations, automatically apply without regard
to taxable years to the same extent as applicable for federal
income tax purposes. All federal changes made to those IRC
sections are automatically adopted by California without
regard to the specified date.
2)Provides that a distribution from a 401(k) plan, a qualified
annuity plan under IRC Section 403(a), a tax-sheltered annuity
under IRC Section 403(b), an eligible deferred compensation
plan under IRC Section 457, or an individual retirement
arrangement (IRA) under IRC Section 408 is included in income
for the year distributed.
3)Imposes a penalty equal to 2 % of the amount includible in
income on early withdrawals from those plans, unless an
exemption applies, in conformity with the federal tax law.
For simple retirement plans under IRC Section 408(p), the
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"early withdrawal" tax is set at 6% of any amount includible
in income, instead of the federal rate of 25%.
FISCAL EFFECT : Unknown.
COMMENTS :
1)Author's Statement . The author states that, "Many
Californians are still facing the possibility of foreclosure,
even those with stable employment, and many cities are dealing
with the consequences of a growing number of vacant homes.
This bill seeks to address these challenges by reducing
penalties that make it easier for families to stay in their
homes. State and federal law authorizes taxpayers to withdraw
from their 401(k) retirement account without penalty at 59
years old. Early withdrawals are subject to a 10% penalty
from the Internal Revenue Services, and a penalty of 2.5% from
the Franchise Tax Board on the amount withdrawn. AB 132
temporarily waives the 2.5% penalty placed on early
withdrawals from retirement plans when the funds are used to
avoid foreclosure. Homeowners are eligible for the waiver if
the early withdrawal is applied to reducing qualified mortgage
costs or applied as part of a loan modification, and the
homeowner owns only one home that is 'underwater.'
"Though there are a number of programs and services available to
homeowners facing foreclosure, there are a few, select cases
where withdrawing $6,000 or less from a retirement account can
be the difference between continuing down the path to
foreclosure and starting on the road to recovery. This bill
is not meant to be a solution for everyone facing foreclosure,
but helps those for whom walking away from one's home without
serious financial consequences is not an option and/or
withdrawal from a retirement plan is still an option. The
withdrawal limit is $6,000 to ensure no one is enticed to raid
their retirement savings for a bad investment, but high enough
that it could be helpful in conjunction with other programs
and funding sources. This bill ensures they will not be
punished for pursuing that solution.
"If a person withdraws up to the $6,000 limit, the federal
penalty will require them to pay $600 to the internal Revenue
Service. This bill will allow the person to keep the $150.00
the California penalty requires. For a person in financial
distress, this $150.00 dollars is not inconsequential.
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"I encourage and expect that a person considering early
withdrawal from their retirement plan for any reason to
receive counseling or guidance from a financial advisor about
the consequences of their decision."
2)Arguments in Support . The proponents of this bill state that,
since the recession, "many homeowners have found themselves
upside down on their mortgages in addition to losing their
job[s]." The proponents argue that, for those "who can no
longer receive unemployment benefits to pay their mortgage, an
early distribution may be the only option that keeps
homeowners from becoming homeless." The proponents assert
that "[h]omeowners staying in their homes and maintaining
their mortgage payment is good for the economy." Finally, the
proponents state that AB 132 "provides an important financing
opportunity for borrowers by allowing them to leverage a small
fraction of retirement income for what is arguably the most
sound investment one can make in their lifetime - a new home."
3)The "Early Withdrawal" Penalty. Congress has authorized
several kinds of retirement savings plans that qualify for
reduced or deferred income taxes to encourage workers to save
for retirement. A qualified retirement plan, such as a 401(k)
plan, for example, allows a worker to save for retirement by
investing a portion of his/her wages while deferring current
income taxes on the original investment and earnings until
withdrawal. All contributions are invested on a pre-tax basis
and not taxed until the money is withdrawn. With the
enactment of the Roth provisions, participants in 401(k) plans
may elect to deposit some or all of their wages in a
designated brokerage account, commonly known as a Roth 401(k).
Qualified distributions from a designated Roth account are
tax free, while contributions are made on an after-tax basis
(i.e., income tax is paid or withheld on the contributions in
the year contributed).
Existing federal tax law imposes a 10% withdrawal penalty on
early distributions made from a qualified retirement or
annuity plan, a 403(b) annuity, or an IRA to a taxpayer under
the age of 59 , unless an exception applies. California
imposes a similar penalty, but at the rate of
2 % of the amount includible in income on early withdrawals
from those plans. However, recognizing that some significant
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events might require people to withdraw money from their
retirement accounts earlier than expected, Congress has
provided for a waiver of the early withdrawal penalty in some
situations, to which California has conformed. The waiver of
the penalty applies to distributions that are (a) used for the
health insurance premiums of an unemployed individual; (b)
used for medical expenses; (c) made to a beneficiary (or to
the estate of the employee) on or after the date of the
employee's death; (d) made to an employee who separates from
service at age 55 or older; (e) made to individuals called to
active duty; or (f) used for first-time home purchases.
4)What Does this Bill Do ? This bill seeks to expand the
universe of qualifying hardship distributions to include early
distributions used by the recipient to make mortgage payments
or loan modification-related payments on his/her principal
residence. The proposed waiver would apply to distributions
made in the 2014, 2015, or 2016 taxable year, with the total
amount of eligible distributions capped at $6,000 for all
taxable years. AB 132 requires that the market value of the
recipient's principal residence be less than the mortgage
balance and prohibits an individual receiving the
distributions from owning more than one residence. This bill
is intended to provide financial relief to homeowners who are
at risk of losing their homes to foreclosure.
5)Should the Penalty Be Waived ? In the aftermath of the 2008
financial crisis, many Californians have been struggling to
find work and pay their bills. Many of those unemployed
individuals have to rely on savings, credit cards, and
potentially, various social services programs to pay for basic
necessities. One of the savings vehicles utilized by many
workers is a 401(k) plan or an IRA. However, the few who had
managed to save for retirement are unable to access their
retirement funds without paying the heavy penalty under both
federal and state tax laws. As discussed, any non-qualified
pre-retirement withdrawal from a qualified retirement plan is
subject to a penalty of 10% at the federal level and 2 % at
the state level, which is levied in addition to any other
applicable income taxes. In the case of a distribution from a
simple retirement account under IRC Section 408(p), the early
withdrawal penalty is 25% of any amount includible in income
under federal law and 6% under California tax law. An early
distribution to pay one's mortgage is not a qualifying
hardship distribution, and as such, is subject to the "early
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withdrawal" penalty. AB 132 would provide relief to
homeowners from the 2% penalty on the first $6,000
distributed from a qualified retirement plan. In doing so,
however, this bill raises a few issues.
a) Conformity. AB 132 would take California out of
conformity with the federal tax law. Failure to conform to
federal law in some areas may lead to improper tax
reporting in California and extra costs to the taxpayers
and tax agencies. Conformity to federal tax law eases the
burden, and reduces the costs, of tax administration
because the state may rely on federal audits, federal case
law, and regulations.
During his first presidential campaign, President Obama
suggested a broad temporary suspension of the penalty on
early withdrawals on distributions from IRAs or 401(k)
plans, up to a $10,000 limit, for two years - 2008 and
2009. However, the proposal never became law; but it did
highlight the problem that many families were "being forced
to make painful choices like selling their homes or not
sending their kids to college."<1> (President Obama's
Speech in Toledo, Ohio where he released his "Rescue Plan
for the Middle Class," a seven-page document that included
the proposal). It seems that a waiver of the federal
penalty would be a more effective and appropriate solution
to the problem.
b) The Scope of the Relief. It is unclear to Committee
staff as to how many individuals would decide to take
advantage of the exception created by AB 132, given that
individuals will still be subject to the 10% federal
penalty, in addition to the regular federal and state
income taxes. In other words, the saving of $150 (2.5% x
$6,000) may not be enough of an incentive for an individual
to take an early distribution when the individual is facing
a $600 penalty, plus an additional federal and income tax
liability on the $6,000 distribution. Moreover,
--------------------------
<1> In response to the steep decline in stock prices in 2008,
which substantially reduced the value of many retirees'
retirement accounts, Congress passed H.R. 7327, signed by then
President Bush, suspending the required minimum distributions
for the 2009 tax year for taxpayers who were 70 or older. It
did not, however, help people who wanted to take funds out of
their retirement accounts.
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withdrawing $6,000 in one year may push an individual into
a higher tax bracket, resulting in an even higher income
tax liability when the individual presumably is unemployed
and/or has little cash on hand to pay his/her mortgage.
Employed individuals have an option of borrowing money from
their 401(k) retirement accounts. Many employers allow
their employees to take a personal loan from the employee's
401(k) account. In general, an employee may borrow the
lesser of $50,000 or one-half of the retirement balance,
and unless the loan is used to acquire a home, it must be
repaid over a five-year period. However, between a 401(k)
loan and an outright early distribution, the loan is still
the preferable option, if available.
c) The Oversight Problem . The relief proposed by this bill
is conditioned upon the market value of the individual's
principal residence. In other words, the relief is allowed
only if the individual owns a principal residence that is
"underwater," i.e. its market value is below the
outstanding mortgage amount. Furthermore, this bill
prohibits an individual from owning more than one home.
This bill, however, does not specify which agency will be
in charge of determining whether those conditions are
satisfied and whether any penalty will apply if the
requirements are not met.
d) Acquisition Indebtedness . While AB 132 adopts a federal
definition of "acquisition indebtedness," it leaves out the
$1 million limitation applicable for purposes of the
mortgage interest deductions. Existing federal and state
tax laws allow a taxpayer to claim a deduction for mortgage
interest but limit the amount of the debt on which the
accrued or paid interest may be deducted to $1 million
($500,000 in the case of a married individual filing
separately). It generally ensures that the federal and
state governments do not subsidize homes that are
affordable only to the most affluent homeowners. It is
unclear to the Committee staff why the limitation was not
incorporated in the provisions of AB 132.
6)The Foreclosure Crisis . According to the author, this bill
seeks to make it easier for families facing foreclosure to
stay in their homes. By the end of 2008, slightly more than
9% of all mortgages in the United States (U.S.) were either
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delinquent or in foreclosure, according to the Mortgage
Bankers Association. Today, however, the foreclosure activity
in much of the nation appears to be accelerating downward,
dropping 7% in a single month according to RealtyTrac.
Foreclosure filings nationwide - default notices, scheduled
auctions, and bank repossessions - numbered 150,864 or one in
every 869 U.S. housing units in January of 2013. This was a
28.5% decrease from January 2012. Foreclosure starts were
down 28% compared to a year earlier and at the lowest level
since June 2006. Bank repossessions or real estate owned
properties dropped 5% from the previous month and were down
24% from January 2012 to the lowest level since February 2008.
Total foreclosure activity in April was at the lowest level
since February 2007, a 74-month low.
The State of California reported 16,161 properties with
foreclosure filings in April, representing a 13% decline from
March and a 59% decrease from the level reported in April of
2012. In fact, according to RealtyTrac, the size of the
overall national decline can be traced to California where the
enactment of a new law - the California Homeowner Bill of
Rights - resulted in a 39.5% decrease in filings from December
to January. Vice President of RealtyTrac, Daren Blomquist,
said the new legislation, which became effective on January 1,
2013, profoundly altered the U.S. foreclosure landscape.
"Dubbed the Homeowners Bill of Rights, this legislation
extends many of the principles in the national mortgage
settlement - including a prohibition on so-called dual
tracking and requiring a single point of contact for borrowers
facing foreclosure - to all mortgage servicers operating in
California. In addition the new law imposes fines of up to
$7,500 per loan for filing of multiple unverified foreclosure
documents. As a result, the downward foreclosure trend in
California accelerated into hyper speed in January, decisively
shifting the balance of power when it comes to the nation's
foreclosure activity."
On April 18, 2013, California Attorney General Kamala D.
Harris also announced that California's National Mortgage
Settlement Grant Program has awarded $9.4 million to 21
organizations in order to assist Californians affected by the
state's foreclosure crisis. In light of the recently enacted
legislation aimed to help struggling homeowners and the
mortgage settlement grant program, the Committee may wish to
consider whether AB 132 is necessary or effective in achieving
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its stated goal.
7)Related Legislation .
AB 726 (Morrell), introduced in the 2011-12 legislative session,
would have waived the 2 % tax penalty for early 401(k)
distributions if the entire amount is paid into a health
savings account (HSA) within 60 days. AB 726 was held under
submission.
AB 558 (Portantino), introduced in the 2011-12 legislative
session, would have temporarily waived the 2 % penalty
otherwise imposed on early distributions from qualified
retirement plans, if those distributions were received by an
individual who had either exhausted his/her unemployment
benefits or was ineligible for unemployment benefits. AB 558
was held in the Assembly Appropriations Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Bankers Association
California Building Industry Association
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098