BILL ANALYSIS �
AB 769
Page 1
Date of Hearing: May 13, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 769 (Skinner) - As Amended: April 23, 2013
SUSPENSE
2/3 vote. Tax levy. Fiscal committee.
SUBJECT : Taxation: deductions: net operating loss carrybacks.
SUMMARY : Prohibits the use of net operating loss (NOL)
carrybacks by individual and corporate taxpayers. Specifically,
this bill :
1)Deletes the provisions allowing for an NOL incurred on or
after January 1, 2013, to be carried back to offset the
taxpayer's income during the two prior tax years, under both
the Personal Income Tax (PIT) and the Corporation Tax (CT)
Laws.
2)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW :
1)Allows a taxpayer to carry an NOL back two years and forward
20 years.
2)Provides special rules for the carryback of NOLs relating to
specified liability losses, casualty or theft losses, disaster
losses of a small business, and farming losses.
3)Allows an eligible small business to elect to increase the NOL
carryback period from two years to three, four, or five years
for NOLs arising in tax years ending after December 31, 2007,
as provided. An "eligible small business" is one that meets a
$15 million (or less) gross receipts test for the taxable year
in which the loss arose.
4)Modifies provisions for the payment of interest and the
statute of limitations for assessing additional tax when
taxpayers take advantage of NOL carrybacks.
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EXISTING STATE LAW :
1)Allows a California taxpayer to calculate its NOL in
accordance with federal rules. For NOLs attributable to
taxable years beginning before January 1, 2008, it limits the
carryforward period to 10 years in circumstances where federal
law allows 20 years. However, for NOLs attributable to
taxable years beginning on or after January 1, 2008, the
applicable carryforward period is 20 years.
2)Suspends NOL deductions for taxable years 2008 through 2011
for PIT and CT taxpayers.
3)Conforms to the federal law allowing NOL carrybacks for NOLs
attributable to taxable years beginning on or after January 1,
2013, with the following modifications:
a) An NOL may be carried back only two years.
b) The amount of NOL carryback attributable to taxable year
2013 is limited to 50% of the NOL.
c) The amount of NOL carryback attributable to taxable year
2014 is limited to 75% of the NOL.
d) The amount of NOL carryback attributable to taxable year
2015 and thereafter is 100% of the NOL.
4)Allows taxpayers to carryback an NOL, from a taxable year
beginning on or after January 1, 2013, to a taxable year
beginning on or after January 1, 2011.
5)Does not modify the rules for interest computations or statute
of limitations relating to NOL carrybacks.
FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates
that this bill would result in an annual General Fund (GF)
revenue gain of $5 million in fiscal year (FY) 2013-14, $75
million in FY 2014-15, and $70 million in FY 2015-16.
COMMENTS :
1)Author's Statement . The author states that, "Corporate tax
giveaways come at the expense of public education, public
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safety, and assistance for the neediest Californians. It is
unfair that large corporations, making record profits and
handing out bonuses, can exploit the tax code to get refunds
from the State for taxes that were lawfully due at the time."
2)Arguments in Support . The sponsor of this bill states that
NOL carrybacks "allow businesses to retroactively reduce
profits and receive refunds for taxes paid on profits made in
previous years," which results in "revenue uncertainty for
future budget years." AB 769 will eliminate this uncertainty
and would close the tax loophole that the state cannot afford.
The proponents argue that, as a matter of tax policy, there
is no economic justification for allowing NOL carrybacks;
rather, it is a pure tax giveaway "with no real return on
investment to taxpayers." In difficult economic times, the
state will be in "the contradictory position of having to pay
out tax refunds while at the same time cutting programs." The
proponents further assert that an economic recovery "requires
that every state dollar be evaluated for effectiveness and
return on investment," including state dollars spent through
tax expenditures.
3)Arguments in Opposition . The opponents of this bill state
that the NOL deduction resolves an inequity in our tax
structure. The purpose of an NOL deduction is to "recognize
that the "business cycle"? does not align with the
government's 12-month timeframe for filing taxes." For some
businesses that cycle is relatively short, for others it can
be very long. The opponents argue that NOL serves to "ensure
that taxable income more closely resembles the actual net
income of the business enterprise." They further assert that
"NOLs are not economic incentive tools" but "are integral to a
fairly applied net income tax regime."
The opponents state that the NOL carryback is particularly
important for keeping struggling businesses afloat, but it is
also "critical for start-up businesses that are often
inconsistently profitable during their first few years and
need help to get off the ground." Finally, the opponents
contend that rescinding the NOL carryback deduction would
undermine employers' faith in the state's commitment to
keeping employers in the state, would "reverse the 2008
compromise just as the taxpayer's benefit from tax agreement
begins to materialize," and would "reinforce with employers
that California's taxing environment is unpredictable."
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4)Background . On September 30, 2008, the Governor signed into
law AB 1452 (Budget Committee), Chapter 763, Statutes of 2008,
to implement provisions of the 2008-09 Budget Agreement.
Among other things, AB 1452 suspended the NOL deduction for
the 2008 and 2009 tax years, except for taxpayers with net
business income of less than $500,000 in either year,
authorized NOL carrybacks for losses incurred in 2011 or later
tax years, and expanded the NOL carryforward period from 10
years to 20 years for losses incurred after January 1, 2008.
AB 1452 authorized taxpayers to use carrybacks to offset their
income during the two prior tax years. The carryback
provisions were scheduled to phase in, with 50% of any 2011
NOLs available for carryback, 75% of any 2012 NOLs, and full
carryback for NOLs in subsequent years.
Two years later, when the Legislature was facing another
difficult budget, SB 858 (Senate Budget and Fiscal Review
Committee), Chapter 721, Statutes of 2010, was enacted into
law. It further suspended the NOL deductions for the 2010 and
2011 taxable years and delayed the implementation of the NOL
carrybacks provisions, among other changes. Specifically, SB
858 disallowed NOL carrybacks for any NOLs attributable to
taxable years beginning before January 1, 2013. Consequently,
under existing law, the carryback provisions are scheduled to
phase in with 50% of any 2013 NOLs available for carryback,
75% of any 2014 NOLs, and full carryback for NOLs attributable
to tax year 2015 and thereafter. AB 769 would repeal the NOL
carryback provisions enacted by AB 1452, as modified by SB
858.
5)What is an NOL ? An NOL is the excess of allowable deductions
over gross income, computed under the law in effect for the
loss year, with certain adjustments. In other words, an NOL
is incurred when a business taxpayer has negative taxable
income. An NOL can be used to obtain a refund for taxes paid
in the past and/or to reduce future tax obligations. The
process of using an NOL to refund previously-paid taxes is
known as an NOL carryback, whereas the process of using an NOL
to reduce future taxes is known as a carryforward.
Individuals, Subchapter C corporations, estates and trusts and
charitable organizations (with respect to the unrelated
business income tax) can benefit from NOLs. Pass-through
entities such as partnerships and Subchapter S corporations do
not benefit from the NOLs themselves, but rather they pass
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through the benefit of the NOL to the partners or
shareholders, respectively.
Under federal law, nearly every taxpayer is allowed to carry
back an NOL from a trade or business to apply as a deduction
against income in prior taxable years. Generally, NOLs can be
carried back to the two years preceding the loss year and then
forward to the 20 years following the loss year. Recently,
the federal carryback period was extended from two to five
years for 2008 and 2009 NOLs. As discussed, California mostly
conforms to the federal law for NOLs and recently authorized
NOL carrybacks beginning in the 2013 tax year.
6)NOL Deductions . The basic rationale for allowing losses to be
deducted against income and be carried forward and back flows
from a recognition that businesses are established with the
goal of making a profit over a business cycle rather than in
any particular year. A 12-month period is not always best
suited for measuring a firm's net income for tax accounting
purposes, especially in the case of businesses with a long
business cycle. According to the Congressional Research
Service (CRS), the average business cycle is approximately six
years. This, of course, is an average; other industries may
have a much shorter business cycle. Therefore, arguably, the
time period within which an NOL is allowed to be carried back
and forward should be tailored to the particular business
cycle of a particular industry.
Economic theory demonstrates that a suitably long period for NOL
deductions helps to smooth out income and taxes paid over a
business cycle, thereby allowing a business to make efficient
decisions regarding financing and investment. For example,
consider two firms, one with a $100 loss in year one and a
$300 gain in year two, the second with a $100 gain in each
year. Without a NOL deduction, over the two years, the first
firm would report $300 taxable income, while the second would
report $200, even though each had $200 net income.
[Department of Finance (DOF), Annual Tax Expenditure Report,
2008-09].
The NOL deduction levels the playing field for firms with
volatile and steady income and is not considered a tax
expenditure by the DOF. Similarly, the federal Joint
Committee on Taxation does not view NOL carrybacks or
carryforwards as tax expenditures. It is assumed that the
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general limits on the number of years that such losses may be
carried back or forward were chosen for reasons of
administrative convenience and compliance concerns and
represent normal income tax law.
7)NOL Carrybacks: Good Tax Policy ? The NOL carryback is
generally that portion of the NOL that has not been previously
applied against income for other years. Under existing law,
nearly every taxpayer is allowed to carry back an NOL from a
trade or business incurred in 2013 to apply as a deduction
against income in prior taxable years. NOL carrybacks are not
contingent on a specified kind of investment by the taxpayer.
A taxpayer will generally prefer to carry back an NOL rather
than carry it forward because a carryback allows for an
immediate benefit in the form of a refunded tax payment,
whereas a carryforward reduces future taxes whose value must
be discounted to the present. (Mark P. Keightley, Net
Operating Losses: Proposed Extension of Carryback Period,
Congressional Research Service, November 13, 2009).
Therefore, an NOL carryback exceeds the present value of an
NOL carryforward.
According to the CRS report, the majority of the tax burden
falls on risky investments. (Id.) As a way of easing this
burden, NOLs are allowed to be carried back, effectively
creating a partnership between the taxpayer and the
government. This allows the government to share both the
return on investment (tax revenue) and the risk of investment
(revenue loss). A refund, as a means of sharing investment
risk, provides a firm with cash flow, which helps pay for
business expenses during tough economic times. The ability to
carryback an NOL is particularly important for businesses that
have historically generated taxable income, but may currently
be experiencing losses. Additionally, an NOL carryback may
provide for a cheap source of funds in an economy with
restrictive credit.
8)Practical Limitations: State vs. Federal Government .
Although there is strong justification for a carryback
provision as a method of averaging business income over time
and as a way of reducing investment risk, there is
disagreement over its ability to stimulate the economy. Some
economists believe that allowing indefinite carrybacks would
encourage investors to undertake riskier investments, and
during periods of economic downturn, could stimulate the
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economy. Id. However, NOL carrybacks may not be the most
effective way to stimulate the economy. The CRS, for example,
found that a dollar of NOL carryback translates into a gross
domestic product (GDP) increase between $0 and $0.40, whereas
a dollar increase in federal government purchases increases
GDP by between $1.00 and $2.50. (Id. at 5).
Further, while minimizing the distorting effects of taxation and
increasing economic efficiencies, NOL carrybacks present a
fiscal challenge for the state's GF. Unlike the federal
government, the state is not able to stimulate the economy by
running deficits. While the federal government may provide
for a carryback deduction without having to offset the cost,
the state is required to fund a carryback deduction by
eliminating government spending in other areas. In other
words, the ability to run deficits allows the federal
government to maintain or increase spending, whereas the state
government must simply shift funds from one program to
another. Therefore, the stimulating effect that a carryback
provision may have at the federal level does not apply at the
state level.
An inability to carry back NOLs would be burdensome for
businesses during tough economic times, since refunds provide
a valuable and predictable source of revenue. (See, e.g.,
Minority of States Still Granting Net Operating Loss
"Carryback" Deductions Should Eliminate Them Now, the Center
on Budget and Policy Priorities, stating that business profits
drop more sharply relative to a drop in economic activity
because of the slow reaction time during economic downturns).
However, when business profits decline sharply during economic
downturns, state tax revenue from business profits also drop
dramatically. Some economists believe that allowing
indefinite NOL carrybacks would result in a large negative
revenue effect, particularly during an economic downturn.
(Andrew Weiss, A Tax Reform to Alleviate Recessions and Reduce
Biases in the Tax Code, Boston University Working Paper, Jan.
1999.) Others have noted that encouraging investors to
undertake risky investments is generally highly desirable,
except in a period of acute economic boom. (Evsey D. Domar
and Richard A. Musgrave, Proportional Income Taxation and
Risk-taking, The Quarterly Journal of Economics, vol. 58, May
1944). All in all, it appears that NOL carrybacks create
great uncertainty for state government, since taxes previously
collected and spent must be refunded, necessitating other cuts
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in public services.
Finally, under the "benefits received principle," it has been
argued that a business benefits from state programs,
infrastructure, protection of property and other activities
that facilitate the operation of business, and therefore,
should compensate the government for services rendered.
Allowing NOLs to be carried back may be good tax policy, but
should unprofitable businesses be able to enjoy the services
without compensating the state for, at least a portion of,
those services? In the past, the sharp drop in state tax
revenue made it difficult for California to fund the programs
and services needed for the operation of business. Although
there is clear tax policy rationale for allowing NOL
carrybacks, practically speaking, in difficult economic times,
it will be challenging for the state to maintain basic
government services while issuing refunds to businesses.
9)Related Legislation .
AB 2408 (Skinner), introduced in the 2011-12 legislative
session, would have disallowed the use of NOL carrybacks by
individuals and corporate taxpayers. AB 2408 failed to pass
out of the Senate by the constitutional deadline.
AB 1936 (DeLeon), introduced in the 2009-10 legislative session,
was similar to this bill. AB 1936 was held under submission
in the Assembly Committee on Appropriations.
SB 858 (Committee on Budget), Chapter 721, Statutes of 2010,
among other things, suspended the NOL deductions under the PIT
and CT Laws for the 2010 and 2011 tax years and delayed the
operation of the NOL carryback provisions by two years.
AB 1452 (Committee on Budget), Chapter 763, Statutes of 2008,
among other tax benefits, expanded the NOL carryforward period
from 10 years to 20 years for losses incurred after January 1,
2008, and authorized two-year NOL carrybacks for losses
incurred in 2011 or later tax years.
REGISTERED SUPPORT / OPPOSITION :
Support
AFSCME (sponsor)
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California Federation of Teachers
California Tax Reform Association
California Labor Federation
California Professional Firefighters
California Teachers Association
Opposition
Advanced Medical Technology Association
Association of California
BIOCOM
Brand Source Pacific Rim Region
Brea Chamber of Commerce
Building Owners and Managers
CalAsian Chamber of Commerce
California Association for Health Services at Home
California Association for Micro Enterprises Opportunity
California Association of Competitive Telecommunications
Companies
California Association of Competitive Telecommunications
Companies
California Bankers Association
California Chamber of Commerce
California Chapter of the American Fence Association
California Fence Contractors' Association
California Grocers Association
California Healthcare Institute
California Independent Oil Marketers Association
California Manufacturers & Technology Association
California Metals Coalition
California Service Station and Automotive Repair Association
California Taxpayers' Association
Council on State Taxation
Engineering Contractors' Association
Flasher Barricade Association
Golden Gate Restaurant Association
Governmental Advocates, Inc.
Marin Builders Association
Monterey County Business Council
National Association of Women Business Owners of San Francisco
Noe Valley Merchants and Professionals Association
Pacific Contractors Association
Plumbing-Heating-Cooling Contractors Association of California
Roofing Contractors Association of California
San Francisco Builders Exchange
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San Francisco Chamber of Commerce
San Francisco Council of District Merchants Association
San Francisco Small Business Advocates
San Francisco Small Business Network
Small Business California
Small Business California
Small Business majority
Small Business Majority
Small Manufacturers Association of California
Southwest California Legislative Council (the coalition of the
Temecula Valley, Murrieta, Lake Elsinore and Wildomar Chambers
of Commerce)
The National Federation of Independent Business
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098