BILL ANALYSIS Ó
PURSUANT TO SENATE RULE 29.10
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 1143 HEARING: 6/18/14
AUTHOR: Skinner FISCAL: Yes
VERSION: 6/9/14 TAX LEVY: No
CONSULTANT: Grinnell
TAXATION (URGENCY)
Enacts three technical changes to the Revenue and Taxation
Code.
Background and Existing Law
I. Limited Liability Companies. Corporations in
California form by filing articles of incorporation with
the Secretary of State. Before transacting intrastate
business in California, a corporation formed elsewhere must
first qualify and register with the California Secretary of
State. A foreign business entity also can qualify and
register to transact business in California by filing the
appropriate forms with the California Secretary of State.
California law requires corporations and limited liability
companies to update the records of the California Secretary
of State on an annual or biennial basis by filing a
statement. Franchise Tax Board (FTB) or the Secretary of
State can suspend a corporation for:
Failure to pay an amount due,
Failure to file a statement of information with the
Secretary of State's office, or
Failure to file any past due returns.
A suspended or forfeited business entity loses the right to
enforce its legal contracts, known as "contract
voidability." The counterparty to a contract with a
suspended entity may seek to void the contract by filing
suit against the suspended corporation. If a business
enters a contract while suspended or forfeited, and then
revives its active legal status, the business still cannot
enforce that contract unless it gets relief from contract
voidability by applying to FTB. Contract voidability is
found only in state law; federal law does not allow for it.
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A limited liability company (LLC) is a hybrid between a
corporation and a partnership. LLCs are generally
partnerships for operational and taxation purposes,
although California imposes a specific fee on LLCs, but
their members enjoy the immunity provided by a corporation
to its shareholders for contract debts or tort liability.
The interest of a member in an LLC is an economic interest,
in the same manner that a partnership interest or a
corporate share is an economic interest, that may be
transferred under terms and conditions provided by the LLC
agreement, the partnership agreement, or the corporate
structure. California first recognized LLCs in 1994 with
the enactment of the Beverly-Killea Limited Liability
Company Act which provided comprehensive provisions for the
organization, management, and dissolution of LLCs (SB 469,
Beverly, 1994).
Foreign corporations are subject to contract voidability:
if they have an FTB account number, contract voidability
commences within 60 days of FTB mailing a final notice, if
not, it begins on the first day of the taxable year in
which the foreign corporation failed to file a return.
However, foreign LLCs are not subject to contract
voidability at all.
II. Check the Box Regulations. California law does not
automatically conform to changes to federal tax law, except
for specific retirement provisions. Instead, the
Legislature must affirmatively conform to federal changes.
Conformity legislation is introduced either as individual
tax bills to conform to specific federal changes, like the
Regulated Investment Company Modernization Act (AB 1423,
Perea, 2011), or as one omnibus bill that provides that
state law conforms to federal law as of a specified date,
currently January 1, 2009 (SB 401, Wolk, 2010).
California doesn't conform to the federal definition of
"corporation" for tax purposes, as corporations taxable
under federal law may not be subject to California's
corporation tax, like insurance companies. However,
California law requires eligible entities taxed under
federal law as corporations the same treatment under state
law. Under United States Department of Treasury
regulations, known as "check the box" regulations, eligible
business entities with two or more owners can choose to be
AB 1143 - 6/9/14 -- Page 3
treated as a corporation for tax purposes, or as a
partnership. Business entities with one owner are
disregarded as a separate entity unless the business entity
has elected to be taxed as a corporation. The
classification of an eligible business entity is binding
for California purposes, with some exceptions. Because
California has its own definition of corporation, it
doesn't automatically apply the federal rules; instead, the
law provides that California can issue its own regulations
consistent with the federal regulations for the
classification of eligible business entities for tax
purposes. However, California law only applies federal
"check-the-box" regulations through January 1, 1997, not
picking up important clerical and administrative details,
such as guidance for foreign corporations in countries that
didn't exist in 1997.
III. Comparable Sales. Assessors are precluded from
considering comparable sales within 90 days of the "lien
date" when valuing a property after a change in ownership.
However, the term "lien date" refers to two distinct dates:
January 1st for the regular roll, and the date of the
change in ownership for the supplemental roll. Strictly
interpreting the legal requirement would prevent the
assessor from using appropriate comparable sales because of
the 90 day preclusion.
Proposed Law
I. Limited Liability Companies. Assembly Bill 1143 adds
foreign limited liability companies onto the list of
corporations that are subject to contract voidability, and
specifies that it commences identically to current
treatment of foreign corporations. The measure also makes
a technical and conforming change.
II. "Check the Box Regulations." The amendments change the
conformity date to January 1, 2014, thereby updating
California's definition for corporations subject to the
Corporation Tax Law to account for changes made in the
intervening period.
III. Comparable sales. Assembly Bill 1143 changes the
term from "lien date" to "valuation date," thereby ensuring
that assessors use appropriate comparisons, that fall
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within a reasonable period of time to assess the market.
State Revenue Impact
According to FTB, AB 1143's provisions regarding contract
voidability for limited liability companies results in
revenue increases of $50,000 in 2013-14, $30,000 in
2014-15, and $50,000 in 2015-16.
Revenue estimate for the measure's check the box
regulations provision is pending.
BOE states that comparable sales provisions don't affect
state or local revenues.
Comments
1. Purpose of the bill . According to the author, "AB 1143
resolves three inadvertent errors in California tax laws
that are preventing fair and efficient enforcement of
property tax valuation, business classifications, and
out-of-state LLCs that break the law. By making these
simple, technical changes we will be better able to enforce
our existing laws and treat all businesses fairly."
2. Equity . AB 1143 advances horizontal equity by applying
the same rules of contract voidability to foreign LLCs that
currently apply to foreign C-Corporations. Horizontal
equity is one of the key values of any tax system:
taxpayers with the same amount of income should pay the
same tax, and be subject to the same rules. Without
horizontal equity, tax systems distort economic decisions
as taxpayers make different decisions to take advantage of
those differences. When California created LLCs in 1994,
the Legislature was concerned that taxpayers would choose
to form them instead of C-Corporations because of tax and
corporate reasons, and imposed a fee on LLCs that sought to
equalize the tax difference. While the Legislature
subsequently abandoned horizontal equity for LLCs when it
changed the fee to eliminate this equalization, taxpayers
are choosing the LLCs form instead of C-Corporations: LLCs
have grown in number from 26,186 in 2000-01 to 75,018 in
2012-13. While S-Corporations have also grown, fewer
C-Corporations file returns today than they did in 2000,
AB 1143 - 6/9/14 -- Page 5
suggesting that the California Corporation Tax lacks
horizontal equity as taxpayers find an advantage in forming
LLCs.
3. Check the box ? "Check the box" regulations are a
significant source of tax evasion; the White House
estimated more than $10 billion in annual revenue loss to
the federal government when proposing to eliminate them in
2009. However, AB 1143's changes don't substantively
change the way the regulations apply at the state level.
Instead, they merely allow FTB to apply clerical and
administrative changes to regulations to enforce its
Corporation Tax law.
4. 29.10 . When the Committee heard the measure last year,
it included only the changes to contract voidability for
limited liability companies. The Senate Rules Committee
referred the bill back to the Committee when the author
amended it on the Senate Floor to add provisions relative
to "check the box" regulations and comparable sales
pursuant to Senate Rule 29.10(b). Under that Rule, the
Committee may (1) hold the bill, (2) return the bill as
approved to the Senate Floor, or (3) rerefer the bill to
the Appropriations Committee.
5. Urgency . AB 1143 is an urgency measure, stating that
it's needed to treat all entities doing business in
California equally, so Legislative Counsel has assigned the
measure a 2/3 vote key.
Assembly Actions
Not relevant to this version of the bill.
Support and Opposition (06/12/14)
Support : California Assessors Association, California
Federation of Teachers, California Tax Reform Association,
Franchise Tax Board, SEIU California.
Opposition : None received.
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