BILL ANALYSIS                                                                                                                                                                                                    




                                                                  SB 211
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          Date of Hearing:  August 12, 2013

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Raul Bocanegra, Chair

                      SB 211 (Price) - As Amended:  May 8, 2013

          Majority vote.  Fiscal committee.

           SENATE VOTE  :  32-6
           
          SUBJECT  :  Tax administration:  disclosure of information:   
          Franchise Tax Board (FTB) and cities

           SUMMARY  :  Extends the sunset on the state-local tax information  
          sharing program, codifies existing safeguard practices, and  
          allows agents of the city to participate in the tax information  
          sharing program.  Specifically,  this bill  :  

          1)Extends the sunset date on the reciprocal sharing of tax  
            information between the FTB and a city's tax officials until  
            January 1, 2019.

          2)Allows a city, participating in the tax information sharing  
            program, to provide tax information to third party agents.

          3)Requires that tax information provided to a city shall be  
            utilized in a form and manner to safeguard the tax information  
            as required by the FTB, including, but not limited to:

             a)   The completion of a data exchange security questionnaire  
               provided by the FTB prior to approval of a data exchange by  
               the FTB;

             b)   The tax official or agent of the city shall allow the  
               FTB to conduct an onsite safeguard review;

             c)   The completion of disclosure training provided by the  
               FTB and a confidentiality statement signed by all employees  
               or agents with access to information provided by the FTB  
               confirming the requirement of data security with respect to  
               that information and acknowledging awareness of penalties  
               for unauthorized access or disclosure under Revenue and  
               Taxation Code (R&TC) Sections 19542 and 19552, and Penal  
               Code Section 502;









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             d)   The tax official or the agent of a city shall notify the  
               FTB within 24 hours upon discovery of any incident of  
               unauthorized or suspected unauthorized access or disclosure  
               of the tax information and provide a detailed report of the  
               incident and the parties involved; and,

             e)   All records received by the tax officials of a city or  
               its agents shall be destroyed in a manner to make them  
               unusable or unreadable so an individual record may no  
               longer be ascertained in a time frame specified by the FTB.


           EXISTING LAW  

          1)Authorizes FTB to permit tax officials of a city to enter into  
            a reciprocal tax sharing information agreement with FTB, as  
            specified.  The information that may be furnished to a city's  
            tax officials is subject to the following limitations:

             a)   The city is only authorized to receive information  
               related to taxpayers operating within the city and who  
               report income from a trade or business to the FTB;

             b)   The information is limited to a taxpayer's name,  
               address, social security or taxpayer identification number,  
               and business activity code;

             c)   Tax information provided to a city's taxing authority  
               may not be furnished to, or used by, any person other than  
               an employee of that taxing authority; and,  

             d)   The information provided to a city's tax officials is  
               subject to Revenue and Taxation Code Section 19542, which  
               makes it a misdemeanor to disclose confidential tax  
               information.  Specifically, the information may only be  
               used for the city's tax enforcement, or as otherwise  
               authorized by state or federal law.  

          2)Provides that any information, other than the limited type of  
            tax information specified above, may be requested by a city's  
            tax officials by affidavit.  

          3)Provides that the information available from cities to the FTB  
            is limited to the following:









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             a)   The name of business if it is a corporation,  
               partnership, or limited liability company, or the owner's  
               name if it is a sole proprietorship;

             b)   Business mailing address;

             c)   Federal employer identification number, if applicable,  
               or the business owner's social security number;

             d)   Standard Industry Classification Code or North American  
               Industry Classification System Code;

             e)   Business start date;

             f)   City number; and,

             g)   Ownership type.
             
          4)Provides for the automatic repeal of the tax information  
            sharing program on January 1, 2014.

           FISCAL EFFECT  :   The FTB estimates an annual revenue increase of  
          $1.5 million in fiscal year (FY) 2014-15, and $4.9 million in FY  
          2015-16. 
           


          COMMENTS  :   

          1)The author states, "SB 211 would extend the sunset date  
            currently in statute until January 1, 2019 to ensure the  
            continuity of a proven cost effective tax data sharing program  
            and would preserve the revenue benefit to the state and  
            participating cities."

          2)Proponents state that this bill "clarifies that cities may  
            contract with third party agents in pursuing such activities.   
            Passage of this measure will continue to allow disclosure of  
            limited confidential tax information for the specific purpose  
            of enhancing local and state tax enforcement activities.  This  
            is an important tool that cities across California use for  
            business license discovery efforts to identify businesses that  
            are operating without a license."










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          3)Opponents state, "despite safeguards, outsourcing tax  
            administration functions heightens the risk for security  
            breaches, resulting in dissemination of confidential  
            information for unauthorized use.  This information can be  
            sold for profit, resulting in physical or financial risk to  
            taxpayers.  Potential security breaches are exacerbated by  
            inappropriate incentives, usually on a contingency-fee basis,  
            to contractors."  

          4)Committee Staff Comments

              a)   Program Background  : As noted in the FTB's staff analysis  
               of this bill, "FTB compiles information from many sources  
               including employers, financial institutions, and federal  
               and state entities for purposes of ensuring compliance with  
               the state's income tax laws. When the FTB receives  
               information indicating that a tax return should be filed  
               for a taxable year, but has no record of a return, the FTB  
               may contact the taxpayer to request that the taxpayer file  
               a return or explain why no return is required. When a  
               taxpayer is required to file a return, but fails to do so,  
               the FTB is authorized to assess tax based on reported and  
               estimated income from all available sources."   
               Additionally, "FTB uses data obtained from cities to ensure  
               compliance with state income tax requirements; cities use  
               data obtained from the FTB to ensure compliance with city  
               business tax requirements."

               The program authorizes the FTB to enter into agreements  
               with cities to exchange tax data.  These agreements can  
               either require the cities to reimburse the FTB's costs for  
               providing the data, or allow for a waiver of the FTB's  
               costs if the cities agree to provide their tax data at no  
               cost to FTB.  Cities providing tax data to the FTB without  
               also receiving tax data from the FTB are required to be  
               reimbursed by the FTB at a maximum rate of $1 per usable  
               record.  The FTB can only provide tax information that  
               contains an address within the city's jurisdiction.  The  
               information is limited, unless agreed to otherwise, to the  
               taxpayer's name, taxpayer's address, taxpayer's social  
               security number or taxpayer identification number, and the  
               principal business activity.  

               This bill would extend the sunset date on the reciprocal  
               sharing of tax information between the FTB and a city's tax  









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               official until January 1, 2019.

              b)   Increased Security Risk  :  The FTB has maintained the  
               integrity of taxpayer information since the inception of  
               the tax information sharing program.  However, providing  
               confidential taxpayer information to third party agents may  
               increase the likelihood of data breaches.  In July, the  
               Office of the Attorney General released the first report  
               detailing 131 data breaches, which compromised the personal  
               information of 2.5 million Californians.  Data Breach  
               Report 2012, Kamala D. Harris, Attorney General, California  
               Department of Justice, July 1, 2013.  Out of the 131  
               breaches, government held responsibility for eight percent  
               of them.  The California Department of Social Services lost  
               a computer storage device containing information on 845,000  
               parents, children, and caregivers.  Information has also  
               been breached from third party agents contracting with  
               cities.  According to the report, Pinkerton Government  
               Services and Advanced Data Processing, two companies that  
               contract with government entities, suffered at least three  
               data breaches in 2012, compromising the social security  
               numbers of potentially thousands of Californians<1>.    

               Even though certain penalties apply to local cities and  
               agents under current law, those penalties do little for  
               taxpayers who must spend time and money rectifying actual  
               and potential identity theft.  A strong correlation exists  
               between data breaches and identity theft.  According to the  
               report, individuals who received a data breach notification  
               had an identity theft incident rate of 22.5 percent, which  
               is four times higher than the average 5.3 percent rate for  
               adults.  Because of this, the report recommended that  
               government agencies and companies offer mitigation products  
               like credit monitoring services or a security freeze when  
               such incidents occur.  

              c)   Contingency Fee  :  According to the FTB, only 102 of the  
               478 incorporated cities in California currently participate  
               in the tax information sharing program.  This, in part, is  
               due to a lack of funds by smaller cities.  As such, this  
               bill hopes to increase participation by allowing smaller  
               cities to contract with third parties.  Although not  

             --------------------------
          <1> Data breaches are only required to be reported to the  
          Attorney General when the breach involves more than 500  
          Californians.








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               specifically stated, it appears that such contracts will  
               exist on a contingency fee basis.  Such contingency fee  
               agreements will likely increase revenue by ensuring  
               additional compliance with city business tax requirements.   
               However, contingency fees, when used for tax audits, may  
               also create an incentive to distort the tax system for  
               private gain.  

               In Sears, Roebuck and Co. v William J. Parsons, the Georgia  
               Supreme Court voided a contract between Chatham County  
               Board of Tax Assessors and Atlantic Resources because the  
               contract allowed for a 35 percent contingency fee on  
               additional revenue plus 100 percent of all first-year  
               penalties.  260 Ga. 824 (1991).  The contract was voided on  
               public policy grounds.  In deciding the case, the Supreme  
               Court noted that "[t]he people's entitlement to fair and  
               impartial tax assessments lies at the heart of our system,  
               and, indeed, was a basic principle upon which this country  
               was founded.  Fairness and impartiality are threatened  
               where a private organization has a financial stake in the  
               amount of tax collected as a result of the assessment it  
               recommends."  Ultimately, government's role in auditing  
               taxpayers is to ensure that the correct tax is paid and  
               collected, but a contingency fee encourages third parties  
               to extract the highest settlement amounts possible, and  
               jeopardizes the tax system in favor of the independent  
               agent.  Specifically, contingency fee agreements make it  
               less likely that a taxpayer will be informed of audit  
               adjustments like tax credits and refund claims that could  
               lower tax payments.  Incidentally, if a tax is later found  
               to have been assessed incorrectly, the city will remain  
               liable to the taxpayer for the full amount, but without any  
               direct method of obtaining a refund from the third party  
               agent.    

               The use of contingency fee arrangements appears to provide  
               a no-cost way of raising additional city revenue and to  
               increase participation rates by smaller cities, but this is  
               not the case.  Cities choosing to enter into these  
               contingency fee agreements give up a large percentage of  
               the funds collected.  For instance, if the City of Los  
               Angeles decides to contract with a third party under a  
               contingency fee model of 35 percent, it could potentially  
               pay out as much as $4.8 million of the $13.9 million  
               collected in FY 2011-12.  Furthermore, it is unclear as to  









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               why the additional revenue, which could be in the hundreds  
               of thousands for smaller cities, is insufficient to offset  
               the hiring of new employees or redirecting existing  
               employees.  The hiring of an additional employee to sift  
               through tax information may actually be less expensive than  
               what the city pays in contingency fees, yet no information  
               has been presented by the sponsors of the bill explaining  
               why cities are incapable of conducting the program in  
               house.  Without such evidence, it seems imprudent for the  
               state to place sensitive financial information at greater  
               risk in exchange for additional revenue.  As such, the  
               Committee may wish to consider amending the bill to remove  
               the third party agent provision.

              d)   Safeguard Standards  :  The codification of existing  
               safeguard practices will help ensure that tax information  
               data remains free of data breaches.  However, because these  
               standards are already being utilized, codifying the  
               standards in law may not actually provide any additional  
               security.  

              e)   Related Legislation  :

               SB 1036 (Cedillo), introduced in the 2009-10 legislative  
               session, would have allowed local cities to share taxpayer  
               information with third party agents.  SB 1036 failed to  
               pass out of this Committee.

               SB 1146 (Cedillo), Chapter 345, Statutes of 2008, extended  
               the authority of the FTB to disclose limited confidential  
               tax information to city tax officials, and allowed a city  
               that administers a business tax to provide specific data to  
               the FTB upon request and authorized cities to exchange data  
               with the FTB in lieu of obtaining mandated cost  
               reimbursement. 

               SB 1374 (Cedillo), Chapter 513, Statutes of 2006, extended  
               the FTB's authority to disclose limited confidential tax  
               information to city tax officials until 2011.

               AB 63 (Cedillo), Chapter 915, Statutes of 2001, authorized  
               the FTB to disclose limited confidential tax information to  
               city tax officials in order to enhance the enforcement of  
               an existing city business tax law.










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           REGISTERED SUPPORT / OPPOSITION  :

           Support 
           
          City of Los Angeles
          City of Santa Monica
           
            Opposition 
           
          CalTax

           Analysis Prepared by  :  Carlos Anguiano / REV. & TAX. / (916)  
          319-2098