BILL ANALYSIS Ó
RECONSIDERATION - FOR VOTE ONLY
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 797 HEARING: 1/15/14
AUTHOR: Anderson FISCAL: Yes
VERSION: 1/6/14 TAX LEVY: Yes
CONSULTANT: Grinnell
FRAUDULENT INVESTMENTS
Conforms state law to federal treatment for Bernie Madoff
Ponzi scheme losses.
Background and Existing Law
Bernard L. Madoff Investment Securities, Inc. began
liquidating on December 11, 2008, with the appointment of
the trustee under the Securities Investor Protection Act.
Bernard Madoff individually went into an involuntary
Chapter 7 liquidation in April 2009. His bankruptcy case
was consolidated with the firm's liquidation. Madoff is
serving a 150-year prison sentence following a guilty plea.
Investors lost approximately $17 billion of principal
according to the trustee, which would normally be treated
as capital losses for state and federal tax purposes.
Under state and federal law, taxpayers may generally only
claim $3,000 of capital losses per year to offset income
earned from other sources, known as a capital loss
limitation.
In response, the Internal Revenue Service (IRS) issued
Revenue Ruling 2009-9 and Revenue Procedure 2009-20 in
March, 2009. Revenue Ruling 2009-9 redefines losses on
fraudulent investment schemes as business losses, thereby
converting losses from Madoff investment from capital
losses to business ones, and allowing taxpayers to apply
them as net operating losses (NOLs). Revenue Procedure
2009-20 provides a safe-harbor method of computing and
reporting losses from Madoff investments.
Federal and state law provides that a NOL is incurred when
a business taxpayer has negative taxable income in a
taxable year. Taxpayers can use NOLs as deductions against
income realized in future taxable years, called a "carry
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forward," or as a deduction against past income, receiving
a refund for previous taxes paid, known as a "carry back."
Under federal law, a NOL can generally be carried back two
years and forward 20 years. Special rules are provided for
the carry back of NOLs relating to issues such as specified
liability losses, casualty or theft losses, disaster losses
of a small business, and farming losses. Recent changes in
federal law extend the carry back period up to five years
for specified losses. The American Recovery and
Reinvestment Act, enacted in March, 2009, allowed certain
taxpayers to make an irrevocable election to carry back
applicable 2008 losses for up to five years. The Worker,
Homeownership, and Business Assistance Act, enacted in
November, 2009, allowed taxpayers with business losses to
make an irrevocable election to carry back losses incurred
in one year (ending after 2007 and beginning before 2010)
for up to five years.
State law previously allowed taxpayers to deduct income for
the next ten taxable years by a percentage of the past NOL,
until the Legislature allowed 100% NOL deductions for the
2004 taxable year and thereafter as part of a measure that
suspended taxpayers from applying NOLs in the 2002 and 2003
taxable years (AB 2065, Oropeza, 2002). However, the
Legislature further expanded the use of NOLs when it again
suspended taxpayers from using NOLs in the 2008 and 2009
tax years except for taxpayers with less than $500,000 in
net business income. The Legislature extended carry
forwards from 10 to 20 years, and authorized two-year NOL
"carry backs," beginning in the 2011 taxable year (AB 1452,
Committee on Budget, 2008). In 2010, the Legislature again
suspended NOLs for the 2010 and 2011 tax years, and
extended the effective dates for NOL carry backs from 2011
to 2013, while exempting taxpayers with less than $300,000
in modified adjusted gross income or corporate taxpayers
with less than $300,000 in pre-apportioned income (SB 858,
Committee on Budget, 2010). SB 858 also exempted one
company from the 2008 and 2009 NOL suspensions. Currently,
taxpayers can claim net operating carry backs as follows:
For NOLs generated in the 2013 taxable year,
taxpayers may carry back 50% of the loss to the 2011
and 2012 taxable years.
For NOLs generated in the 2014 taxable year,
taxpayers may carry back 75% of the loss to the 2012
and 2013 taxable years.
For NOLs generated in the 2015 taxable year and
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thereafter, taxpayers may carry back 100% of the loss
to the 2013 taxable year and thereafter.
Proposed Law
Senate Bill 797 conforms state law to federal law by
applying Revenue Procedure 2009-20 for purposes of the
state personal income and corporation tax. If the taxpayer
deducts the loss as a theft loss, discovers the loss in the
same taxable year detailed by the Revenue Procedure, and
calculates the amount as the same as specified by the
Revenue Procedure, the NOL for state purposes:
Is exempt from the 2008 through 2011 NOL
suspensions.
May be carried back five years, or carried forward
twenty years.
The bill bars FTB from challenging the treatment of a loss
determined under the Revenue Procedure. The measure
conforms by reference to the federal statute of limitations
rules with respect to NOL carrybacks for losses
attributable to application of the Revenue Procedure.
State Revenue Impact
According to FTB, the 4/1/13 version of SB 797 results in
revenue losses of $6 million in 2012-13, and revenue gains
of $2.9 million in 2013-14, $2.2 million in 2014-15, and
$700,000 in 2015-16. A revised estimate of the bill as
amended is pending; however, 1/6/14 amendments are not
expected to affect this estimate significantly.
Comments
1. Purpose of the bill . According to the Author, "The
state should not gain from a criminal act perpetrated
against the victims of a swindle. Senate Bill 797 is a
bi-partisan measure which would provide tax relief for
California families and businesses that have been the
victim of a fraudulent investment scheme such as the highly
publicized Madoff case. If passed, SB 797 would conform
California law to federal law by allowing a net operating
loss carryover of any deduction from losses that are
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attributable to criminal investment fraud. This would
include people who, through no fault of their own, were
victims of Madoff. This is a simple issue of fairness -
innocent investors swindled by Madoff should not be taxed
as if it was just like any other business loss."
2. One of many . Ponzi schemes have occurred often
throughout history, including the eponymous Charles Ponzi
and the match-king of Sweden, Ivar Krueger. Scam artists
have used these rackets to cheat unwitting people out of
money, all of whom didn't receive the tax benefits granted
by the IRS in the Revenue Proclamation and proposed in SB
797. Ordinary taxpayers that suffer capital losses are
subject to capital loss limitations that cap the amount of
loss that can be used to reduce other income, and must wait
until a trustee determines the final amount of the loss
before they can claim it. Only for Madoff investors has
the IRS conferred such unique benefits.
The great majority of investing taxpayers in recent years
haven't invested in a Ponzi scheme, but may have lost money
in investments that can hardly be distinguished from one,
such as AIG stock or in real estate, and therefore don't
benefit from this bill. The measure also applies only to
individuals who directly invested with Madoff; those
invested through intermediary "funds of funds" do not get
the special protection. The Committee may wish to consider
the equity of providing a unique benefit to taxpayers that
suffered from one particular investment scam, and whether
the precedent created will be cited in the future.
3. A little help . In most cases, when taxpayers lose
property in a casualty or theft-related loss, no special
exceptions apply; however, victims of the Madoff Ponzi
scheme receive favorable federal tax treatment by
converting the capital losses to business losses, which can
be carried forward and backwards under federal law, and
providing a realization date for the loss. Even if the
Madoff losses were simply converted from capital losses
into business losses without carry backs, affected
taxpayers could only have applied the losses to future
income, taking many years to recoup what would likely be
only some portion of their lost principal. Under the
ruling and SB 797, affected taxpayers can fully apply the
losses to the past five taxable years, and receive refunds
for previous taxes paid in those years, which California
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taxpayers can only do in limited amounts, and only
commencing in the 2013 taxable year.
4. Play it again . SB 797 is identical to SB 157
(Anderson, 2011) and SB 876 (Florez, 2010). The Committee
on Governance and Finance failed to approve SB 157, while
the former Senate Revenue and Taxation Committee held SB
876 on its suspense file.
Support and Opposition (1/9/14)
Support : State Treasurer Bill Lockyer; Board of
Equalization, Jerome E. Horton; Board of Equalization,
Betty T. Yee; Contra Costa County Treasurer-Tax Collector
Russell Watts; San Bernardino County District Attorney
Michael Ramos; California Taxpayers' Association; seven
individuals.
Opposition : Unkown.