BILL ANALYSIS                                                                                                                                                                                                    

                         Senator Robert M. Hertzberg, Chair
                                2015 - 2016  Regular 

          |Bill No:  |AB 154                           |Hearing    |7/8/15   |
          |          |                                 |Date:      |         |
          |Author:   |Ting                             |Tax Levy:  |No       |
          |Version:  |6/30/15                          |Fiscal:    |Yes      |
          |Consultant|Grinnell                                              |
          |:         |                                                      |

                             TAXATION:  FEDERAL CONFORMITY

          Conforms state law to federal law as of January 1, 2015; makes  
          changes to the large corporate understatement penalty.

           Background and Existing Law

           I.  Conformity.  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 Stephen Beck, Jr., Achieving a Better Life  
          Experience Act of 2014 (AB 449, Irwin, and SB 324, Pavley) 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).  

          II. Large Corporate Understatement Penalty.  Corporation  
          taxpayers are subject to a penalty equal to 20% of any  
          understatement that exceeds $1 million of the tax shown on an  
          original return (or amended return filed on or before the  
          extended due date of the original return) for taxable years  
          beginning on or after January 1, 2003 (SBx1 28, Committee on  
          Budget, 2008).  The measure also applies to understatements on  
          amended returns filed on or before May 31, 2009 for taxable  
          years beginning before January 1, 2008.  The penalty applies to  


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          the total amount of the understatement for an entire combined  
          report, and excludes any understatement attributable to a change  
          in law under specified circumstances or when the taxpayer relied  
          on written advice from the Franchise Tax Board (FTB).  The  
          penalty applies in addition to any other penalty, and is strict  
          liability, meaning that the taxpayer has no appeal rights.  In  
          2010, the Legislature modified the penalty for taxable years for  
          the 2011 taxable year and thereafter to apply only to  
          understatements that exceed the greater of $1 million, or 20%  
          (SB 858, Committee on Budget and Fiscal Review, 2010).

           Proposed Law

           I.  Conformity.  Assembly Bill 154 conforms relevant sections of  
          the Revenue and Taxation Code to the Internal Revenue Code as of  
          January 1, 2015, with some modifications.

          Specifically, the measure conforms the federal net operating  
          loss (NOL) rules that allow corporations expecting an NOL  
          carryback to extend the time for payment of taxes for the  
          preceding taxable year; the exclusion from gross income  
          qualified military base realignment and closure fringe from the  
          Worker, Homeowner, and Business Assistance Act of 2009; the  
          disclosure of information with respect to foreign financial  
          assets in the Hiring Incentives to Restore Employment Act; not  
          treating certain swaps as Section 1256 contracts under the  
          Dodd-Frank Wall Street Reform and Consumer Protection Act; the  
          special rule with respect to certain redemptions by foreign  
          subsidiaries in the State Fiscal Relief and Other Provisions  
          Revenue Offsets; the modification of control definition for  
          purposes of Section 249 in the FAA Modernization and Reform Act  
          of 2012; the transfers of excess pension assets in the Moving  
          Ahead for Progress in the 21st Century Act; modifications to  
          acquisitions, dispositions, and aggregation of expenditures in  
          the research and development credit in the American Taxpayer  
          Relief Act of 2012; Indian general welfare benefits in the  
          Tribal General Welfare Act of 2014, various technical changes in  
          the Tax Technical Corrections Act of 2014; the Investment  
          Direction Rule for 529 accounts in the Achieving a Better Life  
          Experience Act.  In the Small Business Jobs Act of 2010, AB 154  
          conforms to:

                 The limitation on penalty for failure to disclose  


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               reportable transactions based on resulting tax benefits,

                 Removal of cell phones and similar technology from  
               listed property,

                 Increase in information return penalties,

                 Special rules for annuities received from only a portion  
               of a contract.

          AB 154 makes the following modifications for state purposes:

                 Conform to lower state excise tax of 12.5% on  
               nonqualified Archer Medical Savings Account distribution,  
               instead of 20% at federal.  

                 Generally disconnects inflation adjustments to penalty  

          AB 154 doesn't conform to:

                 The higher threshold of 10% of adjusted gross income to  
               claim unreimbursed medical expense deductions, maintaining  
               California current 7.5% threshold.

                 Deferral and ratable inclusion of income arising from  
               business indebtedness discharged by reacquisition of debt.

                 Requirement for certain tax preparers to file returns  

                 Inflation indexing of many penalty amounts.

                 Increase in penalty for failing to file partnership or  
               S-Corporation returns

                 Exempting limitation on net unrealized built-in losses  
               resulting from bank reorganizations. 

                 Expansion of work opportunity tax credit, which would  
               have reduced the value of enterprise zone and other  
               geographically targeted economic development area credits.

          As part of conformity, the measure repeals sections added by AB  


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          1423, AB 36 (Perea, 2010), AB 242 (Committee on Revenue and  
          Taxation, 2011) as the January 1, 2015 general conformity date  
          incorporates subsequent changes made by Congress.  Additionally,  
          AB 154 makes legislative findings and declarations stating that  
          SB 401 (Wolk, 2010) is valid.  

          II.  Large Corporate Understatement Penalty.  AB 154 makes the  
          following changes to the Large Corporate Understatement Penalty:

                 Provides that any amount of tax reflecting a proper 338  
               election doesn't count towards the understatement amount  
               for purposes of the penalty, which can generally be made up  
               to one year after an acquisition, are treated as shown on  
               an original return,

                 States that no penalty shall apply when FTB imposes an  
               alternative apportionment formula under Revenue and  
               Taxation Code 25137, or as a result of a change in the  
               taxpayer's federal accounting method where the due date of  
               the return is before the Secretary of the Treasury's  
               determination to change the accounting method.

           State Revenue Impact

           According to FTB, AB 154's conformity provisions result in net  
          revenue gains of $3.1 million in 2015-16, $8 million in 2016-17,  
          and $14.2 million in 2017-18.  An estimate of the measure's  
          changes to the Large Corporate Understatement Penalty is  


           1.   Purpose of the bill  .  According to the author, "AB 154 is a  
          vital measure conforming state tax law to federal tax, easing  
          tax preparation for taxpayers and tax preparers alike.  This  
          measure is intended to narrow differences between state and  
          federal law and provide relief to members of the United States  
          Armed Forces, businesses, and individual taxpayers."

          2.   Odd couple  .  AB 154 is the state's first omnibus tax  
          conformity measure in five years, and would move ahead the  
          state's conformity date by six years, picking up changes that  


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          will more closely align state and federal personal income and  
          corporation tax statutes, easing compliance headaches for  
          taxpayers as well as administrative difficulties for FTB.   
          However, the measure also contains changes to the state's Large  
          Corporate Understatement Penalty, which only applies to large  
          corporate taxpayers that significantly understate tax on their  
          original returns, and doesn't have a federal counterpart.  While  
          the measure's changes to the penalty simply account for changes  
          where federal law affords taxpayers time to choose between two  
          transaction structures, or have their tax due changed by  
          decisions made by either IRS or FTB, putting the two together is  
          an odd match.  The Committee may wish to consider whether AB  
          154's changes to the understatement penalty should be in a  
          separate bill.  

           3.   Doomsday machine  .  SB 401 was the last tax conformity bill  
          the Legislature enacted by majority vote because Proposition 26  
          (2010) changed the standard that Legislative Counsel uses to  
          determine whether a legislative bill is a tax increase, and  
          therefore must be approved by 2/3 vote of each house of the  
          Legislature.  Instead of "changes in state taxes enacted for the  
          purpose of increasing revenues collected pursuant thereto  
          whether by increased rates or changes in the method of  
          computation," Proposition 26 amended Section 3 of Article XIIIA  
          of the California Constitution to provide that the 2/3 vote  
          applied to any "change in state statute that leads any taxpayer  
          to pay a higher tax."  As such, measures like SB 401 that  
          contained some provisions that increased taxes, and others that  
          decreased them, but resulted in a net revenue loss, were  
          majority vote bills before Proposition 26, but 2/3 vote bills  
          today.  Additionally, the initiative provided that the  
          Legislature must reenact any bill that was enacted one year  
          before its enactment by majority vote or else such measure would  
          be "void," which captured two such bills, the gas tax swap (ABx8  
          6, Assembly Committee on Budget, 2010) and SB 401.  While the  
          Legislature subsequently reauthorized the gas tax swap by 2/3  
          vote, it did not do the same for SB 401.  While no one has yet  
          challenged the bill in court, should the measure be invalidated,  
          an adverse decision could theoretically change the calculation  
          of tax for every return filed for the last five years.  AB 154  
          restates SB 401's validity in the hopes of eliminating any  
          uncertainty regarding SB 401's legality. 

           4.   Urgency  .  AB 154 contains an urgency clause, which states  


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          that the measure's provisions must take effect immediately to  
          grant needed tax relief to taxpayers in conformity with federal  
          tax relief enacted in the last four years and to alleviate  
          administrative burdens on state tax agencies.  As such,  
          Legislative Counsel has assigned the measure a 2/3 vote.   
          However, the urgency clause isn't necessary as the measure is  
          keyed a tax levy, which means that its changes affect the  
          current 2015 taxable year.   

           5.   Tax Increase  .  Because the measure would result in an  
          increase in tax on any taxpayer according to Section 3 of  
          Article XIIIA of the California Constitution, Legislative  
          Counsel has keyed the measure a 2/3 vote.

           Assembly Actions

           Assembly Floor                75-0

          Assembly Appropriations       15-0
          Assembly Revenue and Taxation   6-0


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          Support and  
          Opposition   (7/2/15)

           Support  :  California Asian Chamber of Commerce, California  
          Bankers Association, California Chamber of Commerce, California  
          Manufacturers and Technology Association, California Society of  
          Enrolled Agents, California Taxpayers Association, Computing  
          Technology Industry Association, Hewlett Packard Company,  
          National Federation of Independent Business, Spidell Publishing,  

           Opposition  :  None received.

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