BILL ANALYSIS Ó
AB 328
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Date of Hearing: May 18, 2015
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Philip Ting, Chair
AB 328
(Grove) - As Introduced February 13, 2015
SUSPENSE
Majority vote. Tax levy. Fiscal committee.
SUBJECT: Minimum franchise tax: annual tax: exemption:
veteran-owned small businesses.
SUMMARY: Eliminates the Annual Tax (AT) for the first three
taxable years for a limited liability company (LLC) that is a
new veteran-owned small business, and eliminates the minimum
franchise tax (MFT) for a corporation that is a new
veteran-owned small business for its second and third taxable
years. Specifically, this bill:
1)Provides that, for taxable years beginning on or after January
1, 2016, a LLC that is a new veteran-owned small business
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shall not be subject to an AT for its first three taxable
years.
2)Provides that, for taxable years beginning on or after January
1, 2016, every corporation that is a new veteran-owned small
business shall not be subject to the MFT for its second and
third taxable years.
3)Provides that the exemption shall not apply to any LLC or
corporation that reorganizes solely for the purpose of
reducing its AT or MFT.
4)Defines a "veteran" as an individual honorably discharged from
the Armed Forces of the United States.
5)Defines a "new veteran-owned small business" (NVOSB) as a
veteran-owned LLC or veteran-owned corporation (VOC) that is
formed under the laws of California or has qualified to
transact intrastate business in California that begins
business operations at or after the time of its formation, and
that has a total income derived from, or attributable to, the
state of $250,000 or less. A NVOSB does not include any LLC
or corporation that began business operations as a sole
proprietorship, a partnership, a corporation, or any other
form of business entity prior to its formation.
6)Defines a "veteran-owned limited liability company" (VOLLC) as
an LLC in which more than 50% of the membership interest is
owned by one or more veterans.
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7)Defines a "VOC" as a corporation in which stock representing
more than 50% of the voting power of the corporation and
representing more than 50% value of the stock of the
corporation is owned by one or more veterans.
EXISTING LAW:
1)Imposes franchise tax on all corporations doing business in
California equal to 8.84% of the taxable income attributable
to California. A MFT of $800 is imposed on all corporations
that are incorporated under the laws of California, qualified
to transact intrastate business in California, or are doing
business in California. Taxpayers must pay the MFT only if it
is more than their regular franchise tax liability.<1>
2)Provides exceptions with respect to imposition of the MFT.
For instance, credit unions and nonprofit organizations are
not subject to MFT and a corporation is not subject to the MFT
for its first taxable year. However, even though a
corporation is not subject to the MFT in its first taxable
year, it will be subject to the regular franchise tax in its
first taxable year based on its taxable income.
3)Provides that LPs, LLPs, and LLCs that are doing business in
California, registered or qualified to do business in
California, or formed in this state, are subject to AT in an
amount equal to the MFT, currently set at $800. These
entities (known as 'pass-through entities') are not subject to
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<1> According to the FTB, for taxable years beginning on or
after January 1, 1997, only taxpayers with net incomes of less
than approximately $9,040 pay the MFT because the amount of
measured tax owed would be less than $800 ($9,039 x 8.84% =
$799).
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any tax based on taxable income. Rather, the items of income,
gain, loss, deduction and credit are passed-through to the
owners and reported on their respective income or franchise
tax returns.
4)Provides that real estate mortgage investment conduits
(REMICs) and financial asset securitization investment trusts
(FASITs) are subject to and are required to pay the MFT.
Regulated investment companies (RICs) and real estate
investment trusts (REITs) organized as corporations are also
subject to and are required to pay the MFT. RICs, REITs,
REMICs, and FASITs are entities authorized by the federal
government for special tax treatment. California conforms in
large part to federal tax provisions but subjects each entity
to payment of the annual minimum tax.
5)Provides that LLCs and certain small corporations, solely
owned by a deployed member of the United States (U.S.) Armed
Forces, are exempted until January 1, 2018 from the $800 AT
and MFT.
FISCAL EFFECT: The Franchise Tax Board (FTB) estimates that
this bill will reduce General Fund revenue by $17 million in
fiscal year (FY) 2015-16, $22 million in FY 2016-17, and $23
million in 2017-18.
COMMENTS:
1)Author's Statement : The author has provided the following
statement in support of this bill:
AB 328 seeks to reduce the tax burden for new businesses
owned and operated by U.S. military veterans. This bill
will extend the current one-year exemption to three years
for newly established veteran-owned businesses from paying
the state's [MFT].
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The state of California owes a great debt of gratitude to
the men and women who have served to protect our freedom to
live, work, and play in this great state and nation. By
exempting the $800 MFT in additional two years for these
men and women who put their effort into furthering our
business community, we are removing a significant obstacle
to overcome in order to help them maintain and grow their
new and still fragile startup business.
2)Argument in Support : The Southwest California Legislative
Council (SWCLC) states, "This bill is similar to SB 641
(Anderson, which was supported by the SWCLC in 2013 seeking to
eliminate the [MFT] for ALL eligible new businesses.
Unfortunately that bill did not pass in spite of the minimal
impact to the state budget furthering the impression that
California is not a business-friendly state. Let's all get
behind this bill which would grant some minor and temporary
relief to entrepreneurial veterans who have already given so
much to their country."
3)Argument in Opposition : The California Professional
Firefighters state "[they] proudly support our nation's
veterans and do not dispute the concept of aiding them;
particularly those who were deployed to combat duty in recent
foreign wars. That said, however, such an exemption is an
ineffective way to aid veterans who could most benefit from
state assistance, specifically poorer veterans who need aid
via other state programs." Also, the California Tax Reform
Association (CTRA) states "veteran-owned business advantages
have been notoriously gamed in the past." Moreover, CTRA
continues on to say that "there is no evidence that the
minimum tax impedes the ability of anyone to pursue
entrepreneurial ambitions, let along veterans. There is no
apparent relationship between this tax exemption and the need
to assist veterans, who are in all walks of life and all types
of businesses."
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4)Minimum Tax : The MFT, the AT, and annual fee, were enacted to
ensure that all corporations and LLCs pay at least a minimum
amount of tax for the privilege of doing business in
California, regardless of the businesses income or loss.
Thus, the minimum tax is not an "income tax", but rather a tax
on the right to exercise the powers granted to a corporation
doing business in California. Even when a business earns no
income, it still receives the benefits of its corporate
status, including the limited liability protection under
California law.
5)Supply-Side Economics : Generally, advocates for tax
incentives, such as Arthur Laffer and N. Gregory Mankiw, argue
that reduced taxes allow taxpayers to invest money that would
otherwise be paid in taxes, thereby creating additional
economic activity. "Supply-siders" posit that higher taxes do
not result in more government revenue; instead, they suppress
additional innovation and investment that would have led to
more economic activity and, therefore, healthier public
treasuries, under lower marginal tax rates. Critics, however,
assert that tax incentives rarely result in additional
economic activity. Companies conduct business in California
because of its competitive advantages, namely its environment;
transportation infrastructure; access to ports, highways, and
railroads; as well as its highly skilled workforce and
world-class higher education system. $800 is a nominal amount
in light of the benefits that are conferred to struggling
veteran-owned small companies. Moreover, regardless if the
MFT or AT were stayed for the first three years, NVOSB would
still be liable for the measure tax owed on any income
produced. Therefore, it is unclear to Committee staff if
reducing or eliminating the MFT would achieve the desired
result. Alternatively, if the taxpayer cannot afford to pay
either the MFT or the AT, there is always the alternative of
establishing a sole proprietorship. As a sole proprietorship,
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the taxpayer would not be liable for either tax.
6)LLCs : For most of American history, business owners had a
choice of either a partnership or a corporation. Relatively
recently, however, the LLC business structure has become one
of the most popular choices for starting a new business
because it provides owners with the limited liability of "C"
corporations and the flow through tax status of partnerships.
In 2007, formation of LLCs in the U.S. outpaced the number of
corporations by a margin of two-to-one. As a result, the
number of new partnerships, although difficult to track, has
also substantially decreased. According to Professor Howard
Freidman, the general partnership can easily be replaced by an
LLC, providing the informal benefits of a partnership along
with limited liability. General partnerships that exists
today are either those that exist from the pre-LLC days or are
informal agreements that by default fall within the Uniform
Partnership Act. Professor Howard Freidman went on to say
that "[t]he once-elaborately drafted partnership agreement has
gone the way of the buggy whip and slide rule. It has been
replaced by the LLC operating agreement." (Rodney D.
Chrisman, LLCs are the New King of the Hill, Fordham Journal
of Corporate and Financial Law, Vol. 15, Issue 2, 2009.)
In general, LLCs provide limited liability, avoidance of double
taxation, flexibility of income distribution, simplicity of
formation and procedures, and no restrictions on ownership.
For a small business owner who has never considered forming as
a "C" corporation, the major benefit of an LLC is the limited
liability. Generally, members of the LLC are not liable for
the debts, liabilities, or obligations of the firm. (Jonathan
Macey, The Limited Liability Company: Lessons for Corporate
Law, Washington University Law Review, Vol. 73, Issue 2,
1995.) The goal of providing limited liability appears to be
the state's need to promote investment by transferring risk
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from investors to creditors. (David Millon, Piercing the
Corporate Veil, Financial Responsibility, and the Limits of
Limited Liability, Emory Law Journal, Vol. 65, Number 5,
2007.) Therefore, LLCs and other limited liability structures
provide a substantial benefit to entrepreneurs at a nominal
cost of $800 per year, even when their businesses are
insolvent or operating at a loss.
7)How is a tax expenditure different from a direct expenditure :
As the Department of Finance notes in its AT Expenditure
Report, there are several key differences between tax
expenditures and direct expenditures. First, tax expenditures
are reviewed less frequently than direct expenditures once
they are put in place. This can offer taxpayers greater
certainty regarding applicable tax laws, but it can also
result in tax expenditures remaining a part of the tax code
without demonstrating any public benefit. Second, there is
generally no control over the amount of revenue losses
associated with any given tax expenditure. Finally, it should
also be noted that, once enacted, it takes a two-thirds vote
to rescind an existing tax expenditure absent a sunset date.
For this reason, the author may wish to include a five-year
sunset date for this deduction, to provide the opportunity for
future legislative review.
8)Related Legislation :
a) AB 799 (Allen) would make nonsubstantive changes to the
provision imposing an AT on LLCs. AB 799 is pending
hearing by this Committee.
b) AB 612 (Patterson) would reduce that MFT in the second
taxable year for a new corporation, and the AT in the first
taxable year for a new limited partnership, new LLP, and
new LLC that is a small business, which is defined as a
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"business entity with gross receipts of $5,000 or less", as
specified. AB 612 is pending hearing by this Committee.
1)Prior Legislation :
a) AB 2495 (Melendez), of the 2013-2014 Legislative
Session, exempts new qualifying corporations, limited
partnerships, limited liability partnerships, and limited
liability companies from the annual minimum tax for the
first five consecutive taxable years. AB 2495 was held on
this Committee's Suspense File.
b) AB 2466 (Nestande), of the 2013-2014 Legislative
Session, reduces the annual minimum tax for new
veteran-owned businesses and eliminate the tax if the
business operates at a loss or ceases operation. AB 2466
failed passage in Assembly Appropriations.
c) AB 990 (Conway), of the 2013-2014 Legislative Session,
would have reduced the MFT from $800 to $700. AB 990 was
never heard by this Committee.
d) AB 2671 (Cook), Chapter 394, Statutes of 2010, exempts,
until 2010, certain small corporations and LLCs solely
owned by a deployed member of the U.S. Armed Forces from
the annual MFT.
e) AB 327 (Garrick), of the 2009-10 Legislative Session,
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would have reduced the MFT from $800 to $100. AB 237 was
held on this Committee's Suspense File.
f) AB 2178 (Garrick), of the 2007-08 Legislative Session,
would have reduced the MFT from $800 to $200. AB 2178 was
held on this Committee's Suspense File.
g) AB 1419 (Campbell), introduced in the 1997-98
Legislative Session, would have reduced the MFT for a
qualified corporation from $800 to $100. AB 1419 failed
passage in the Senate Revenue and Taxation Committee.
REGISTERED SUPPORT / OPPOSITION:
Support
National Federation of Independent Businesses
Southwest California Legislative Council
Opposition
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American Federation of State, County and Municipal Employees,
AFL-CIO
California Professional Firefighters
California Tax Reform Association
Analysis Prepared by:Paul Kim / REV. & TAX. / (916) 319-2098