BILL ANALYSIS Ó AB 428 Page 1 Date of Hearing: May 18, 2015 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Philip Ting, Chair AB 428 (Nazarian) - As Amended May 12, 2015 Majority vote. Tax levy. Fiscal committee. SUBJECT: Income taxes: credit: seismic retrofits SUMMARY: Allows a credit equal to 30% of a "qualified taxpayer's" "qualified costs" incurred for "seismic retrofit construction", as specified. Specifically, this bill: 1)Allows the credit for taxable years beginning on or after January 1, 2016, and before January 1, 2021. 2)Defines a "qualified taxpayer" as an owner of a "qualified building" located in California. A taxpayer that owns a proportional share of a "qualified building" may claim the AB 428 Page 2 credit based on the taxpayer's share of the "qualified costs". 3)Defines "qualified costs" as costs paid or incurred by the qualified taxpayer for any completed "seismic retrofit construction" on a "qualified building", including any engineering or architectural design work necessary to permit or complete the "seismic retrofit construction". "Qualified costs" shall not include any of the following: a) Maintenance, including abatement of deferred or inadequate maintenance, and correction of violations unrelated to the "seismic retrofit construction"; b) Repair, including repair of earthquake damage; c) "Seismic retrofit construction" required by local building codes as a result of addition, repair, building relocation, change of use, or occupancy; d) Other work or improvement required by local building or planning codes as a result of the intended "seismic retrofit construction"; e) Rent reductions or other associated compensation, compliance actions, or other related coordination involving the qualified taxpayer and any other party, including a tenant, insurer, or lender; f) Replacement of existing building components, including equipment, except as needed to complete the "seismic retrofit construction"; g) Bracing or securing nonpermanent building contents; h) The offset of costs, reimbursements, or other costs transferred from the qualified taxpayers to others; or, i) Amounts paid to the jurisdiction with authority for building code enforcement for issuing the certification AB 428 Page 3 required by this bill. 4)Defines "seismic retrofit construction" as alteration of a "qualified building" or its components to substantially mitigate seismic damage. Seismic retrofit construction shall be for work performed voluntarily, and for which qualified costs were paid or incurred, on or after January 1, 2016. Seismic retrofit construction shall include the following: a) Anchoring the structure to the foundation; b) Bracing cripple walls; c) Bracing hot water heaters; d) Installing automatic gas shutoff valves; e) Repairing or reinforcing the foundation to improve the foundation's integrity against seismic damage; f) Anchoring fuel storage; and, g) Installing an earthquake-resistant bracing system for mobile homes registered with the California Department of Housing and Community Development. 5)Defines a "qualified building" as a building that has been certified as an "at-risk property" by "the local building code enforcement" for the area within which the building is located. A qualified building specifically includes a mobile home registered by the Department of Housing and Community Development. 6)Defines an "at-risk property" as a building deemed hazardous and in danger of collapse in the event of a catastrophic earthquake, including soft story buildings, nonductile concrete residential buildings, and pre-1994 concrete residential buildings. AB 428 Page 4 7)Provides that, to be eligible for the credit, the following must apply: a) The qualified taxpayer must obtain certification from the appropriate jurisdiction with authority for building code enforcement, upon a review of the building, that the completed construction satisfies the definition of seismic retrofit construction. The certification shall identify what part of the completed construction, if any, is not seismic retrofit construction. Upon request of the Franchise Tax Board (FTB), the qualified taxpayer must provide a copy of the certification to the FTB. b) The jurisdiction with authority for building code enforcement in which a qualified building is located has entered into an agreement with the state to provide certifications and to not seek reimbursement for any costs incurred in providing those certifications. 8)Requires the credit amount allowed to be claimed by a qualified taxpayer at the rate of 1/5th of the credit amount for the taxable year in which the credit is allowed, and one-fifth of the credit amount for each of the subsequent four taxable years. 9)Provides that, in cases where the credit amount exceeds the taxpayer's tax liability, the excess credit amount may be carried over to the following taxable year, and succeeding four taxable years, until the credit has been exhausted. 10)Provides that, for purposes of computing the credit, the qualified costs shall be reduced by any grant provided by a public entity for the seismic retrofit construction. 11)Provides that this credit shall be in lieu of any other credit or deduction that the qualified taxpayer may otherwise claim with respect to qualified costs. 12)Allows the credit under both the Personal Income Tax (PIT) AB 428 Page 5 Law and the Corporation Tax (CT) Law. 13)Provides that Revenue and Taxation Code (R&TC) Section 41 shall not apply to the credit. 14)Takes immediate effect as a tax levy. 15)Sunsets the credit provisions on December 1, 2021. EXISTING LAW: 1)Allows various tax credits under both the PIT Law and the CT Law. These credits are generally designed to encourage socially beneficial behavior or to provide relief to taxpayers who incur specified expenses. 2)Allows taxpayers engaged in a trade or business to deduct expenses considered ordinary and necessary in conducting that trade or business. 3)Requires any bill authorizing a new credit to contain all of the following: a) Specific goals, purposes, and objectives that the tax credit will achieve; b) Detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives stated in the bill; and, c) Data collection requirements to enable the Legislature to determine whether the tax credit is meeting, failing to meet, or exceeding those specific goals, purposes, and objectives. The requirements shall include the specific data and baseline measurements to be collected and remitted AB 428 Page 6 in each year the credit is in effect, for the Legislature to measure the change in performance indicators, and the specific taxpayers, state agencies, or other entities required to collect and remit data. (R&TC Section 41.) FISCAL EFFECT: The FTB estimates that this bill will reduce General Fund revenues by $1.4 million in fiscal year (FY) 2015-16, by $5.2 million in FY 2016-17, and by $9.1 million in FY 2017-18. COMMENTS: 1)The author has provided the following statement in support of this bill: The recent earthquakes, which shook Southern California cities [in] 2014, remind us that an earthquake can strike at any given moment and it is imperative that we ensure our structures are suitable to withstand a catastrophic earthquake. According to the Southern California Earthquake Center, California has a 99.7% chance of having a magnitude 6.7 or larger earthquake during the next 30 years, and the likelihood of an even more powerful quake of magnitude 7.5 or greater in the next 30 years is 46%. It is imperative that we take every precaution to make sure that human life and property is saved in the event of a catastrophic earthquake. This measure will improve California's resilience against earthquakes, saving the public money that would otherwise have been required for disaster relief. AB 428 Page 7 2)Proponents of this bill note the following: We all know that the cost to retrofit a building is very expensive. While older buildings were constructed according to building codes in place at the time, new studies have found that some of these buildings may not survive a strong earthquake. Your bill will help and encourage property owners to have work done to their buildings to ensure they are safe. Your bill is important not only to property owners, but also to tenants who live in these buildings. 3)Committee Staff Comments a) What is a "tax expenditure" ? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, U.S. Treasury officials began arguing that these features of the tax law should be referred to as "expenditures" since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each (in the form of foregone revenues). b) How is a tax expenditure different from a direct expenditure ? As the Department of Finance notes in its annual Tax 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. While this affords taxpayers greater financial predictability, 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 AB 428 Page 8 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, effectively resulting in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their cost or efficacy, without a supermajority vote. c) What would this bill do ? This bill would allow a credit equal to 30% of a qualified taxpayer's qualified costs incurred for seismic retrofit construction. According to the United States Geological Survey, there is a 99.7% chance that a major earthquake of 6.7 in scale will strike California in the next 30 years. This bill's tax credit is designed to lower the overall cost for property owners to improve the seismic safety of their buildings. Proponents note that such action, in turn, could save countless lives in the event of a catastrophic earthquake, and would reduce the demand for state and local emergency services by hopefully minimizing structural damage. Older concrete structures are particularly vulnerable to earthquake damage; last year, the author noted that recent research has identified 1,500 concrete buildings that are seismically vulnerable in the Los Angeles area alone. d) Implementation considerations : Committee staff has identified certain implementation concerns with this bill's current language. Committee staff is available to work with the author's office to resolve these and any other concerns that may be identified. These issues include the following: i) This bill currently requires a taxpayer to obtain a "certification" from the "appropriate jurisdiction with authority for building code enforcement." This AB 428 Page 9 certification, in turn, must attest to the fact that the completed construction satisfies the statutory definition of "seismic retrofit construction." The certification must also identify what part of the completed construction, if any, is not seismic retrofit construction. This bill does not, however, currently require this certification to verify a building's "at-risk" status prior to construction, which may ease administration of the credit. These provisions raise a number of additional issues. First, this bill provides little definitional guidance for identifying the "appropriate jurisdiction" with building code enforcement authority. Additional ambiguity is created by this bill's definition of a "qualified building", which is deemed one that has been certified as an at-risk property by the local "building code enforcement" for the area within which the building is located. The author may wish to consider appropriate amendments clarifying which entities will have certification authority. ii) This bill defines an "at-risk property" as a building deemed hazardous and in danger of collapse in the event of a catastrophic earthquake, including, but not limited to, soft-story buildings, nonductile concrete residential buildings, and pre-1994 concrete residential buildings. This language may create ambiguity regarding which building types potentially qualify for this designation. On one hand, this language would appear to vest local building code entities with unfettered discretion to designate any building as "at-risk" as long as it is deemed in danger of collapse in the event of an earthquake. On the other hand, references to specific building types such as "pre-1994" concrete residential buildings may suggest that concrete buildings constructed after 1994 do not qualify. AB 428 Page 10 iii) This bill currently specifies that seismic retrofit construction must be for work performed "voluntarily"; it is not entirely clear what this term means. If a local government were to enact an ordinance requiring certain seismic safety improvements for specified buildings, would compliance with this ordinance be considered "voluntary"? What if the ordinance gave all property owners three years to comply? Would improvements completed before the ordinance's operative date be considered "voluntary"? The author may wish to consider amendments clarifying these issues, especially given that tax credits are generally allowed, as a matter of legislative grace, to encourage action that otherwise would not occur. e) R&TC Section 41 shall not apply : On September 29, 2014, Governor Brown signed into law SB 1335 (Leno), Chapter 845, Statutes of 2014, which added R&TC Section 41. SB 1335 recognized that the Legislature should apply the same level of review used for government spending programs to tax preference programs, including tax credits. Thus, Section 41 requires any bill introduced on or after January 1, 2015 that allows a new credit to contain specific goals, purposes, and objectives that the tax credit will achieve. In addition, Section 41 requires detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives so-identified. The present bill provides that R&TC Section 41 shall not apply to this credit. The Committee may wish to consider the appropriateness of this Section 41 exemption. Critics of a Section 41 exemption might argue that the exemption exacerbates one of the primary problems inherent in crafting tax expenditure measures - namely, it is often AB 428 Page 11 unclear what objectives the Legislature is aiming to achieve. f) Prior legislation : i) AB 1510 (Nazarian), of the 2013-14 Regular Session, would have allowed a credit equal to 30% of a "qualified taxpayer's" "qualified costs" incurred for "seismic retrofit construction". AB 1510 was held on the Assembly Appropriations Committee's Suspense File. ii) AB 1756 (Scott), of the 1999-2000 Regular Session, would have allowed a credit equal to 55% of the amount incurred for seismic retrofit construction on residential dwellings built prior to 1979. AB 1756 was held on the Assembly Committee on Appropriations' Suspense File. iii) SB 677 (McPherson), of the 2001-02 Regular Session, would have allowed a credit equal to an unspecified percentage of the final cost of seismic retrofitting, as specified. SB 677 was never heard by the Senate Committee on Revenue and Taxation. REGISTERED SUPPORT / OPPOSITION: Support California Apartment Association Western Manufactured Housing Communities Association AB 428 Page 12 Opposition None on file Analysis Prepared by:M. David Ruff / REV. & TAX. / (916) 319-2098