BILL ANALYSIS Ó AB 505 Page 1 Date of Hearing: May 18, 2015 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Philip Ting, Chair AB 505 (Melendez) - As Introduced February 23, 2015 Majority vote. Tax levy. Fiscal committee. SUBJECT: Personal Income Tax Law: exclusion: veterans: concurrent retirement and disability pay. SUMMARY: Excludes from gross income Concurrent Retirement and Disability Pay (CRDP) payments, as defined. Specifically, this bill: 1)Excludes from gross income, for taxable years beginning on or after January 1, 2016, CRDP payments received by an eligible individual during the taxable year. AB 505 Page 2 2)Defines an "eligible individual" as an active, reserve, or retired member of the United States (U.S.) military who served in active duty. 3)Defines "CRDP" as payments received by an eligible individual, as provided in Section 1414 of Title 10 of the U.S. Code. 4)Provides that no inference shall be drawn with respect to the property tax treatment of CRDP payments received before January 1, 2016. 5)Takes effect immediately as a tax levy. EXISTING FEDERAL LAW: 1)Provide that "gross income" includes all income from whatever source derived, including compensation for services, business income, gains from property, interest, dividends, rents, and royalties, unless specifically excluded. 2)Exclude from gross income certain types of income received by an individual as a result of the individual's active service in the Armed Forces of the U.S. as follows: a) A pension, annuity, or similar payment for personal injuries or sickness that resulted from combat-related service in the Armed Forces or a disability annuity (Internal Revenue Code (IRC) Section 104); b) Compensation received for active service by a member of the U.S. Armed Forces below the grade of commissioned officer for any month during which the individual served in combat zones or was hospitalized as a result of wounds, AB 505 Page 3 disease, or injury incurred in a combat zone (IRC Section 112); c) The premium paid into a survivor annuity account for the qualified survivors of military personnel; d) Disability retirement pay that is computed on the basis of the percentage of disability (IRC Section 104); e) Dividends and proceeds from maturing government endowment insurance contracts under the National Service Life Insurance Act of 1940 and all other acts relating to veterans; f) Interest left on deposit with the Veterans Administration (VA); g) Veterans' benefits under any law administered by the U.S. Department of Veterans Affairs (VA), including amounts paid to veterans or their families in the form of educational, training, or subsistence allowances, disability compensation and pension payments for disabilities, compensation for participation in a work therapy programs (38 U.S.C. §5301 and following); and, h) Armed Forces allowances. (IRC Section 265.) 3)Defines "combat-related injuries" as injuries incurred as a direct result of armed conflict, while engaged in extra-hazardous service, or in the performance of duty under conditions simulating war. 4)Does not exclude from gross income CRDP, which is paid for non-combat related injuries. 5)Exempts from taxation military death benefits paid to qualified survivors. (IRC Section 134). EXISTING STATE LAW generally conforms to the federal tax law AB 505 Page 4 with respect to various exclusions from gross income of amounts received as veterans' benefits. FISCAL EFFECT: The Franchise Tax Board (FTB) staff estimates that this bill will result in an annual General Fund loss of $14 million in the fiscal year (FY) 2015-16, $24 million in FY 2016-17, and $24 million in FY 2017-18. COMMENTS: 1)Author's Statement . The author has provided the following statement in support of this bill: "Currently, service members who have sustained injuries while in battle receive compensation for their sacrifice in the form of Combat-Related Special Compensation (CRSC). CRSC payments received by an eligible individual who performed service in a combat zone are exempt from state and federal taxes. "Concurrent Retirement and Disability Pay (CRDP) are payments received by an eligible veteran who is retired and entitled to receive disability income. Currently, these payments are not excluded from federal and state tax liability. "Our retired veterans have selflessly put their lives on the line for this country. This bill would simply allow those who are injured or disabled to be able to take full advantage of their disability benefits. Relieving these brave men and women of CRDP tax liability is the least this state can do to honor those that have sacrificed so much." 2)Existing Tax Treatment of Military Compensation under Federal and State Laws . Prior to the enactment of the Tax Reform Act of 1986, a variety of benefits for military personnel were excluded from gross income under federal law and various regulations. In 1986, Congress determined that in the future AB 505 Page 5 no such exclusions would be permitted except under some provisions of the IRC, but "grandfathered" all of the previous non-Code exclusions. (IRC Section 134). Benefits administered by the Department of Veterans Affairs, including disability compensation, are not subject to federal income tax. As explained by the FTB staff, before 2002 federal law "prohibited the concurrent receipt of military retired pay and disability compensation from the VA for the same period of service. Consequently, the retired pay of a military retiree was reduced by the amount of disability compensation received from the VA." In 2002, federal law was amended to authorize the payment of additional compensation for a combat-related disability to certain military retirees, known as Combat-Related Special Compensation (CRSC). The CRSC payment is considered disability compensation and is excluded from gross income under both federal and state tax laws. In 2003, Congress authorized additional payments to those military retirees whose retired pay was reduced by the amount of disability compensation administered by the VA. However, the new retired pay, known as Concurrent Receipt of Disability Pay (CRDP), is currently subject to both federal and state income taxes. 3)What Does This Bill Do ? This bill is intended to create an exclusion from gross income for one type of military retiree compensation - CRDP payments. CRSC compensation is paid for combat-related injuries and, as explained above, is considered disability compensation. CRSC compensation is currently not taxable under the federal and state laws. In contrast, CRDP payments are paid to a retired member of the U.S. military for noncombat-related injuries and are taxable under both federal and state law. Thus, this bill provides an exclusion from gross income for CRDP compensation received in taxable years beginning on or after January 1, 2016. 4)Income Limitation . This bill provides an exclusion from gross income for CRDP to all military retirees, regardless of their income. Tax exemptions are often granted with some type of AB 505 Page 6 income limitation. 5)Non-Conformity to Federal Law . State conformity with federal law promotes greater simplicity and eases administration of complex tax laws. By providing an exclusion from gross income for retired pay and survivor annuities, this bill would bring California out of conformity with the federal law. 6)FTB's Implementation Concerns . The FTB staff notes that, because for federal purposes gross income includes both military retirement pay and CRDP, "it is unclear how the department would be able to validate the CRDP exclusion for state purposes." The FTB staff is concerned that "the lack of guidance could cause disputes between taxpayers and the department and require the department to open up an audit in order to verify the amount of gross income reported by taxpayers." 7)FTB's Technical Concerns . The FTB staff recommends a technical amendment to replace the phrase "eligible individual" with "qualified retiree," which would be consistent with Title 10 of the U.S. Code Section 1414. 8)Sunset Date . This bill lacks a sunset date to allow periodic legislative review of this tax expenditure. The Committee staff recommends an amendment to add a sunset date. 9)Prior Legislation : a) AB 2329 (Melendez), of the 2013-14 Legislative Session, is substantially similar to this bill. AB 2329 was held on the Assembly Appropriations' Suspense File. b) AB 2004 (Knight), of the 2011-12 Legislative Session, would have allowed an individual to exclude from his/her gross income Combat-Related Special Compensation and Concurrent Retirement and Disability Pay payments, as defined. AB 2004 was held on the Assembly Committee on Appropriations' Suspense File. AB 505 Page 7 c) SB 401 (Wolk), Chapter 14, Statutes of 2010, provided specified date conformity to the IRC, including the gross income exclusions for combat-related injury pay and combat-related disability pay. d) AB 53 (Klehs), Chapter 1138, Statutes of 1987, repealed the pension and retirement pay exclusions as a result of active duty in the Armed Forces. REGISTERED SUPPORT / OPPOSITION: Support None on file Opposition None on file Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916) 319-2098 AB 505 Page 8