BILL ANALYSIS Ó AB 1275 Page 1 Date of Hearing: May 18, 2015 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Philip Ting, Chair AB 1275 (Gray) - As Introduced February 27, 2015 Majority vote. Tax levy. Fiscal committee. SUBJECT: Personal income taxes: exclusion: military retirement pay SUMMARY: Excludes from gross income, for taxable years beginning on or after January 1, 2015, retirement pay received by a taxpayer from the federal government for military service performed in the Armed Forces of the United States (Armed Forces), the reserve component of the Armed Forces, or the National Guard. Specifically, this bill: 1)Excludes from gross income, for taxable years beginning on or after January 1, 2015, survivor benefits received by a AB 1275 Page 2 taxpayer from the federal government pursuant to Chapter 73 of Title 10 of the United States Code. 2)Takes immediate effect as a tax levy. EXISTING FEDERAL LAW: 1)Defines "gross income" as all income from whatever source derived, except as otherwise provided. (Internal Revenue Code (IRC) Section 61.) Gross income specifically includes compensation for services, business income, gains from property, interest, rents, royalties, dividends, and pensions. 2)Excludes from gross income compensation received for active service as a member below the grade of commissioned officer in the Armed Forces for any month during any part of which such member: a) Served in a combat zone, as defined; or, b) Was hospitalized as a result of wounds, disease, or injury incurred while serving in a combat zone, as specified. (IRC Section 112(a).) The term "compensation" specifically excludes pensions and retirement pay. (IRC Section 112(c).) 3)Excludes from gross income amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the armed forces of any country, as specified. (IRC Section 104(a)(4).) AB 1275 Page 3 4)Excludes from gross income any "qualified military benefit". (IRC Section 134(a).) A "qualified military benefit" is defined as any allowance or in-kind benefit that: a) Is received by any member or former member of the uniformed services of the United States or any dependent of such member by reason of the member's status or service; and, b) Was excludable from gross income on September 9, 1986, under any provision of law, regulation, or administrative practice in effect on such date, as provided. (IRC Section 134(b).) EXISTING STATE LAW: 1)Provides that IRC Section 61, relating to the definition of gross income, shall apply, except as specified. (Revenue and Taxation Code (R&TC) Section 17071.) 2)Provides various exclusions from gross income in determining tax liability under the Personal Income Tax Law. (R&TC Section 17131 et seq.) 3)Excludes from gross income specified death benefits received by the surviving spouse or designated beneficiary of any member of the California National Guard, State Military Reserve, or Naval Militia who dies or is killed in the performance of duty, as specified. (R&TC Section 17132.4.) AB 1275 Page 4 4)Defines the term "Armed Forces of the United States" to include all regular and reserve components of the uniformed services which are subject to the jurisdiction of the Secretary of Defense, the Secretary of the Army, the Secretary of the Navy, or the Secretary of the Air Force, and the Coast Guard. The members of such forces include commissioned officers and personnel below the grade of commissioned officers in such forces. (R&TC Section 17022.) FISCAL EFFECT: The Franchise Tax Board (FTB) estimates that this bill would reduce General Fund revenues by $330 million in fiscal year (FY) 2015-16, by $210 million in FY 2016-17, and by $210 million in FY 2017-18. COMMENTS: 1)The author has provided the following statement in support of this bill: As California grows, it will need experienced employees and business owners who understand how to lead and manage California's most valuable resource - its people. Who better to lead than a retired NCO or officer? Making military retirement pay tax-free makes California a more enticing employment opportunity for retiring military personnel, offsetting some of the costs that drive retirees elsewhere. After 20 years in the service, retirees are entitled to a pension worth half their base pay, but that rarely provides enough compensation for most to stop working. Many leave the service between the ages of 38 to 45, with every intention of staring a second career. With the anticipated decline in US Military participation in Iraq and AB 1275 Page 5 Afghanistan, significant numbers of new military retirees will begin their search for a place to call home. They will bring their leadership, expertise, and capital with them. For California to remain an attractive and competitive place to live, we must keep up with the 30 other states [that] have already acknowledged the mutual benefit of this policy: higher property and sales tax revenues for the state and more money in the pockets of our retired Veterans. 2)Proponents of this bill note the following: We support your effort to eliminate California income tax on veterans [sic] military retirement pay. A majority of states offer some sort of tax relief, whether partial relief or complete exemption from state income tax. Many veterans from California relocate to those states because of the tax friendly environment. This bill will make California a veteran friendly state. 3)Opponents of this bill note the following: We have no problem with providing tax relief to those who were disabled in combat, or for survivor benefits for those who were killed in combat, but this bill is far too broad and exempts substantial amounts of income for those who receive generous and deserved retirement benefits from military service. Many of those who receive retirement benefits - teachers, first responders and others - serve their country as well, but income should be counted as income except in the exceptional cases of service mentioned above. AB 1275 Page 6 4)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 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 efficacy or cost, without a supermajority vote. c) General background : The FTB notes that, for taxable years beginning December 22, 1972, through January 1, 1986, California law provided taxpayers an annual $1,000 income exclusion for compensation received during active duty in the Armed Forces or State Military Reserve. State law also AB 1275 Page 7 provided taxpayers an exclusion of up to $500 per month for any compensation received during active duty in the National Guard in connection with an emergency. Additionally, an income exclusion applied to pensions or retirement pay received by an individual for his or her service in the Armed Forces, the State Military Reserve, or the National Guard. (See former R&TC Section 17146.) For taxable years beginning on or after January 1, 1987, and before January 1, 1992, a member of the Armed Forces was allowed a credit, rather than an exclusion from gross income, in an amount equal to 4% of the eligible income received by an individual whose adjusted gross income was less than $27,000. Eligible income included salary, wages, bonuses, allowances, pensions, retirement pay, and other compensation received by an individual for his or her services on extended active duty as a member of the Armed Forces, including the California National Guard, or the State Military Reserve. This law remained in effect until January 1, 1992 and was repealed by its own terms as of that date. (See former R&TC Section 17053.13.) d) Lack of conformity : This bill would allow an exclusion from gross income for military retirement pay and survivor benefits for which federal law has no counterpart, thus bringing state law out of conformity. State conformity with federal law promotes greater simplicity and eases the administration of complex tax laws. e) A potential precedent : While cognizant of the personal and professional sacrifices made by members of the military, Committee staff notes that this bill would favor one group of taxpayers over another, thereby establishing a precedent for excluding the retirement benefits received by other taxpayers the state wishes to recognize (e.g., police, firefighters, teachers). AB 1275 Page 8 f) Absence of a sunset date : In its current form, this bill's proposed tax expenditure lacks an automatic sunset provision. This Committee has a longstanding policy favoring the inclusion of sunset dates to allow the Legislature periodically to review the efficacy and cost of such programs. The author may wish to consider the addition of appropriate sunset provisions. g) Related legislation : AB 505 (Melendez) excludes from gross income concurrent retirement and disability pay payments received by an "eligible individual", defined as an active, reserve, or retired member of the United States military who served in active duty. AB 505 is scheduled to be heard by this Committee on May 18, 2015. h) Prior legislation : i) AB 2329 (Melendez), of the 2013-14 Legislative Session, would have excluded from gross income Concurrent Retirement and Disability Pay payments received by an eligible individual, defined as an active, reserve, or retired member of the United States military who served in active duty. AB 2329 was held on the Assembly Appropriations Committee's Suspense File. ii) AB 1077 (Anderson), of the 2009-10 Legislative Session, would have excluded from gross income retired pay and survivor annuities received by an individual as a result of the active service of a member of the Armed Forces. AB 1077 was held on this Committee's Suspense File. AB 1275 Page 9 REGISTERED SUPPORT / OPPOSITION: Support American Legion-Ceres Post 491 American Legion-Department of California AMVETS-Department of California California Association of County Veterans Service Officers California Senior Legislature California State Commanders Veterans Council Military Officers Association of America, California Council of Chapters National Association for Uniformed Services VFW-Department of California Vietnam Veterans of America-California State Council AB 1275 Page 10 9 private individuals Opposition California Tax Reform Association Analysis Prepared by:M. David Ruff / REV. & TAX. / (916) 319-2098