BILL ANALYSIS                                                                                                                                                                                                    Ó



                                                                    AB 1736


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          Date of Hearing:   May 9, 2016


                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION


                           Sebastian Ridley-Thomas, Chair



          AB 1736  
          (Steinorth) - As Amended May 3, 2016


          Majority vote.  Fiscal committee.  Tax levy. 


          SUBJECT:  Personal income taxes:  deduction:  homeownership  
          savings accounts


          SUMMARY:  Creates a homeownership savings account (HSA) under  
          the same rules as apply to the Individual Retirement Account  
          (IRA) and allows a deduction for contributions made by qualified  
          individuals to the HSA, as specified.  Specifically, this bill: 


          1)Allows a deduction equal to the amount contributed in the HSA  
            by a qualified taxpayer in any taxable year commencing on or  
            after January 1, 2017, not to exceed:


               a)     $20,000 for qualified taxpayers who are married  
                 filing a joint return, a head of household and surviving  
                 spouses, as defined.  


               b)     $10,000 for qualified taxpayers filing a return  
                 other than those specified.








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          2)Defines a "Homeownership Savings Account" as a trust that  
            meets all of the following requirements: 


               a)     Is designated as a HSA by the trustee;


               b)     Is established for the exclusive benefit of any  
                 qualified taxpayer establishing the account where the  
                 written governing instrument creating the account  
                 provides for the following: 


                     i.          All contributions to the account are  
                      required to be in cash; and 


                     ii.         The account is established to pay,  
                      pursuant to applicable requirements and limitations,  
                      for the qualified homeownership savings expenses of  
                      a qualified taxpayer establishing the account. 


               c)     Is, except as otherwise provided, subject to the  
                 same requirements and limitations as an IRA established  
                 under Section 408 of the Internal Revenue Code, relating  
                 to individual retirement accounts, and any regulations  
                 adopted thereunder.


               d)     Is established by a qualified taxpayer who has a  
                 gross income of 80 percent or less than the area median  
                 income.


               e)     Is the only homeownership savings account  
                 established by the qualified taxpayer. 








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          3)Excludes from gross income, for each taxable year beginning on  
            or after January 1, 2017, any income accruing to a HSA during  
            the taxable year.


          4)Specifies that any withdrawals for other than qualified  
            expenses shall be included in income of the payee or  
            distributee for the taxable year in which the payment or  
            distribution is made, unless the payment or distribution is  
            used to pay for the homeownership savings expenses of a  
            qualified taxpayer who established the account.   


          5)Defines a "qualified homeownership savings expense" as  
            expenses, including a down payment or closing costs, paid or  
            incurred in connection with the purchase of a qualified  
            taxpayer's principal residence in California for use by that  
            taxpayer who established the HSA.


          6)Defines a "qualified taxpayer" as any individual, or  
            individual's spouse, who has never had an ownership interest  
            in a principal residence subject to the contribution allowed  
            by this section. 


          7)Provides that the term "trustee" has the same meaning as it  
            has under Section 408 of the IRC, relating to traditional  
            IRAs.


          8)Takes effect immediately as a tax levy. 


          EXISTING FEDERAL LAW:  










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          1)Provides for two types of IRAs: traditional IRAs and Roth  
            IRAs.  Limits the amount of qualified contributions to both  
            traditional and Roth IRAs to the smaller of $5,500 ($6,500 for  
            taxpayers 50 years of age or older), or the taxpayer's taxable  
            compensation for the year.


          2)Allows an income tax deduction for contributions (other than a  
            rollover contribution) made only to a traditional IRA.  
            Contributions made a Roth IRA are subject to tax. 


          3)Provides that amounts held in a traditional IRA are generally  
            included as income when withdrawn, except to the extent the  
            withdrawal is a return of nondeductible contributions.  
            Withdrawals are subject to an additional tax of 10% if  
            withdrawn prior to age 59 , with some exceptions.  
            Specifically, the taxpayer is not subject to the early  
            withdrawal tax if the withdrawal is used for first-time  
            homebuyer expenses of up to $10,000. 


          4)Allows an exclusion from gross income for any qualified  
            distribution from a Roth IRA.


          5)Allows various deductions and exclusions in computing taxable  
            income and provides that an individual may elect to claim  
            itemized deductions for a taxable year in lieu of the standard  
            deduction. 


          EXISTING STATE LAW:


          1)Provides that federal changes to Part I of Subchapter D of  
            Chapter 1 of IRC Sections 401 through 420, inclusive, relating  
            to pension, profit-sharing, stock bonus plans, other employee  
            benefit plans, and IRC Section 457, relating to deferred  








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            compensation plans of state and local governments and  
            tax-exempt organizations, automatically apply without regard  
            to taxable years to the same extent as applicable for federal  
            income tax purposes.  All federal changes made to those IRC  
            sections are automatically adopted by California without  
            regard to the specified date.  

          2)Provides that a distribution from a 401(k) plan, a qualified  
            annuity plan under IRC Section 403(a), a tax-sheltered annuity  
            under IRC Section 403(b), an eligible deferred compensation  
            plan under IRC Section 457, or an individual retirement  
            arrangement under IRC Section 408 is included in income for  
            the year distributed.





          3)Imposes a penalty equal to 2%, instead of the federal rate of  
            10%, of the amount includible in income on early withdrawals  
            from those plans, unless an exemption applies, in conformity  
            with the federal tax law.  

          1)Allows various deductions and exclusions in computing taxable  
            income under the Personal Income Tax (PIT) law and generally  
            conforms to the federal rules that apply to itemized  
            deductions. 


          2)Specifies that the California Housing Finance Agency (CalHFA)  
            may provide down payment assistance in the form of deferred  
            payment, low-interest, and junior mortgage loans, which are  
            designed to reduce principle and interest payments to make  
            financing affordable for first time low and moderate income  
            homebuyers.  In most cases, CalHFA programs may be used in  
            conjunction with other first-time homebuyer programs,  
            including programs offered by nonprofit entities.










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          FISCAL EFFECT:  The Franchise Tax Board (FTB) staff estimates  
          that this bill will result in an annual revenue loss of $220  
          million in the fiscal year (FY) 2017-18 and $450 million in FY  
          2018-19. 


          COMMENTS:  


           1)Author's Statement  . The author has provided the following  
            statement in support of this bill:



          "The dream of owning a home is the foundation our middle class  
            is built on.  I am firmly committed to keeping that dream  
            alive.  AB 1736 presents an innovative solution to enable  
            first-time homebuyers to save more of their hard-earned money  
            and put it towards their very first home.  The benefits of  
            homeownership are clear, and this bill will make those  
            benefits more attainable for families across California.  In  
            turn, the state will be able to retain more workers and  
            businesses alike, and encourage the construction of more  
            needed homes."
           2)Agreements in suppor t:   According to the Building Industry  
            Association, data recently released by Beacon Economic shows  
            California ranks 49th in homeownership and last in overall  
            housing affordability.  "While an average California home cost  
            $440,000, homebuyers need additional tools to attain the  
            American Dream.  As the state grapples with a housing  
            affordability crisis, AB 1736 will allow first-time homebuyers  
            to save more of their own money in order to attain the  
            benefits of homeownership." 


              
          3)Arguments in Opposition  :  According to the California Tax  
            Reform Association, "This bill provides little or no help to  
            those struggling to buy a home in California's expensive  








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            housing market.  By allowing a deduction, it provides the  
            greatest benefits to those who are better off, that is, are in  
            the higher tax brackets in our progressive tax system. In  
            fact, since it has no income limitation it merely provides a  
            tax shelter for those with substantial income, but even with  
            such a limitation it would still provide disproportion  
            benefits to the well-off who can save the most and are at  
            least in need of help in buying a home. "


           4)Tax-Advantaged Savings Accounts and Retirement Plans  .   
            Congress has authorized several kinds of retirement savings  
            plans that qualify for reduced or deferred income taxes to  
            encourage workers to save for retirement.  A qualified  
            retirement plan, such as a 401(k) plan or an IRA, allows a  
            worker to save for retirement by investing a portion of  
            his/her wages while deferring current income taxes on the  
            original investment and earnings until withdrawal.  All  
            qualified contributions are invested on a pre-tax basis and  
            not taxed until the money is withdrawn. With the enactment of  
            the Roth provisions, participants in qualified IRA plans may  
            elect to deposit some or all of their wages in a designated  
            brokerage account, commonly known as a Roth IRA.  Qualified  
            distributions from a designated Roth account are tax free,  
            while contributions are made on an after-tax basis (i.e.,  
            income tax is paid or withheld on the contributions in the  
            year contributed).



           5)Exceptions to the Early Withdrawal Penalty  .  Existing federal  
            tax law imposes a 10% withdrawal penalty on early  
            distributions made from a qualified retirement or annuity  
            plan, a 403(b) annuity, or an IRA to a taxpayer under the age  
            of 59, unless an exception applies.  California imposes a  
            similar penalty but at the rate of 2% of the amount  
            includible in income on early withdrawals from those plans.   
            However, recognizing that some significant events might  
            require people to withdraw money from their retirement  








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            accounts earlier than expected, Congress has provided for a  
            waiver of the early withdrawal penalty in some situations, to  
            which California has conformed.  An exception applies to  
            distributions that are (a) used for the health insurance  
            premiums of an unemployed individual (in the case of IRA  
            distributions only); (b) used for medical expenses; (c) made  
            to a beneficiary (or to the estate of the employee) on or  
            after the date of the employee's death; (d) made to an  
            employee who separates from service at age 55 or older; (e)  
            made to individuals called to active duty; or (f) used for  
            first-time home purchases (in the case of IRA distributions  
            only).


            
           6)The "First-Time Home Buyer" Exception  .  Both federal and state  
            laws already authorize penalty-free withdrawals of a limited  
            amount of IRA funds for first-time homebuyers. The definition  
            of "first-time homebuyer" is broad and includes not only to  
            the taxpayer's very first home purchase, but also applies in  
            the case of a taxpayer whose spouse has not owned a principal  
            residence at any time during the past two years even if the  
            taxpayer himself/herself would not qualify as the first home  
            buyer.  Furthermore, a taxpayer does not have to purchase the  
            residence for himself/herself.  The taxpayer may also qualify  
            for the exemption if he/she is helping his/her child,  
            grandchild or parent to buy a home.  



          In the case of a traditional IRA, the maximum amount of IRA  
            funds that may be withdrawn without the penalty is $10,000.   
            In the case of a Roth IRA, this limitation applies only to the  
            amount of earnings withdrawn from the account because one can  
            always withdraw his/her contributions to a Roth tax- and  
            penalty-free. The $10,000 limitation applies on an individual  
            basis, which means that both the taxpayer and his/her spouse  
            may qualify individually for the homebuyer exemption,  
            potentially doubling the amount of money they can withdraw  








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            from IRA accounts. 

          In light of the existing waiver under both federal and state  
            laws allowing a penalty-free distribution of funds from  
            qualified individual retirement accounts, the Committee may  
            wish to consider whether this bill is necessary. 

           7)High-Income Taxpayers Benefit More Than Low-Income Taxpayers  .   
            The proposed deductions for contributions to HSAs would  
            disproportionately benefit taxpayers in higher tax brackets  
            because the "value" of a deduction varies with the marginal  
            tax rate (or tax bracket) of the taxpayer.  Thus, when a  
            taxpayer who is in the 30% tax bracket deducts a $100  
            contribution, his/her tax is reduced by $30.  On the other  
            hand, if the taxpayer is in a 20% bracket, a $100 contribution  
            deducted from his/her gross income would reduce his/her tax  
            liability only by $20.  Because of the progressive rate  
            structure of the tax system, taxpayers in higher tax brackets  
            benefit more from income deductions than individuals in lower  
            tax brackets.  This effect is magnified in the case of HSAs:   
            a higher income taxpayer, with presumably a greater ability to  
            purchase a house, would receive a greater tax benefit than the  
            lower income taxpayer.



           8)Existing Tax Incentives for Homeowners  .  Existing law heavily  
            subsidizes owner-occupied housing.  Tax preferences that  
            encourage homeownership include:  deductibility from income of  
            mortgage interest on first and second homes for state and  
            federal purposes; deductibility from income of property taxes  
            for state and federal tax purposes; and exclusion from income  
            of certain capital gains on the sale of a home for state and  
            federal tax purposes.  For example, taxpayers may deduct  
            interest payments on up to $500,000 single/$1 million joint of  
            indebtedness used to purchase a first and second home.   
            Taxpayers may also deduct interest payments on up to $100,000  
            in home improvement loans.  In addition, taxpayers may exclude  
            up to $250,000 single/$500,000 joint in income resulting from  








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            the sale of their principal residence.  The Department of  
            Finance estimates that these tax benefits resulted in more  
            than $7.2 billion in foregone revenue in fiscal year (FY)  
            2014-15.  



          Homeownership is also encouraged by the non-taxability of the  
            housing services that are received by the owner.  In fact,  
            according to the Congressional Research Service report, some  
            analysts argue that this preferential tax treatment encourages  
            households to over-invest in housing and invest less in  
            business investments that might contribute more to the  
            nation's productivity and output. 
           
           9)Tax Expenditures  .  Each year, more and more interest groups  
            are seeking ways to increase funding through alternative  
            means, such as tax credits and other tax incentives.  However,  
            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, which can offer  
            taxpayers greater certainty but can also result in tax  
            expenditures remaining a part of the tax code in perpetuity  
            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  
            generally takes a two-thirds vote to rescind an existing tax  
            expenditure.  This effectively results in a "one-way ratchet"  
            whereby tax expenditures can be conferred by majority vote,  
            but cannot be rescinded, irrespective of their efficacy,  
            without a supermajority vote.





           10)Tax Subsidy vis-à-vis Grant Program: Is the Tax Code the Best  








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            Way to Subsidize Homeownership?   Although well intentioned,  
            this bill represents an attempt to use the tax code to  
            accomplish a public policy objective that may be more  
            efficiently addressed through a direct outlay of state funds.   
            This bill proposes a tax subsidy to taxpayers to help them  
            achieve the dream of homeownership.  The FTB staff estimates  
            that this bill would eventually result in an annual GF revenue  
            loss of $450 million.  

          As discussed in the Housing and Community Development  
            Committee's analysis of this bill, the California Housing  
            Finance Agency (CalHFA) operates the California Homeowner  
            Downpayment Assistance Program (CHDAP) and provides homebuyers  
            between 3% and 6% in downpayment assistance secured as a  
            second mortgage on the home. The program operates as a  
            revolving loan; when a home is sold, CalHFA is repaid allowing  
            the funds to go to another homebuyer.  There is approximately  
            $150 million available in CHDAP at this time.  The program can  
            provide downpayments to individuals that make up to 120% of  
            the area median income (AMI) and just recently raised its  
            income limits to 140% of AMI in high-cost areas.  CalHFA  
            operates independently of the state General Fund and derives  
            the funding for its downpayment assistance program from the  
            sale of bonds.  The Committee may wish to consider whether  
            expanding the CHDAP program to include more homebuyers would  
            be a better vehicle to subsidize homeownership.   
            Alternatively, given the shortage of affordable housing in  
            California, the Committee may wish to consider whether a  
            priority should be given to affordable housing, rather than  
            individual homeownership.

           11)Double Benefit  .  This bill would allow taxpayers to make  
            tax-deductible contributions to, and receive tax-free  
            withdrawals from, a HSA as long as the funds are used for  
            qualified expenses.  In contrast, a traditional IRA allows  
            tax-deductible contributions, but imposes a tax on  
            distributions.  And while qualified distributions from Roth  
            IRAs are tax-free, contributions to these accounts are  
            taxable.  The Committee may wish to consider whether this  








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            preferential tax treatment of savings for homeownership, but  
            not retirement, is justified and whether either the  
            contributions to, or distributions from, an HSA should be  
            taxable.



           12)Lack of Conformity  .  Conformity with federal law reduces  
            taxpayer errors and eases tax filing and administration.  This  
            bill would create a state and federal difference, which adds  
            complexity to the tax return as the income excluded or  
            deferred by this bill is still subject to federal income tax.   
            In the absence of similar federal treatment, taxpayers and  
            banks will need to keep separate accounting of the deposits  
            and withdrawals for state and federal tax purposes.



           13)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 an  
            appropriate sunset provision.



           14)Definition of "Qualified Taxpayer  ." This bill defines a  
            "qualified taxpayer" as an individual or his/her spouse that  
            has never had an ownership interest in a principal residence  
            subject to the contribution allowed by this section.  It is  
            unclear to Committee staff whether this definition is intended  
            to apply to individuals who have never owned a principal  
            residence in their lives or to individuals who have never used  
            HSA moneys to purchase a principal residence.  The Committee  
            may wish to consider limiting the application of this bill  
            only to the former category of individuals. 









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           15)Double Referred :  This bill was referred to both the Assembly  
            Committee on Housing and Community Development and this  
            Committee.  This bill passed the Committee on Housing and  
            Community Development with amendments on 7-0 vote. 


          REGISTERED SUPPORT / OPPOSITION:




          Support


          California Building Industry Association


          California Council for Affordable Housing


          County of San Bernardino


          Habitat for Humanity California


          League of California Cities


          Western Manufacturing Housing Communities Association




          Opposition










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          None on file




          Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916) 319-2098