BILL ANALYSIS                                                                                                                                                                                                    Ó






                                                                    AB 2392


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          Date of Hearing:  May 9, 2016


                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION


                           Sebastian Ridley-Thomas, Chair





          AB 2392  
          (Nazarian) - As Introduced February 18, 2016


          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, 2017, and before January 1, 2022.  
          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  
            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  











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            or complete the "seismic retrofit construction" less the  
            amount of any grant provided by a public entity for 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, 












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             i)   Amounts paid to the jurisdiction with authority for  
               building code enforcement for issuing the certifications  
               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, and for which qualified costs were paid  
            or incurred, on or after January 1, 2017.  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 Department of Housing and  
               Community Development. 


          5)Provides that seismic retrofit construction does not include  
            construction performed to bring a building into compliance  
            with local building codes.  
          6)Defines a "qualified building" as a building that has been  
            certified as an "at-risk property," as specified.  A qualified  











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            building specifically includes a mobile home registered by the  
            Department of Housing and Community Development.   


          7)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.


          8)Provides that, to be eligible for the credit, the following  
            must apply:


             a)   The qualified taxpayer must, prior to construction,  
               obtain certification from the appropriate jurisdiction with  
               local building code enforcement authority that the building  
               is an at-risk property.  
             b)   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, and specify a dollar amount  
               of qualified costs.  


             c)   The qualified taxpayer must request and be granted an  
               allocation of the credit from the Franchise Tax Board  
               (FTB).  To request an allocation, the taxpayer shall sign  
               and submit to the FTB an application to receive a credit  
               for the seismic retrofit construction and provide a copy of  
               the certification.  


             d)   The jurisdiction with authority for building code  
               enforcement in which a qualified building is located has  











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               entered into an agreement with the state to provide  
               certifications and to not seek reimbursement for any costs  
               incurred in providing those certifications.  


          9)Requires the credit amount allowed to be claimed by a  
            qualified taxpayer at the rate of one-fifth of the credit  
            amount for the taxable year in which the credit is allocated,  
            and one-fifth of the credit amount for each of the subsequent  
            four taxable years.  
          10)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. 


          11)Provides that the total amount of credit that may be  
            allocated shall not exceed the sum of the following:


             a)   $12 million for the 2017 calendar year and each calendar  
               year thereafter; and, 
             b)   The amount of previously unallocated credits allowed.  


          12)Requires the FTB, upon receipt of the credit application, to  
            notify the taxpayer of the amount, if any, of the credit  
            allowed and to allocate the credit to qualified taxpayers on a  
            first-come-first-served basis.  
          13)Requires the taxpayer to claim the credit on a timely filed  
            original return.  


          14)Provides that the FTB's determination with respect to the  
            allocation of the credit, and whether a return has been timely  
            filed, may not be reviewed in any administrative or judicial  
            proceeding.  













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          15)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. 


          16)Authorizes the FTB to prescribe rules, guidelines, or  
            procedures necessary or appropriate to carry out the purposes  
            of administering the credit.  


          17)Allows the credit under both the Personal Income Tax (PIT)  
            Law and the Corporation Tax (CT) Law.


          18)Provides that, for purposes of complying with Revenue and  
            Taxation Code (R&TC) Section 41, the Legislature finds and  
            declares all of the following with respect to the credits:


             a)   The specific goals, purposes, and objectives that the  
               tax credits will achieve are as follows:
               i)     Leveraging $60 million in private investment;
               ii)    Creating thousands of engineering or construction  
                 jobs; and, 


               iii)   Mitigating seismic damage to save lives.


             b)   The detailed performance indicators for the Legislature  
               to use when measuring whether the credits meet those  
               specific goals, purposes, and objectives are as follows:
               i)     The amount of private sector investment enabled by  
                 allocation of the tax credits;
               ii)    The number of engineering and construction jobs  
                 created as a result of this investment; and, 


               iii)   The estimated number of lives saved by the seismic  











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                 retrofitting of buildings facilitated by the tax credits.  
                  


             c)   The data collection requirements to enable the  
               Legislature to determine whether the tax credits are  
               meeting, failing to meet, or exceeding those specific  
               goals, purposes, and objectives are as follows:
               i)     To assist the Legislature in measuring whether the  
                 tax credits meet the goals, purposes, and objectives  
                 specified, the Legislative Analyst shall review the  
                 effectiveness of the tax credits and may request  
                 information from the FTB and any state governmental  
                 entity with authority relating to the seismic retrofit  
                 construction of at-risk properties; and,   
               ii)    Requires the FTB and any state governmental entity  
                 with authority relating to the seismic retrofit  
                 construction of at-risk properties to provide the  
                 Legislative Analyst any data requested by the Legislative  
                 Analyst.  


          19)Takes immediate effect as a tax levy.
          20)Sunsets the credit provisions on December 1, 2022.


          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  











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            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  
               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 would reduce  
          General Fund revenues by $0.8 million in fiscal year (FY)  
          2016-17, by $2.7 million in FY 2017-18, and by $4.7 million in  
          FY 2018-19.   


          COMMENTS:  


          1)The author has provided the following statement in support of  
            this bill:  


               According to the United States Geological Survey (USGS),  
               California is one of the most seismically active states in  
               the U.S. - second only to Alaska.  A major earthquake  
               occurring in California is simply a matter of when, not if.  











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                The USGS estimates a 99.7% chance that a major earthquake  
               of 6.7 in scale will strike California in the next 30  
               years.  With less than 12% of homes covered with earthquake  
               insurance, as reported by the Department of Insurance,  
               recovery from a disaster of a major temblor will be even  
               more costly than financial losses of past earthquakes in  
               California.  This bill will provide Californians with a  
               reasonable incentive to retrofit at-risk homes and  
               businesses by providing a tax credit equal to 30% of the  
               qualified costs to seismically retrofit the at-risk  
               building, as defined.  


          2)This bill is supported by the California Association of  
            Realtors, which notes the following:


               AB 2392 (Nazarian) will help incentive more Californians to  
               retrofit their homes before it's too late.  This bill  
               provides a substantial incentive for homeowners to make the  
               investment and be proactive about retrofitting their homes.  
                The high cost of retrofits is the biggest hurdle to  
               homeowners to take action in advance of the next big  
               earthquake.  AB 2392 (Nazarian) will help save lives and  
               protect property while minimizing losses and allowing  
               Californians to return to their normal lives after an  
               earthquake.  


          3)This bill is opposed by the California Tax Reform Association,  
            which notes the following:


               Property owners have every incentive to earthquake-proof  
               their property, since it would otherwise be lost.  Thus a  
               substantial amount of this tax credit will be used for  
               activity which otherwise would take place.  The problem is  
               for those who cannot afford the necessary work and who  
               generally cannot make sufficient use of a tax credit.  For  











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               those property owners, the revenue loss in this bill, and  
               more, would be far better directed to a zero-interest  
               revolving loan fund.   


          4)The FTB notes the following technical consideration in its  
            staff analysis of this bill:


               To provide clarity for the department and taxpayers, it is  
               recommended the bill be amended to specify an ordering rule  
               for claiming the carryover credits in regards to the  
               one-fifth usage requirement.  For example, if a taxpayer  
               can use one-fifth of the credit in year one, but carries  
               over half of the credit from year one to year two, would  
               the taxpayer have to use the remaining credit carried over  
               from year one in year two?  Or would the taxpayer use the  
               one-fifth of the credit allowed in year two first[?]


          5)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  











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               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.<1>  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; the author has 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  

             --------------------------


          <1> It should be noted that this bill does limit potential  
          revenue losses by capping the credit amount at $12 million per  
          calendar year.  








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               concerns that may be identified.  These issues include the  
               following:


               i)     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 appropriate jurisdiction with  
                 local building code enforcement authority.  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.    


              e)   R&TC Section 41 compliance  :  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  











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               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.


               This bill identifies three separate goals the tax credit is  
               seeking to attain.  First, the tax credit seeks to leverage  
               $60 million in private investment.  Second, the credit  
               seeks to create thousands of engineering or construction  
               jobs.  Finally, the credit seeks to mitigate seismic damage  
               to save lives.  In connection with this last goal, this  
               bill identifies the following performance indicator for the  
               Legislature to use when assessing credit efficacy - namely,  
               the "estimated number of lives saved by the seismic  
               retrofitting of buildings facilitated by the tax credits."   
               While Committee staff appreciates that completion of  
               seismic retrofit construction will increase safety in the  
               event of a future earthquake, it is not clear how an  
               assessment of lives saved can be made absent such a  
               catastrophe.  


               In addition, this bill calls for the Legislative Analyst to  
               review the effectiveness of the credits, and grants the  
               Legislative Analyst the power to request relevant  
               information from the FTB and any other state governmental  
               entity.  This bill, however, does not specify the date by  
               which the Legislative Analyst shall complete this review.   
               In addition, there is no language requiring a report of  
               this review to be provided to the Legislature.  This  
               Committee may wish to consider amendments requiring the  
               preparation and issuance of such a report by a date  
               certain.    


              f)   Suggested technical amendments  :  Committee staff  
                            










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               suggests adoption of the following technical amendments:


               i)     On page 5, in line 14, after "section" insert "and  
                 section 23650";  


               ii)    On page 5, in line 20, insert "qualified" before  
                 "taxpayer"; 


               iii)   On page 8, in line 15, strike "his or her" and  
                 insert "its";  


               iv)    On page 8, in line 39, after "section" insert "and  
                 section 17053.50"; and,


               v)     On page 9, in line 6, insert "qualified" before  
                 "taxpayer".


              g)   Related legislation  :  AB 428 (Nazarian) would have  
               allowed a similar credit for seismic retrofits to at-risk  
               properties.  On October 10, 2015, the Governor vetoed AB  
               428, along with several other tax expenditure bills, noting  
               the following in his veto message:


                 Despite strong revenue performance over the past few  
                 years, the state's budget has remained precariously  
                 balanced due to unexpected costs and the provision of new  
                 services.  Now, without the extension of the managed care  
                 organization tax that I called for in special session,  
                 next year's budget faces the prospect of over $1 billion  
                 in cuts. 













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                 Given these financial uncertainties, I cannot support  
                 providing additional tax credits that will make balancing  
                 the state's budget even more difficult.  Tax credits,  
                 like new spending on programs, need to be considered  
                 comprehensively as part of the budget deliberations.    

              h)   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


          American Red Cross


          Apartment Association, California Southern Cities












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          Apartment Association of Orange County


          California Apartment Association


          California Association of Realtors


          City of Santa Monica


          East Bay Rental Housing Association


          North Valley Property Owners Association


          San Diego County Apartment Association


          Western Manufactured Housing Communities Association




          Opposition


          California Tax Reform Association




          Analysis Prepared by:M. David Ruff / REV. & TAX. / (916)  
          319-2098













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