BILL ANALYSIS Ó AB 2392 Page A 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 AB 2392 Page B 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, AB 2392 Page C 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 AB 2392 Page D 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 AB 2392 Page E 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. AB 2392 Page F 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 AB 2392 Page G 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 AB 2392 Page H 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. AB 2392 Page I 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 AB 2392 Page J 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 AB 2392 Page K 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. AB 2392 Page L 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 AB 2392 Page M 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 AB 2392 Page N 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. AB 2392 Page O 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 AB 2392 Page P 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 AB 2392 Page Q