BILL ANALYSIS Ó
AB 2625
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Date of Hearing: May 9, 2016
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Sebastian Ridley-Thomas, Chair
AB 2625
(Lopez) - As Amended May 2, 2016
Majority vote. Tax levy. Fiscal committee.
SUBJECT: Corporation taxes: minimum franchise tax: annual
tax: microbusiness
SUMMARY: Reduces the minimum franchise tax (MFT) for a
corporation that is a new microbusiness, or the annual tax for a
limited partnership (LP), limited liability partnership (LLP),
or limited liability company (LLC) that is a new microbusiness.
Specifically, this bill:
1)Provides that for taxable years beginning on or after January
1, 2017, every corporation that is a new microbusiness will
pay a reduced MFT in the second through fifth taxable years of
its existance. Every LP, LLP, or LLC that is a new
microbusiness will pay a reduced annual tax for the first five
taxable years of its existence. The reduced tax shall be
equal to:
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a. $200 for a new microbusiness with gross receipts, less
returns and allowances, derived from or attributable to
this state of $50,000 or less;
b. $400 for a new microbusiness with gross receipts, less
returns and allowances, derived from or attributable to
this state of $100,000 or less; or,
c. $600 for a new microbusiness with gross receipts, less
returns and allowances, derived from or attributable to
this state of $150,000 or less.
2)Defines "gross receipts, less returns and allowances, derived
from or attributable to this state" as the sum of the gross
receipts from the production of business income and
nonbusiness income, determined pursuant to Revenue and
Taxation Code (R&TC) Sections 25135, 25136, and 25137, except
for provisions that exclude receipts from the sales factor.
3)Defines a "new microbusiness" as a corporation, LP, LLP, or
LLC, that on or after January 1, 2017 is organized under the
laws of this state or has qualified to transact intrastate
business in this state, and first begins doing new business in
this state, pursuant to R&TC Section 17276, on or after the
time of its organization.
4)Specifies that the gross receipts derived from or attributable
to any other business that is owned by persons either directly
or indirectly related, pursuant to Internal Revenue Code (IRC)
Section 267, 318, or 707, to the new microbusiness will be
aggregated with the new microbusiness's gross receipts for
purposes of determining whether the reduced MFT or annual tax
applies.
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5)Provides that if a corporation or LLC's reasonably estimated
gross receipts exceed the amount that qualifies it for a
reduction in MFT or annual tax, an additional tax in the
amount of the reduction for that taxable year must be paid on
the due date of its return, without regard to extension.
6)Takes effect immediately as a tax levy.
EXISTING LAW:
1)Imposes franchise tax on all corporations doing business in
California equal to 8.84% of the taxable income attributable
to California.
2)Requires a corporation incorporated in California, doing
business in California, or qualified to transact intrastate
business in California to pay a MFT of $800 if that amount
exceeds its regular franchise tax liability. However, credit
unions and nonprofit cooperative organizations are exempt from
MFT, as is a corporation in its first taxable year (although
it will be subject to franchise tax in its first taxable year
based on its taxable income).
3)Requires a LP, LLP, or LLC doing business in California,
registered or qualified to do business in California, or
formed in California to pay an annual tax equal to the MFT for
the privilege of doing business in this state. The tax is due
until a certificate of cancellation is filed with the
Secretary of State. These entities (known as 'pass-through
entities') are not subject to any tax based on taxable income.
Rather, the items of income, gain, loss, deduction and credit
are passed-through to the owners and reported on their
respective income or franchise tax returns.
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4)Exempts a corporation or LLC from MFT or annual tax,
respectively, until January 1, 2018 in taxable years when the
corporation or LLC is a small business solely owned by a
deployed member of the United States Armed Forces and operates
at a loss or ceases operation.
5)Requires a real estate mortgage investment conduit (REMIC),
financial asset securitization investment trust (FASIT), and
if organized as a corporation, a regulated investment company
(RIC) and real estate investment trust (REIT), to pay the MFT.
FISCAL EFFECT: The Franchise Tax Board (FTB) analysis of this
bill is still pending. However, analyses of similar prior bills
estimated annual General Fund revenue losses in the millions.
COMMENTS:
1)Author's Statement : The author has provided the following
statement in support of this bill:
Small businesses and micro-businesses are critically
important to our state's economy. But the number of
California small businesses still has not recovered to
pre-2008 numbers while other states are in fact seeing
larger increases in the number of small businesses.
More and more, a trend is emerging where start-up
California small businesses are incorporating out of the
state to avoid the annual minimum corporate filing fee of
$800. For those small businesses which do not incorporate
they find that their income for the first 3-5 years
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fluctuates, and are more adversely affected by the
corporate filing fees at a disproportionate rate to larger
well-funded corporations.
By creating a tiered system for the new small businesses
and micro-businesses, this legislation will both encourage
incorporation and tax compliance for these businesses
within California, and provide these small businesses with
the same corporate protections as larger businesses.
2)Arguments in Support : The sponsor of this bill, CalSmallBiz,
states that "this important legislation directly addresses a
cumbersome challenge for many people by seeking to reduce the
minimum $800 annual corporate filing fee for startup
micro-businesses and small businesses" because "hefty startup
fees negatively affect [them] disproportionately to their
larger corporate counter parts." The sponsor believes that
"this legislation will further level the playing field and
encourage micro-businesses and small businesses to incorporate
in California."
3)Arguments in Opposition : Opponents of this bill state that
"many companies subject to the MFT are held for a variety of
purposes and may show zero in gross receipts or income. It is
not clear from the language of this bill that such companies,
owned by other companies, would be excluded from the bill."
Additionally, "there have been many bills on this subject over
the years, and no evidence has ever been presented that the
MFT is a barrier to business formation."
4)What is a "Tax Expenditure" ? Existing law provides various
credits, deductions, exclusions, and exemptions for particular
taxpayer groups. In the late 1960s, United States Treasury
officials began arguing that these features of the tax law
should be referred to as "expenditures," since they are
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generally enacted to accomplish some governmental purpose and
there is a determinable cost associated with each (in the form
of forgone revenues). This bill would enact a new tax
expenditure program by reducing the MFT or annual tax required
to be paid by new microbusinesses.
5)Tax Expenditure vs. 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. This can offer taxpayers greater certainty, but it can
also result in tax expenditures remaining 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.
This bill does not include a sunset date. The Committee may
wish to consider adding a five-year sunset date to this bill
to provide an opportunity to evaluate whether reducing the MFT
or annual tax for new microbusinesses stimulates greater
proliferation of these businesses in California.
6)Purpose of the MFT : The MFT and annual tax were enacted to
ensure that all corporations, LPs, LLPs, and LLCs pay at least
a minimum amount of tax for the privilege of conducting
business in California, regardless of the business's income or
losses. Thus, the tax is not an "income tax," but rather it
is a tax on the right to exercise the powers granted to a
corporation conducting business in California. Even when a
business earns no income, it still receives the benefits of
its corporate status, including the limited liability
protection under the laws of this state.
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7)Purpose of This Bill : According to the author's office, small
businesses contribute at a greater rate to local economies by
returning more revenues to the surrounding community - they
donate to nonprofits, sponsor local youth sports and community
events, hire local youth, add culture to their communities,
and serve on local boards and commissions. However, there are
fewer small businesses in California today than prior to the
recession, while many states other than California have
enjoyed a per capita increase in the number of incorporated
businesses over the last 20 years. Since small businesses
with uncertain income cannot always afford the $800 MFT or
annual tax, this bill seeks to create a five-year reduction in
taxes based upon actual income.
8)What is a Microbusiness ? There is no clear definition of a
"microbusiness" in California. To qualify as a microbusiness
for state procurement purposes, a small business must have
average annual gross receipts of $3.5 million or less, or be a
manufacturer with 25 or fewer employees. The US Small
Business Association (SBA) characterizes microbusinesses as
firms with one to nine employees. Other entities that serve
microbusinesses provide even more limited definitions. For
example, the Aspen Institute's FIELD program describes a
microbusiness as a firm with five or fewer employees that
requires $35,000 or less in start-up capital and does not have
access to the traditional commercial banking sector. This
bill does not define "microbusiness" except for providing that
in order to qualify for a reduction in tax, the microbusiness
must be within its first five years of formation and have
gross receipts under $150,000.
According to the Aspen Institute's 2015 Annual Client Outcomes
Survey, the average revenue for a microbusiness was $85,000.
However, it is unclear how many business entities in
California have gross receipts under $150,000 and are
organized as a corporation, LP, LLP, or LLC instead of as a
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sole proprietorship common for very small businesses, thereby
meeting the thresholds in this bill to qualify for a reduction
in their MFT or annual tax. It is also difficult to
distinguish which business entities exist as true
microbusinesses struggling to expand and which exist simply to
serve as holding companies. In order to provide more targeted
assistance, the Committee may wish to further limit which
microbusinesses are eligible for the tax expenditure proposed
in this bill.
Furthermore, early access to capital is one of the chief
obstacles cited to small business and microbusiness
development. According to a report prepared for the SBA, the
major constraint limiting the growth, expansion, and wealth
creation of small firms - especially women- and minority-owned
businesses - is inadequate capital. These small firms have
little or no collateral and, as relatively young firms, lack
an extensive history from which future performance can be
surmised.<1> If the purpose of this bill is to encourage new
microbusiness incorporation in California, the Committee may
to consider alternatives such as improving access to capital
and new markets or developing business training and management
skills.
9)Doing Business in California : Neighboring states impose a
lower minimum tax than California. For example, Oregon
assesses a minimum corporate income tax of $150 and Nevada
does not assess a tax on corporate income, but requires a
state business license fee of $500 for corporations and $200
for all other business entity types. However, these states
also possess a much smaller business market share than
California. California's current population is about 39.1
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<1> Alicia Robb, Marin Consulting, LLC, Access to Capital among
Young Firms, Minority-owned Firms, Women-owned Firms, and
High-tech Firm, US Small Business Administration. April 2013.
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million residents, compared to Oregon's 4.0 million residents
and Nevada's 2.8 million residents. A microbusiness in
California has access to tens of millions of additional
customers than a business in neighboring states, allowing
businesses the opportunity to attain greater profits from a
potentially larger customer base. Companies choose to do
business in California, despite other states' tax policies,
because of this and other competitive advantages, including
the state's environment, transportation infrastructure, access
to ports, highways, and railroads, as well as its highly
skilled workforce and world-class higher education system. It
is unclear whether reducing the MFT or annual tax by $200 to
$600 will spur increased incorporation of new microbusinesses
in California.
10)Costs of Limited Liability : Business entities that would see
their MFT or annual tax reduced under this bill all benefit
from having organizational structures that limit personal
liability for one or more of the entity's owners. By
providing limited liability to these entities, California is
essentially allowing a business owner to transfer part of the
cost of doing business onto creditors and tort victims<2>. As
an example, if an owner of a construction company, having
limited liability, injures an individual during the course of
business, the victim's redress is limited to the assets of the
company. If the company is insolvent, part of the cost of the
injury is borne by the victim. Before the advent of LLCs and
LLPs, that small business owner would have likely started the
company as a sole proprietor or general partnership, allowing
the victim to go after the personal assets of the owner.
As a public policy, California has decided that the risk borne
--------------------------
<2> Jonathan Macey, The Limited Liability Company: Lessons for
Corporate Law, Washington University Law Review, Vol. 73, Issue
2, 1995.
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by creditors and potential tort victims is outweighed by the
need to encourage investment. Providing limited liability to
small businesses, presumably with limited or no assets, may
cause business owners to consider only those marginal costs
and benefits associated with their enterprise that they will
internalize. The idea that people will take on greater risk
because someone else will pay for the costs is known as "moral
hazard" and tends to occur when businesses are shielded from
liability or lack financial resources to provide adequate
compensation to creditors<3>. Business structures subject to
the MFT or annual tax allow business owners the benefit of
taking greater investment risks without necessarily
shouldering the burden of the costs if the enterprise proves
unsuccessful.
New microbusinesses that believe the $800 MFT or annual tax is
too costly have the option of doing business as a sole
proprietor or general partnership, which is not subject to the
tax. In these alternate scenarios, however, business owners
could be held personally liable by aggrieved customers and for
the actions of other partners. In exchange for the benefits
that organization as a corporation, LP, LLP, or LLC provides,
the state requires payment of the MFT or annual tax.
11)Technical Amendment : On Page 15, Line 33, strike "limited
liability company" and insert "corporation".
12)Related Legislation :
a) AB 2544 (Travis Allen and Quirk) would exempt a LLC
classified as a qualified investment partnership from the
annual tax and associated fee. AB 2544 is scheduled to be
--------------------------
<3> Id.
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heard by this Committee today.
b) AB 799 (Travis Allen and Quirk) was substantially
similar to AB 2544. AB 799 was held under submission in
this Committee.
c) AB 612 (Patterson) would have reduced the MFT or annual
tax to $400 if the corporation or LP, LLP, or LLC,
respectively, qualified as a new small business. AB 612
was held under submission in this Committee.
d) AB 328 (Grove) would have eliminated the MFT or annual
tax if the corporation or LLC, respectively, qualified as a
new veteran-owned small businesses. AB 328 was held under
submission in this Committee.
REGISTERED SUPPORT / OPPOSITION:
Support
CalSmallBiz (Sponsor)
Opposition
California Tax Reform Association
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Analysis Prepared by:Irene Ho / REV. & TAX. / (916) 319-2098