BILL ANALYSIS                                                                                                                                                                                                    Ó



          SENATE COMMITTEE ON GOVERNANCE AND FINANCE
                         Senator Robert M. Hertzberg, Chair
                                2015 - 2016  Regular 

                              
          
           ------------------------------------------------------------------ 
          |Bill No:  |SB 377                           |Hearing    |4/22/15  |
          |          |                                 |Date:      |         |
          |----------+---------------------------------+-----------+---------|
          |Author:   |Beall                            |Tax Levy:  |Yes      |
          |----------+---------------------------------+-----------+---------|
          |Version:  |4/16/15                          |Fiscal:    |Yes      |
           ------------------------------------------------------------------ 
           ----------------------------------------------------------------- 
          |Consultant|Grinnell                                              |
          |:         |                                                      |
           ----------------------------------------------------------------- 

             INCOME TAXES:  CREDITS:  LOW-INCOME HOUSING:  SALE OF CREDIT



          Allows taxpayers to sell low-income tax credits; removes sunset  
          on provisions allowing partnership agreements to allocate state  
          tax credits differently than federal ones.


           Background and Existing Law

           Current federal law allows tax credits against the Persona  
          Income Tax, Corporation Tax, and Gross Premiums Tax for  
          investors who provide project capital to low-income housing  
          projects.  Taxpayers claim Low-Income Housing Tax Credits  
          (LIHTCs) equal to either 9% or 4% of the project's basis over 10  
          years, and start claiming the credit in the taxable year in  
          which the project is placed in service.  Projects must remain  
          affordable to residents for 55 years.  

          The California Tax Credit Allocation Committee (CTCAC),  
          comprised of the State Treasurer, the State Controller, the  
          Director of Finance, and three non-voting members, allocates the  
          federal credits.  CTCAC awards federal credits based on a  
          formula in federal law, currently $2.25 per capita for each  
          state.  Housing developers design projects, and apply to CTCAC  
          for credits.  CTCAC then reviews the application, and either  
          denies it or grants credits.  The housing developer then forms  
          partnership agreements with taxpayers that provide project  
          capital for the low-income housing project in exchange for the  







          SB 377 (Beall) 4/16/15                                  Page 2  
          of ?
          
          
          credits at a discount.  Tax credits are generally equal to 100%  
          of a project's eligible basis, or its cost less non-depreciable  
          items.  CTCAC may allocate federal tax credits to any area of  
          the state, but must conduct a feasibility analysis to ensure  
          that the amount of credits granted doesn't exceed the amount of  
          capital needed to build the project.  Additionally, state law  
          uniquely allows the partnership agreement to allocate the state  
          tax credit to investors in a manner that differs from the  
          proportional division of the federal credit (SB 585, Lowenthal,  
          2008).  However, this provision is due to sunset on January 1,  
          2016.

          Generally, California doesn't allow taxpayers to sell tax  
          credits; however, taxpayers with motion picture production  
          credits from independent films can sell the credit to unrelated  
          investors, which can be a key financing tool for filmmakers to  
          raise capital to produce a motion picture.   Additionally,  
          corporation taxpayers can share credits within their unitary  
          group (AB 1452, Committee on Budget, 2008).  Seeking additional  
          financing options, the State Treasurer wants to allow low-income  
          housing developers to sell tax credits to unrelated taxpayers,  
          and remove the sunset on provisions of the LIHTC allowing state  
          tax credits to be allocated differently than federal ones.






           Proposed Law

           Senate Bill 377 allows a taxpayer to make an irrevocable  
          election to sell all or any portion of LIHTC to an unrelated  
          party.  The taxpayer cannot sell the credit in exchange for  
          consideration that is less than 80% of the credit's value, but  
          the director of CTCAC may revoke the election if the  
          consideration amount falls below that level after CTCAC makes  
          the credit reservation.  The taxpayer originally receiving and  
          selling the credit can choose the method of documentation, and  
          can change the sale in any subsequent year if the sale is  
          expressly shown on a return.  The taxpayer originally receiving  
          the credit must also report to the Franchise Tax Board specified  
          information, and is responsible for all obligations and  
          liabilities imposed by each tax law.  Taxpayers purchasing  








          SB 377 (Beall) 4/16/15                                  Page 3  
          of ?
          
          
          credits can use the credit in the same way the taxpayer  
          originally receiving it can, but cannot subsequently sell it.   
          CTCAC must also provide an annual listing to FTB of taxpayers  
          selling and purchasing credits.

          The measure also repeals the sunset on the taxpayer's ability to  
          make allocations of LIHTCs within the partnership agreement  
          without economic substance, thereby allowing state tax credits  
          to be allocated differently than federal ones.

          The bill also makes several technical, grammatical, and  
          conforming changes.


           State Revenue Impact

           Pending.


           Comments

           1.  Purpose of the bill.   According to the author, "SB 377 seeks  
          to increase the impact of the state's existing low-income  
          housing tax credit (LIHTC) with no fiscal impact to the state by  
          structuring the credits in a way that is not subject to federal  
          taxation.  LIHTCs are awarded to developers of qualified  
          projects and are the primary source of capital to construct and  
          rehabilitate thousands of affordable housing units each year.   
          Non-profit affordable housing developers, who do not have the  
          required tax liability on their own, must seek out private  
          equity investments for their developments.  Under current law,  
          investors must become owners of the property to claim the  
          credits against their state tax liabilities.  Due to the fact  
          that state taxes are deductible from federal taxes, a reduction  
          in the state tax liability increases the federal tax liability  
          for the investor.  With the federal corporate tax rate at 35%,  
          investors will generally invest no more than 65 cents for each  
          dollar of state credit.  SB 377 addresses this issue by allowing  
          a developer who is awarded state credits to sell the credits to  
          an investor without admitting the investor to the ownership  
          partnership and thereby increasing the value of the credit,  
          closer to one dollar for each dollar of credit, to the investor.  
           









          SB 377 (Beall) 4/16/15                                  Page 4  
          of ?
          
          
          SB 377 will significantly increase the value of state LIHTCs and  
          therefore the public benefit because it will largely eliminate  
          the federal tax impacts associated with investors claiming state  
          credits.  It will also greatly increase the efficiency of the  
          program and allow many more affordable housing units to be built  
          for the same level of state tax expenditure.  In other words,  
          this bill gives the state a bigger bang for its buck."

          2.   A different kind of credit  .  The LIHTC induces investment in  
          low-income housing by providing a tax shelter for investors for  
          allocating capital to an asset class with a relatively poor rate  
          of return.  In return for providing the tax shelter, the state  
          gets more low-income housing than it otherwise would have.   
          Low-income housing projects face many barriers in California:  
          high costs of land, labor, and capital; resistance from local  
          residents and state and local laws and policies protecting the  
          environment, among others.  Because the credit is capped and  
          allocated, CTCAC awards tax credits to projects on a competitive  
          process based on an evaluation of the most effective use of the  
          tax credits.  This program is much different than other tax  
          credits, where any individual or businesses can qualify for a  
          credit by virtue of incurring specific costs such as research  
          and development or hiring specific individuals.  Currently,  
          housing sponsors form partnership agreements with investors, who  
          provide capital to fund the housing construction in exchange for  
          the allocated tax credits.  The tax credits exceed the value of  
          the investment because demand for the tax credits does not meet  
          supply.  For example, a partnership agreement may allocate 100%  
          of tax credits to an investor that provides 75% of the necessary  
          project funding; the value of the discounted tax credits is  
          sufficient for investors to participate.  Investors claim the  
          credit until exhausted, then walk away from the partnership, and  
          deduct the amount paid to the partnership in exchange for the  
          tax credits as a capital loss.  

          3.   Gimme shelter  .  With the exception of the motion picture  
          production credit, California generally doesn't allow sales of  
          tax credits because it allows high-income taxpayers to buy down  
          their tax obligations.  A taxpayer can shelter income from other  
          sources by purchasing credits at a discount that other  
          taxpayer's can't.  However, as discussed above, Congress and the  
          Legislature designed LIHTCs as a tax shelter because it's hard  
          for these socially beneficial projects to attract capital.  This  
          especially true after the end of redevelopment and the  








          SB 377 (Beall) 4/16/15                                  Page 5  
          of ?
          
          
          conservatorship of large institutional buyers in federal housing  
          authorities, so credit sales simply become another mechanism  
          that builds on existing ones to draw investment into a public  
          good.  

          4.   Taxing  .  The IRS Chief Counsel Advised in 2011 that the  
          proceeds of sales of tax credits results in taxable income for  
          federal purposes, as nothing in federal law explicitly exempts  
          these sales from the Internal Revenue Code's definition of  
          income.  California also conforms to this definition, which  
          would normally trigger a significant combined liability for  
          taxpayers selling tax credits under SB 377.  However, because  
          most low-income housing developers are non-profit, tax-exempt  
          entities, they can sell tax credits without a tax implication. 

          5.   Permanence  .  In addition to allowing sales of LIHTCs, SB 377  
          makes permanent the ability of partnership agreements to  
          allocate state credits differently than federal credits, which  
          is generally precluded by federal and state law guiding  
          partnerships.  CTCAC reports that this ability has been used  
          several times, and allows much more flexibility for insurance  
          companies and banks to invest in low-income housing.  CTCAC also  
          reports that this ability has drawn additional investors and  
          capital into the state.  Allowing the ability to expire would  
          result in a reduction in demand, and thereby a loss of available  
          capital.  

          6.   The sun also sets  .  One way to compel an assessment in the  
          future of SB 377's credit selling authority is to insert a  
          sunset provision, which repeals the law at a specified future  
          date.  Those seeking to extend the law will have to convince a  
          future Legislature to extend the provision using information  
          gathered during the bill's effective period.  The Committee may  
          wish to consider inserting a sunset provision into SB 377's  
          credit selling authority, much like a previous Legislature did  
          for the ability for partnership agreements to allocate state  
          LIHTCs from federal ones.





          7.   Technicals  .  Committee staff recommends technical amendments  
          to:








          SB 377 (Beall) 4/16/15                                  Page 6  
          of ?
          
          

                 Strike paragraph (2) in each section, as it conflicts  
               with recent amendments enacting an irrevocable election,  
               and 

                 Require taxpayers to notify CTCAC of sales within ten  
               days.


           Support and  
          Opposition   (4/17/15)


           Support  :  State Treasurer John Chiang, California Coalition for  
          Rural Housing, Charities Housing, Chinatown Community  
          Development Center, Community Action North Bay, Community  
          Economics, East Bay Asian Local Development Corporation, Housing  
          California, Integrity Housing, LINC Housing, the Nonprofit  
          Housing Association of Northern California, Northern California  
          Community Loan Fund, Peoples' Self-Help Housing, 


           Opposition  :  Unknown.



                                      -- END --