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 --