BILL ANALYSIS Ó
SB 377
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Date of Hearing: August 17, 2015
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Philip Ting, Chair
SB
377 (Beall) - As Amended June 1, 2015
Majority vote. Tax levy. Fiscal committee.
SENATE VOTE: 38-1
SUBJECT: Income taxes: insurance taxes: credits: low-income
housing: sale of credit.
SUMMARY: Allows taxpayers to sell Low-Income Housing Tax (LIHT)
credits and removes the sunset date on provisions relating to
the allocation of federal and state LIHT credits. Specifically,
this bill:
1)Allows a taxpayer to make an irrevocable election to sell all
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or any portion of the state LIHT credit to an unrelated party,
provided that the consideration received by the taxpayer from
the sale of the LIHT credit equals at least 80% of the credit
amount.
2)Requires the taxpayer to report to the California Tax Credit
Allocation Committee (TCAC), within 10 days of the sale of the
credit, certain specified information regarding the purchase
and sale of the credit, as provided by the TCAC.
3)Requires the TCAC to provide an annual listing to the
Franchise Tax Board (FTB), in a form and manner agreed upon by
the TCAC and the FTB, of the taxpayers that have sold or
purchased a LIHT credit.
4)Applies to projects that receive a preliminary reservation
beginning on or after January 1, 2016.
5)Prohibits a sale of the LIHT credit to more than one unrelated
party or a re-sale of the credit by the unrelated party to
another taxpayer or party.
6)Specifies that the taxpayer that originally received the LIHT
credit will remain solely liable for all obligations and
liabilities imposed on the taxpayer by law with respect to the
credit, none of which shall apply to any party to whom the
credit has been sold or subsequently transferred.
7)Disallows a sale of a LIHT credit if the taxpayer was allowed
the credit on any of his/her tax returns.
8)Allows the taxpayer who has made an election to sell a LIHT
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credit, with the approval of the Executive Director of the
TCAC, to rescind this election if the consideration for the
credit falls below 80% of the amount of the credit after the
TCAC reservation.
9)Authorizes the FTB to prescribe rules, guidelines, or
procedures, as specified.
10)Requires the TCAC to enter into an agreement with the FTB to
pay any costs incurred by the FTB in the administration of the
LIHT credit that was sold.
11)Repeals the sunset date, thus making permanent the provisions
allowing the state LIHT credit to be allocated within the
partnership agreement differently than federal LIHT credits.
12)Takes effect immediately as a tax levy.
EXISTING LAW:
1)Allows a state tax credit for costs related to construction,
rehabilitation, or acquisition of low-income housing. This
credit, which mirrors a federal LIHT credit, may be used by
taxpayers to offset the tax under the Personal Income Tax
(PIT), the Corporation Tax (CT), and the Insurance Tax (IT)
laws.
2)Requires the California TCAC to allocate each year the
California LIHT credits based upon qualifications of the
applicant and proposed project. The California LIHT credit is
available only to projects that have received an allocation of
the federal LIHT credit.
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3)Limits the annual aggregate amount of the state LIHT credit to
$70 million, as adjusted for an increase in the California
consumer price index from 2002, plus any unused LIHT credits
for the preceding calendar year and any LIHT credits returned
in the calendar year. The California LIHT credit awarded may
be claimed as a credit against tax over a four-year period.
4)Requires TCAC to certify the amount of tax credit allocated.
In the case of a partnership or an S Corporation, a copy of
the certificate is provided to each taxpayer. The taxpayer is
required, upon request, to provide a copy of the certificate
to the FTB.
5)Allows, until January 1, 2016, the partnership agreements
formed to construct low-income housing projects to allocate
the state LIHT credits to investors in a manner that differs
from the proportional allocation of the federal LIHT credits
by disconnecting federal tax rules that apply to partnerships,
to which California conforms.
FISCAL EFFECT: The FTB staff estimates that this bill would
result in a revenue gain of $170,000 in fiscal year (FY) 2015-16
and $450,000 in FY 2016-17, and a revenue loss of $250,000 in FY
2017-18.
COMMENTS:
1)The Author's Statement . The author has provided the following
statement in support of this bill:
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"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 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)Arguments in Support . The proponents of this bill explain
that under current law "investors must become owners of the
property to claim the [LIHT] credits against their state tax
liability." With the federal corporate tax rate at 35%,
"investors will generally invest no more than 65 cents for
each dollar of state credit." This bill will allow a
developer "to sell the credits to an investor without
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admitting the investor to the ownership partnership and
thereby [increase] the value of the credit to the investor."
As such, this bill will increase "the price investors are
willing to pay for the tax credits" because it "will largely
eliminate the federal tax impacts associated with investors
claiming state credits." Consequently, this bill will
"increase the efficiency of the program" and "the value of the
tax credit without additional cost to the state," generating
more affordable housing units for the same level of state tax
expenditure.
3)Background: Federal LIHT Credit Program . The LIHT credit is
an indirect federal subsidy developed in 1986 to incentivize
the private development of affordable rental housing for
low-income households. The federal LIHT credit program
replaced traditional housing tax incentives, such as
accelerated depreciation, with a tax credit that enables
low-income housing sponsors and developers to raise project
equity through the allocation of tax benefits to investors.
Two types of federal tax credits are available: the 9% and 4%
credits.<1>
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<1>
These terms refer to the approximate percentage of a project's
"qualified basis" a taxpayer may deduct from his/her annual
federal tax liability in each of 10 years. For projects that
are not financed with a federal subsidy, the applicable rate is
9%. For projects that are federally subsidized (including
projects financed more than 50% with tax-exempt bonds), the
applicable rate is 4%. Although the credits are known as the
"9% and 4% credits", the actual rates fluctuate every month,
based on the determination made by the Internal Revenue Service
on a monthly basis. Nonetheless, Congress has established the
minimum applicable percentage of 9% for allocations made for
non-federally subsidized new buildings before January 1, 2015.
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Each year, the Federal Government allocates funding to the
states for LIHT credits on the basis of a per-resident
formula. State or local housing authorities review proposals
submitted by developers and select projects based on a variety
of prescribed criteria. Only rental housing buildings, which
are either undergoing rehabilitation or newly constructed, are
eligible for the LIHT credit programs. In addition, the
qualified low-income housing projects must comply with both
rent and income restrictions. Rents on tax credit units
cannot exceed 30% of an imputed income based on 1.5 persons
per bedroom. Furthermore, the initial incomes of households
in those units may not exceed either 60% or 50% of the area
median income, adjusted for household size. A project
developer or sponsor who applies for the tax credit allocation
must also elect to set aside a minimum of either 40% of the
units to be occupied by households with incomes of 60% or less
of the area median gross income or 20% of the units to
household with incomes of 50% or less of the area median gross
income. Finally, credit projects must remain affordable for
at least 30 years. However, in California, project developers
or housing sponsors must agree to a minimum of 55 years of
rent and income restrictions. Federal law specifies that each
state must designate a "housing credit agency" to administer
the federal LIHT credit program. In California,
responsibility for administering the federal program is
assigned to the California TCAC.
4)State LIHT Credit Program . In 1987, the Legislature
authorized a state LIHT credit program to augment the federal
program. Current state tax law generally conforms to federal
law with respect to the LIHT credit, except that it is limited
to projects located in California. While the state LIHT
credit program is patterned after the federal program, there
are several differences, including a provision allowing
investors to claim the state LIHT credit over a four-year,
rather than the federal 10-year, allocation period.
State tax credits can only be awarded to projects that have also
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received, or are concurrently receiving, an allocation of the
federal LIHT credits. The amount of state LIHT credit that
may be annually allocated by the TCAC is limited to $70
million, adjusted for inflation. In 2014, the total credit
amount available for allocation was $103 million (representing
all four years of allocation) plus any unused or returned
credit allocations from previous years. Because the LIHT
credit is capped and allocated, TCAC awards tax credits to
projects on a competitive basis. The TCAC evaluates the
applications and allocates the available funds to those
investors/developers who promise to produce the most housing
for the state's dollar. Although the program is in the form
of a tax credit, all the participants behave virtually as
though they were dealing with an allocation of grant funds.
5)The Financing Structure . To raise funds for construction or
rehabilitation of low-income housing buildings, the project
developers or housing sponsors usually enter into various
financing transactions with private entities. Investment
partnerships are a primary source of equity financing for LIHT
credit projects. A typical arrangement is to match a
corporate tax credit investor with a project developer or
sponsor, creating a partnership (such as a general partnership
or a LLC) where the investor is allocated the LIHT credits in
exchange for cash and the developer acts as a general partner
(or managing member). The money that investors pay for the
partnership interest is paid into the low-income housing
project as equity financing. Although investors are buying an
interest in a rental housing partnership, this process is
commonly referred to as "buying" tax credits because they
receive tax credits in return for their investment. According
to the TCAC report, partnership equity contributed to the
project in exchange for the credit usually finances 30% to 60%
of the capital costs of project construction.
The financing of a low-income housing building construction or
rehabilitation using the LIHT credit thus requires the
participation of a private investor (mostly a taxable
corporation) that could take advantage of the credits to
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reduce its income tax liability. Once the low-income housing
project is placed in service, or ready for occupancy,
investors can receive their share of the federal and/or state
credits each year of the 10-year or 4-year credit period,
whichever is applicable, and can use the credit to offset
federal or state income taxes otherwise owed as long as the
project meets the LIHT credit requirements. Under both federal
and state laws, an investor must retain ownership of the
property (i.e., remain in the partnership) for at least 15
years after the project is placed in service in order to
receive the full benefit of the tax credits, or the tax
credits will be subject to recapture.
6)What is the Problem with the Existing Ownership Structure ? As
discussed, under current state law, investors in a low-income
housing project must receive an ownership interest in the
partnership that develops the project in order to obtain a
LIHT credit in exchange for the equity investment. According
to the TCAC, the face amount of the state LIHT credits
allocated to an investor generally exceeds the value of the
investment. For example, a partnership agreement may allocate
100% of the state LIHT credits to an investor that in turn
provides only 65% of the necessary equity funding for the
project. Arguably, the discounted value attributable to the
state LIHT credits is due to the fact that a state tax credit
reduces the investor's state tax liability, which in turn
decreases the amount of deductions available to offset the
investor's federal tax liability. For example, a taxpayer who
has claimed a $10 state tax credit to reduce his/her state
income tax liability of $100 would pay less state income tax,
namely $90 instead of $100. However, his/her federal tax
liability potentially may be increased because he/she will be
able to deduct only $90 worth of state tax instead of $100.
At the 35% federal tax rate, the value of a $100 deduction is
$35, whereas the value of a $90 deduction is only $31.50.
According to the author, with the federal corporate tax rate
of 35%, corporate investors are willing to pay no more than
$0.65 for each $1 of a state LIHT credit.
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7)The Proposed Solution . This bill proposes to allow a project
developer to sell the state LIHT credit to any unrelated
person or entity regardless of whether the person or entity
acquires an ownership interest in the partnership that
develops the low-income housing project. As explained by the
author, this bill would allow the developer to convert the
state LIHT credit into cash, without tying the buyer to the
project. From a tax law perspective, the credit will be
treated as an asset that if sold by the developer would
trigger only a capital gain tax payable by the developer.
Presumably, in the case of a developer that is a non-profit
entity, no tax will be due.<2> Furthermore, the TCAC argues,
the purchaser of the LIHT credit will be able to deduct the
full amount of the state tax liability, plus the amount of the
credit, in calculating the federal income tax liability.<3>
Consequently, the value of the state LIHT credit would be
significantly enhanced to the potential purchasers.
8)Federal Tax Treatment of State Tax Credits . In 2011, the
Office of Chief Counsel of the Internal Revenue Service
advised that "a state tax credit, to the extent it can only be
applied against the original recipient's current or future
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<2> It is unclear to Committee staff whether proceeds from the
sale of credits would or would not be treated as unrelated
business taxable income (UBTI). However, proponents have argued
that gains from the sale of property (like credits) by a
tax-exempt non-profit generally are exempt from UBTI treatment
unless one of the exceptions applies (e.g., if the property is
stock in trade, inventory, or held primarily for sale; or if the
property is debt-financed). If one of the exceptions applies,
the UBTI provisions still might not apply to the sale of the
credits, if, as the tax-exempt non-profit is likely to argue,
the sale of the credits constitutes a trade or business that is
substantially related to the non-profit's tax-exempt purposes.
<3> In reaching this conclusion, the California Housing
Partnership Corporation relies on the IRS Chief Counsel
Memorandum issued in 2004 with respect to a similar LIHT credit
program implemented in Massachusetts.
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state tax liability, is treated as a reduction or potential
reduction in the taxpayer's state tax liability," and not as a
payment of cash or property to the taxpayer that is includible
in the taxpayer's gross income. As such, the amount of the
state tax credit received by the taxpayer may not be deducted
for federal tax purposes. In these circumstances, the federal
effect of a state tax credit is to decrease a taxpayer's
federal deduction for payment of state tax (Internal Revenue
Code (IRC) Section 164).
In contrast, a sale or transfer of a state tax credit to another
taxpayer for value would result in a different tax treatment.
Specifically, the original recipient of the tax credit will be
required to include the amount of consideration in his/her
gross income and recognize capital gain on the credit sale,
which means that a low-income housing developer may face a
significant federal and state tax liability on the sale of tax
credits proposed by this bill. However, many developers are
nonprofit organizations not subject to either federal or state
income tax. They may be able to sell the state LIHT credits
without significant tax consequences. A potential purchaser
of the discounted credit may also be subject to federal income
tax on the discounted portion of the credit when he/she uses
the credit to satisfy the state tax liability. Nonetheless,
the purchase of a state tax credit may still be overall
beneficial to the purchaser. As discussed, under existing
federal law, a taxpayer may only deduct the actual payment of
state tax liability and must exclude the amount of any state
tax credit applied to reduce his/her original tax liability.
But in the case of a transferrable state tax credit, the
purchaser is not required to reduce the amount of a federal
tax deduction by the amount of the purchased state credit. <4>
Presumably, while the purchaser will be subject to federal
tax on the discounted portion of the state credit when
utilized, the amount of that tax will be less than the value
of the federal deduction for the payment of state tax
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<4> The usage of the transferrable state tax credit to satisfy
the purchaser's state tax liability is not considered a
reduction in that liability under IRC Section 164(a).
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liability, including the state tax credit amount.
9)A "Slippery Slope" . The LIHT credit program induces
investment into low-income housing by sanctioning a tax
shelter structure that helps compensate private investors for
allocating capital to an asset class with a relatively poor
rate of return. Low-income housing projects face many
barriers in California: the high cost of land, labor, and
capitol, as well as state laws and policies protecting the
environment among others. Thus, in return for providing the
LIHT credit, the state receives more affordable housing.
However, some opponents of the federal LIHT credit program
believe that government subsidies for housing are not as
efficient as demand-based subsidies, and that the LIHT credit
program is not efficient as compared with other subsidy
mechanisms: the equity capital raised from investment
generally comes from syndicates of individual investors or
from corporations at a steep price and the costs of the LIHT
credit include the costs of administration by federal and
state housing and tax agencies.<5>
If this bill were to become law, it would allow a sale of the
LIHT credits to unrelated parties. Under federal law, no sale
of LIHT credits is allowed. Furthermore, part of the LIHT
credit claimed in previous years may be subject to recapture
if, for example, the "qualified basis" in the low-income
housing building decreases from one year to the next or the
taxpayer disposes of the building or his/her interest in the
building, without following the prescribed compliance
procedures.
California largely conforms to the federal LIHT credit program
and the California LIHT credit is available only to projects
that have received an allocation of the federal LIHT credit.
This bill would create non-conformity in the application of
the federal and state LIHT credit programs by disconnecting
the ownership in a low-income housing project from the
--------------------------
<5> See, e.g., Low-Income Housing Credit, L.E. Burman, Tax
Policy Center.
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utilization of the state LIHT credit. While the potential to
increase the value of the LIHT credits is certainly important,
so are arguably many other socially beneficial activities,
including research and development, hiring new employees,
encouraging monetary charitable contributions, and
rehabilitating historic buildings, among others. Once the
Legislature authorizes a sale of the LIHT credit in the open
market, it may be asked later to provide a similar treatment
to other worthy tax credits or expenditures, thus departing
from this Committee's long-standing tax policy of allowing
taxpayers that have earned a tax credit to use it in
offsetting only their tax liability and not the tax liability
of unrelated parties. The Committee may wish to consider
whether this bill will be one of many suggesting extraordinary
circumstances for which a sale of tax credits is warranted.
The Committee may also wish to consider whether the benefits
of a tax credit sale outweigh the downside of creating a
questionable policy precedent for other tax expenditure
programs. In the alternative, the Committee may wish to
consider limiting the scope of the proposed sale only to
existing investors eligible to claim either federal or state
LIHT credits with respect to the original or a different
qualified low-income housing project.
10)The 80% Limitation . This bill requires that the taxpayer
receive at least 80% of the face value of the tax credit when
sold to a third party. Establishing an arbitrary market price
threshold, however, creates several problems. It is unclear
whether or not third parties would be willing to receive a 20%
benefit from the purchase of the tax credit. Furthermore,
when considering a purchase of a tax credit, purchasers take
into account all accompanying transaction costs, including the
fees charged by independent brokers facilitating the sale. It
appears that setting a floor of 80% may be a price above the
point of equilibrium, pushing many buyers out of the market
and unintentionally leaving many taxpayers without a way of
liquidating acquired tax credits.
11)Administration of the Tax Credit Sale . This bill provides
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that a seller of the LIHT credit will remain solely liable for
all obligations and liabilities imposed on the seller with
respect to the credit. However, this bill does not prohibit
the sale of the credit prior to the completion of a federal or
state audit of the credit; nor does it specify how the
credits, that were approved for sale and purchase and then
subsequently disallowed at audit, would or could be recaptured
by the FTB. The Committee may wish to consider granting FTB
the ability to collect from either the buyer or the seller of
an LIHT credit if the taxpayer improperly claimed the
purchased credit.
12)Sunset Date . This bill does not contain a sunset date.
Generally, a sunset date repeals the law at a specified future
date and, thus, requires the Legislature to assess the
effectiveness of the law. 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
efficacy, without a supermajority vote. The Committee may
consider adding a five-year sunset to this bill and requiring
the Legislative Analyst to prepare a study regarding the
effectiveness of the LIHT credit sale provisions, reporting
back to the Legislature its findings prior to the sunset date.
REGISTERED SUPPORT / OPPOSITION:
Support
California State Treasurer John Chiang (Co-Sponsor)
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California Housing Partnership Corporation (Co-Sponsor)
Abode Communities
Arthur J. Gallagher & Co.
Burbank Housing Development Corporation
California Association of Housing Authorities
California Land Title Association
California Reinvestment Coalition
Christian Church Homes (CCH)
City of Redwood
Charities Housing
Coachella Valley Housing Coalition
Community Housing Opportunity Corporation
Corporation for Supportive Housing
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EAH Housing
East Bay Housing Organizations
ElderFocus
Gubb & Barshay LLP
Housing California
Housing Leadership Council of San Mateo County
Independent Living Resource Center San Francisco
Irvine Community Land Trust
Law Office of Kim Savage
Many Mansions
MidPen Housing Corporation
Mutual Housing California
National Community Renaissance
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Napa Valley Community Housing
Non-Profit Housing Association of Northern California (NPH)
Northern California Community Loan Fund
Palm Communities
PATH (People Assisting the Homeless)
PATH Ventures
Peoples' Self Help Housing Corporation
Public Counsel
Rural Community Assistance Corporation
Rural Communities Housing Development Corporation (RCHDC)
San Diego Habitat for Humanity
San Diego Housing Federation
San Luis Obispo County Housing Trust Fund
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Satellite Affordable Housing Associates (SAHA)
Skid Row Housing Trust
Tenderloin Neighborhood Development Corporation
Wakeland Housing and Development Corporation
Western Park Apartments
5 private individuals
Opposition
None on file
Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916)
319-2098
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