BILL ANALYSIS                                                                                                                                                                                                    Ó






                                                                     SB 377


                                                                     Page A


          (Without Reference to File)





          SENATE THIRD READING


          SB  
          377 (Beall)


          As Amended  September 11, 2015


          Majority vote. Tax levy


          SENATE VOTE:  38-1


           ------------------------------------------------------------------ 
          |Committee       |Votes|Ayes                  |Noes                |
          |                |     |                      |                    |
          |                |     |                      |                    |
          |                |     |                      |                    |
          |----------------+-----+----------------------+--------------------|
          |Housing         |7-0  |Chau, Steinorth,      |                    |
          |                |     |Burke, Chiu, Beth     |                    |
          |                |     |Gaines, Lopez, Mullin |                    |
          |                |     |                      |                    |
          |----------------+-----+----------------------+--------------------|
          |Revenue &       |8-0  |Ting, Brough,         |                    |
          |Taxation        |     |Dababneh, Gipson,     |                    |
          |                |     |Mullin, Patterson,    |                    |
          |                |     |Quirk, Wagner         |                    |
          |                |     |                      |                    |
          |----------------+-----+----------------------+--------------------|











                                                                     SB 377


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          |Appropriations  |16-0 |Gomez, Bigelow,       |                    |
          |                |     |Bloom, Bonta,         |                    |
          |                |     |Calderon, Chang,      |                    |
          |                |     |Daly, Gallagher,      |                    |
          |                |     |Eduardo Garcia,       |                    |
          |                |     |Holden, Jones, Quirk, |                    |
          |                |     |Rendon, Wagner,       |                    |
          |                |     |Weber, Wood           |                    |
          |                |     |                      |                    |
           ------------------------------------------------------------------ 


          SUMMARY:  Allows taxpayers to sell Low-Income Housing Tax (LIHT)  
          credits, subject to certain requirements, and repeals the sunset  
          date on provisions relating to the allocation of the federal and  
          state LIHT credits to the partners of a partnership owning a  
          low-income housing project.  Specifically, this bill:  


          1)Allows a taxpayer to make an irrevocable election to sell all  
            or any portion of the state LIHT credit to an unrelated party,  
            as defined, provided that the consideration received by the  
            taxpayer from the sale of the LIHT credit equals at least 80%  
            of the credit amount.


          2)Defines an "unrelated party" as a taxpayer allowed either the  
            state or federal LIHT credit in connection with a low-income  
            housing project in California. 


          3)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.  


          4)Requires the TCAC to provide an annual listing to the  
            Franchise Tax Board (FTB), in a form and manner agreed upon by  











                                                                     SB 377


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            the TCAC and the FTB, of the taxpayers that have sold or  
            purchased a LIHT credit. 


          5)Applies to projects that receive a preliminary reservation  
            beginning on or after January 1, 2016, and before January 1,  
            2026.


          6)Allows a one-time resale of the LIHT credits by an original  
            purchaser to an unrelated party, provided that all of the  
            applicable requirements and definitions are satisfied. 


          7)Specifies that a 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. 


          8)Prohibits a sale of a LIHT credit if the taxpayer was allowed  
            the credit on any of his/her tax returns. 


          9)Allows the taxpayer who has made an election to sell a LIHT  
            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. 


          10)Authorizes the TCAC to prescribe rules, guidelines, or  
            procedures, as specified. 


          11)Requires the CTCA to report to the Legislature, on or before  
            January 1, 2021, the total amount of credits allowed to, and  
            sold by, taxpayers, as specified, including a separate  











                                                                     SB 377


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            accounting of credits sold to original purchasers by the  
            original investors and credits resold by the original  
            purchasers to secondary purchasers. 


          12)Repeals the sunset date that applies to provisions allowing a  
            partnership to allocate state LIHT credits to investors,  
            within the partnership, in a manner that differs from the  
            proportional allocation of the federal LIHT credits, by  
            disconnecting the federal tax rules that apply to  
            partnerships, to which California otherwise conforms. 


          13)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, the  
            Corporation Tax, and the Insurance Tax 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.  


          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.













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          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, partnerships 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 otherwise conforms.  
          FISCAL EFFECT:  Unknown


          COMMENTS:  


          1)The Author's Statement.  The author has provided the following  
            statement in support of this bill:


               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  











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               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)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%  


















                                                                     SB 377


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            credits.<1>  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.   
            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.  


          3)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  
          ---------------------------


          <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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            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  
            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.  


          4)What is the Problem with the Existing Ownership Structure?   
            Under existing California 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  











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            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.  


          5)The Proposed Solution.  This bill proposes to allow a project  
            developer to sell the state LIHT credit to any unrelated  
            person or entity, provided that the person or entity already  
            has an ownership interest in any low-income housing project in  
            California.  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 specific 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  
          ---------------------------


          <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.












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            federal income tax liability.<3>  Consequently, the value of  
            the state LIHT credit would be significantly enhanced to the  
            potential purchasers. 




          Analysis Prepared by:                                             
                          Oksana Jaffe / REV. & TAX. / (916) 319-2098  FN:  
          0002438














          ---------------------------
          <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.