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 Page B |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 Page C 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 Page D 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. SB 377 Page E 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 SB 377 Page F 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 Page G 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. SB 377 Page H 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 SB 377 Page I 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. SB 377 Page J 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.