BILL ANALYSIS                                                                                                                                                                                                    



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

                              
          
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          |Bill No:  |SB 873                           |Hearing    |3/30/16  |
          |          |                                 |Date:      |         |
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          |Author:   |Beall                            |Tax Levy:  |Yes      |
          |----------+---------------------------------+-----------+---------|
          |Version:  |1/14/16                          |Fiscal:    |Yes      |
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          |Consultant|Grinnell                                              |
          |:         |                                                      |
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            Income taxes:  insurance taxes:  credits:  low-income housing:  
                                    sale of credit



          Allows taxpayers to sell low-income housing tax credits;  
          reenacts authority for partnership agreements to allocate state  
          tax credits differently than federal ones.


           Background 

           Current federal law allows tax credits against federal taxes 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.  State law also allows  
          credits against the Personal Income Tax, Corporation Tax, and  
          Gross Premiums Tax for the same projects.  The credits are only  
          available for rental housing projects which remain affordable to  
          residents for 55 years, enforced by regulatory agreements  
          recorded against each project.  

          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  
          both federal and state credits.  CTCAC awards a federal credit  
          based on a formula in federal law, currently $2.25 per capita  
          for each state, and a state credit up to a statutory cap  







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          annually adjusted for inflation, plus any unallocated credits  
          from previous years.  Housing developers design projects and  
          apply to CTCAC for credits, who then review 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  
          credits at a discount.  Tax credits generally total 100% of a  
          project's eligible basis, or its cost less non-depreciable  
          items.  CTCAC may allocate federal tax credit to any area of the  
          state, but must conduct a feasibility analysis to ensure that  
          the amount of credit granted doesn't exceed the amount of  
          capital needed to build the project.  

          From 2009 to 2016, state law allowed LIHTC partnership  
          agreements to allocate the state LIHTC to investors in a manner  
          that differs from the proportional division of the federal  
          credit (SB 585, Lowenthal, 2008), a unique departure from  
          federal partnership rules to which California conforms.  These  
          rules generally require that any allocation from the partnership  
          to any of its members, such as income, losses, or tax credits,  
          must have "substantial economic effect," meaning that the  
          partnership's tax benefits must be proportionally allocated to  
          each partner according to his or her contribution to or  
          interests in the partnership relative to its other members. 

          Generally, California doesn't allow taxpayers to sell state 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, and reenact the  
          authority for projects to allocate state tax credits differently  
          than federal ones.


           Proposed Law

           Senate Bill 873 amends the LIHTC for each tax to allow a  
          taxpayer to make an irrevocable election to sell all or any  
          portion of LIHTC to another taxpayer as part of its application  
          to CTCAC, subject to several requirements, including: 








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                 The taxpayer buying the credit is also allowed the  
               federal or state credit in connection with a project in  
               California in the same or a previous taxable year as the  
               credit they purchase, which restricts the pool of potential  
               buyers only to those who currently or in the past provided  
               project capital for other LIHTC projects in the state.

                 The taxpayer selling the credit must receive  
               consideration that is not less than 80% of the credit's  
               value; however, the director of CTCAC may revoke the  
               election if the consideration amount falls below that level  
               after CTCAC makes the credit reservation.

                 The taxpayer selling the credit must report specified  
               information to CTCAC within ten days of the sale.

                 The taxpayer selling the credit remains solely liable to  
               comply with statutes authorizing the LIHTC; the bill  
               explicitly exempts taxpayers purchasing the credits from  
               these requirements, but allows them to use the credit in  
               the same manner as the taxpayer who sold it.

                 The taxpayer cannot sell the credit if he or she claims  
               it on any return.  

                 CTCAC issues the taxpayer a preliminary reservation on  
               or after January 1, 2016.

          Taxpayers purchasing the credit can use the credit in the same  
          way the taxpayer originally receiving it can, and can sell to  
          more than one other party.  Taxpayers who originally purchase  
          credits can resell them once, but after that, credits cannot be  
          subsequently resold.  CTCAC must also provide an annual listing  
          to the Franchise Tax Board (FTB) of taxpayers selling and  
          purchasing credits.  CTCAC may also prescribe rules, guidelines,  
          or procedures necessary to carry out the bill, which are exempt  
          from the Administrative Procedures Act.  

          The measure also reenacts without a sunset provision 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.








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


           State Revenue Impact

           FTB estimates revenue gains of $300,000 in 2016-17, and revenue  
          losses of $100,000 in 2017-18, $700,000 in 2018-19, which  
          gradually increases to $2 million by 2021.


           


          Comments

           1.  Purpose of the bill  .  According to the author, "SB 873 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 873 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 873 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.   








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          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  
          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 its evaluation of the most effective use of the  
          tax credits, which contrasts with other state tax credits, where  
          any individual or businesses can qualify for a credit by virtue  
          of incurring specific costs such as research and development.   
          Currently, housing sponsors form partnership agreements with  
          investors, who provide capital to construct the housing project  
          in exchange for the tax credits and an ownership stake in the  
          project.  The tax credits can exceed the value of the investment  
          because tax credit demand exceeds 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, and  
          then walk away from the partnership, deducting 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, as sales allow high-income taxpayers to buy down  
          their tax obligations, often at a discount.  A taxpayer with  
          available capital can buy an LIHTC to shelter income from other  
          sources from tax, whereas less sophisticated taxpayers cannot.   
          However, Congress and the Legislature designed LIHTCs in this  
          specific way because of the difficulty these socially beneficial  
          projects experience attracting available capital.  

          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  








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          income.  California also conforms to this definition, which  
          would normally trigger a significant combined liability for  
          taxpayers selling tax credits under SB 873.  However, because  
          many 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 873  
          resurrects the currently expired 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 several projects have  
          allocated capital using this authority, which adds 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, and  
          allowing this provision to remain expired would result in a  
          reduction in demand, and thereby a loss of available capital.  

          6.   Do it again  .  SB 873 is almost identical to the last version  
          of SB 377 (Beall, 2015), which the Committee approved  
          unanimously last year.  That measure was amended in the Assembly  
          Revenue and Taxation Committee to restrict the pool of potential  
          buyers to those taxpayers who currently or in the past claimed  
          state or federal EITCs, among other changes.  However, Governor  
          Brown vetoed the bill, using the same veto message that he  
          issued for several other bills, stating:

               "Despite strong revenue performance over the past few  
               years, the state's budget has remained precariously  
               balanced due to unexpected costs and the provision of new  
               services.  Now, without the extension of the managed care  
               organization tax that I called for in special session, next  
               year's budget faces the prospect of over $1 billion in  
               cuts.  Given these financial uncertainties, I cannot  
               support providing additional tax credits that will make  
               balancing the state's budget even more difficult.  Tax  
               credits, like new spending on programs, need to be  
               considered comprehensively as part of the budget  
               deliberations." 

           7.   Technical  s.  FTB and Committee Staff recommend the  
          following grammatical amendments:

                 On page 3, line 2, after "subject" insert "to"








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                 On page 13, line 32, after "party" insert "or parties"

                 On page 27, line 3, after "party" insert "or parties"


           Support and  
          Opposition   (3/24/16)


           Support  :  State Treasurer John Chiang, Association of Regional  
          Center Agencies, California Housing Partnership Corporation, The  
          Arc and United Cerebral Palsy California Collaboration, Santa  
          Clara County Board of Supervisors.  


           Opposition  :  Unknown.




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