BILL ANALYSIS                                                                                                                                                                                                    






                                                                     SB 873


                                                                     Page A


          Date of Hearing:  June 20, 2016





                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION


                           Sebastian Ridley-Thomas, Chair





          SB  
          873 (Beall) - As Amended April 5, 2016


          


          Majority vote.  Fiscal committee. Tax levy. 

          SENATE VOTE:  39-0
          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  
            or any portion of the state LIHT credit to an unrelated party,  
            subject to both of the following conditions:












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             a)   The consideration received by the taxpayer from the sale  
               of the LIHT credit equals at least 80% of the credit  
               amount; and,


             b)   The purchaser of the credit is a taxpayer allowed a  
               state or federal LIHT credit in connection with a project  
               in this state in the same taxable year as the credit  
               purchased, or any previous taxable year.  


          2)Applies to projects that receive a preliminary reservation  
            beginning on or after January 1, 2016. 


          3)Allows an LIHT credit purchaser to resell the credit once,  
            subject to all of the applicable requirements. 


          4)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.  


          5)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. 


          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. 













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          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  
            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)Allows TCAC to issue regulations necessary to implement this  
            bill and exempts these regulations from the Administrative  
            Procedures Act. 


          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)Makes several technical, grammatical, and conforming changes.  



          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  











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            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.  

          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 $300,000 in fiscal year (FY)  
          2016-17, and a revenue loss of $100,000 in FY 2017-18 and  











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          $700,000 in FY 2018-19.  


          COMMENTS:  


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



          "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 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 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 by keeping an additional $25 million  
            in California and allow 535 more affordable housing units to  











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            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%  
            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  
          ---------------------------
          <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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            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.  
           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 state law 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  
            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  











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            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)The Financing Structure  .  To raise funds for construction or  
            rehabilitation of low-income housing buildings, 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  
            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  











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            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. 


           5)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.   
           
           6)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  











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            state LIHT credit into cash, without tying the buyer to the  
            project.  This bill, nonetheless, requires the purchaser to  
            claim a state or federal LIHT credit received in connection  
            with any other project in this state in the same taxable year  
            as the credit purchased or any previous taxable year.  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. 

           7)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  
            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  
          ---------------------------
          <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 (such as 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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            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  
            liability, including the state tax credit amount. 
           
           8)A "Slippery Slope"  .  The LIHT credit program induces  

          ---------------------------
          <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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            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  
            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,  


            --------------------------
          <5> See, e.g., Low-Income Housing Credit, L.E. Burman, Tax  
          Policy Center. 










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            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.  Although the proposed sale of LIHT  
            credit is limited 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  
            in California, the Committee may wish to consider whether the  
            benefits of this tax credit sale outweigh the downside of  
            creating a questionable policy precedent for other tax  
            expenditure programs.  The Committee may also wish to consider  
            whether this bill will be one of many suggesting extraordinary  
            circumstances for which a sale of tax credits is warranted.  

           9)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.

           10)Administration of the Tax Credit Sale  .  This bill provides  
            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  











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            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. 


           11)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.  
             


           12)Retroactivity  .  This bill would allow a taxpayer to sell all  
            or any portion of any LIHT credit for a project that receives  
            a preliminary reservation beginning on or after January 1,  
            2016.  Generally, tax credits are provided as a matter of  
            legislative grace to encourage socially beneficial behavior  
            that likely would not occur absent a financial incentive.   
            This bill, however, applies to taxable years beginning on or  
            after January 1, 2016, and thus would be providing a credit  
            for behavior that had already taken place before this bill's  
            enactment.  The Committee may wish to consider the policy  
            implications of providing such an incentive.

           13)Double-referred .  SB 873 was referred to both this Committee  
            and Committee on Housing and Community Development.   SB 873  











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            passed out of the Committee on Housing and Community  
            Development on a 6-0 vote. 


           14)Related Legislation  .  SB 377 (Beall), which was almost  
            identical to this bill, was vetoed.  The veto message follows:  



               "I am returning the following nine bills without my  
               signature: 


               Assembly Bill 35


               Assembly Bill 88
               Assembly Bill 99
               Assembly Bill 428
               Assembly Bill 437
               Assembly Bill 515
               Assembly Bill 931
               Senate Bill 251
               Senate Bill 377

               "Each of these bills creates a new tax credit or expands an  
               existing tax credit. 

               "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  











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               new spending on programs, need to be considered  
               comprehensively as part of the budget deliberations."
            AB 35 (Chiu) would modify the existing LIHT credit program and  
            would increase the aggregate credit amount that may be  
            annually allocated to low-income housing projects by $300  
            million for the 2016 calendar year and each calendar year  
            thereafter.  AB 35 was vetoed.


            AB 2817 (Chiu) would modify the existing LIHT credit program  
            and would increase the aggregate credit amount that may be  
            annually allocated to low-income housing projects by $300  
            million for the 2017 calendar year and each calendar year  
            thereafter.  AB 2817 is pending hearing by the Senate  
            Committee on Governance and Finance and the Senate Committee  
            on Transportation and Housing. 


          


          REGISTERED SUPPORT / OPPOSITION:




          Support


          California Apartment Association


          Santa Clara County Board of Supervisors


          North Los Angeles County Regional Center


          Palm Communities











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          Opposition


          None on file




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