BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |SB 1149 |Hearing |4/27/16 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Stone |Tax Levy: |Yes | |----------+---------------------------------+-----------+---------| |Version: |2/18/16 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Grinnell | |: | | ----------------------------------------------------------------- Personal income taxes: deduction: individual home ownership savings accounts Creates "individual homeownership savings accounts," and allows two tax benefits for taxpayers who create them. Background The Internal Revenue Code creates several forms of tax-preferred individual accounts, such as Health Savings Accounts, Qualified Tuition Programs, and Individual Retirement Accounts (IRAs). While California law does not automatically conform to changes to federal tax law, it does automatically conform to changes made to Subchapter D - Deferred Compensation, etc., which includes retirement accounts such as traditional and Roth IRAs. For everything else, the Legislature must affirmatively conform to federal changes. Conformity legislation is introduced either as stand-alone legislation to conform to specific federal changes, like the Regulated Investment Company Modernization Act (AB 1423, Perea, 2011), or as one omnibus bill that provides that state law conforms to federal law as of a specified date, currently January 1, 2015 (AB 154, Ting, 2015). California conforms to two types of IRAs: traditional, and Roth. Other than rollovers, taxpayers can generally deduct contributions to traditional IRAs in the year they make them, but must include distributions in taxable income in the year SB 1149 (Stone) 2/18/16 PageB of? received in most cases. Federal law limits the amounts a taxpayer can contribute to a traditional IRA to $5,500 per year; however, limits for other plans, such as a 401(k), are considerably higher. Taxpayers cannot deduct contributions to Roth IRAs; however, taxpayers need not include distributions in taxable income in most cases. Taxpayers younger than age 59 , or as a result of death or disability, who receive traditional IRA distributions for nonqualified purposes must include the income for tax purposes, and pay an additional federal (10%), and state (2.5%) penalty. However, federal law contains several exceptions to the penalty, including a one-time distribution of $10,000 for first-time homebuyers for the qualified acquisition cost of a residence. California law allows various income tax credits, deductions, and sales and use tax exemptions to provide incentives to compensate taxpayers that incur certain expenses, such as child adoption, or to influence behavior, including business practices and decisions, such as research and development credits. The Legislature typically enacts such tax incentives to encourage taxpayers to do something that but for the tax credit, they would not do. The Department of Finance must annually publish a list of tax expenditures; according its most recent report, the Department estimates tax expenditures result in $57 billion in foregone revenue in 2015-16. California allows taxpayers to deduct expenses incurred for certain activities or purchases up to a certain amount in one of two ways. First, taxpayers can claim deductions from total gross income, known as "above-the-line" deductions, for specified expenses, such as student loan interest, IRA contributions, or alimony paid, among others, to calculate adjusted gross income. After that, state law gives taxpayers a choice to either claim the standard deduction, or itemized deductions for other expenses, such as business expenses, higher education expenses, mortgage interest, and other miscellaneous deductions that exceed 2% of adjusted gross income, among others, to determine taxable income. Taxpayers will usually itemize when these itemized deductions exceed the standard deduction ($4,044 single/$8,088 joint in 2015). Seeking to assist individuals who want to save money to purchase a home, the author wants to create new tax-preferred accounts to help first-time homebuyers purchase residences. SB 1149 (Stone) 2/18/16 PageC of? Proposed Law Senate Bill 1149 creates "individual homeownership savings accounts," and allows taxpayers two tax benefits similar to traditional IRAs commencing in the 2017 taxable year. The bill defines individual homeownership savings accounts as a trust that is: Designated by the trustee as such an account, Established for the exclusive benefit of any qualified taxpayer establishing the account where the written governing instrument creating the account provides that all contributions must be made in cash, and that the account is established to pay for the qualified home ownership expenses of a qualified taxpayer, Is subject to the same requirements and limitations set by Section 408 of the Internal Revenue Code, or any regulations, for individual retirement accounts, and Is the only individual homeownership savings account established by the qualified taxpayer. SB 1149 excludes from gross income any income accruing during the taxable year to the account, as defined, under the same conditions as Section 408 of the Internal Revenue Code imposes on traditional IRAs. The measure also allows an itemized miscellaneous deduction equal to the amount a taxpayer contributes to the account, limited to $30,000 per taxable year (joint, head of household, surviving spouses)/$15,000 (all others), so long as the deduction exceeds 2% of the taxpayer's adjusted gross income. To be eligible, a taxpayer or their spouse must not hold a present ownership interest in a principal residence during the preceding three-year period ending on the date of the purchase of the residence, and have annual income of less than $100,000 (joint, head of household, surviving spouses)/$50,000 (all others). The Franchise Tax Board (FTB) must adjust these amounts annually for inflation as measured by the California Consumer Price Index. The bill also provides that withdrawals must be included in SB 1149 (Stone) 2/18/16 PageD of? income in the taxable year in which the payment or distribution is made, unless it is made to pay for the taxpayer's individual home ownership savings expenses, which the measure defines as expenses, including a down payment or mortgage payment paid or incurred in connection with the purchase of the qualified taxpayer's principal residence in California for use by the taxpayer creating the account. State Revenue Impact According to FTB, SB 1149 results in revenue losses of $80 million in 2017-18, and $160 million in 2018-19, increasing by $80 million per year indefinitely. Comments 1. Purpose of the bill . According to the author, "the housing crisis in California is in full bloom, and low-to-middle income individuals across the state are being affected by the lack of affordable housing. More than 90% of California families earning less than $35,000 per year spend more than 30% of their income just on housing. As a result more and more people find themselves renting a home, instead of chasing the American Dream. SB 1149 was devised as a way to help people accumulate savings towards a down payment on a house - which is crucial as home ownership is a key way for a family to develop and transfer wealth between generations. Currently, the only option for renters available to them from a tax perspective is the renters' tax credit - $60 for individuals and $120 for the head of a household or married filing jointly. SB 1149 establishes individual home ownership savings accounts. This bill will allow for qualified deductions of up to $30,000 for those filing jointly and $15,000 for those filing individually. By allowing people a special account to put away pre-tax money towards a home, SB 1149 will enable middle and low income individuals an opportunity to build savings towards a home." 2. Will it work ? Tax benefits intended to subsidize specific purchases do two things: First, they may reward behavior that would have occurred without the subsidy, so-called "deadweight SB 1149 (Stone) 2/18/16 PageE of? loss." Some taxpayers will save funds to purchase a house without any additional incentive, so the bill will give these taxpayers a windfall benefit equal to taxes not paid, providing no marginal benefit. Second, the bill may alter decisions at the margin; the exclusion and deduction may spur individuals to create and contribute to an account, and subsequently purchase a residence, thereby increasing benefits from community ownership statewide. A successful tax incentive creates more economic activity at the margin than its deadweight loss, but no tax benefit has yet conclusively demonstrated that its benefits outweigh its costs. Another possible outcome for the measure's tax subsidy is to increase house prices because taxpayers would have less income subject to tax as a result of the measure's tax benefits, which the Legislative Analyst's Office found could be a result of the state's mortgage interest deduction. The Committee may wish to consider whether the bill's benefits will outweigh its deadweight loss. 3. Double benefit . Both traditional and Roth IRAs offer tax advantages; however, taxpayers can choose to enjoy one tax benefit, but not two, either by allowing deductions for contributions (traditional) or an exclusion from income for withdrawals (Roth). However, SB 1149 provides both a deduction and exclusion, so long as withdrawn funds are used to help the taxpayer buy a home, providing a double benefit. The measure's exclusion from tax on both the front and back ends would set a precedent in state tax law only for home ownership savings. The Committee may wish to consider whether both benefits are necessary for the measure to accomplish its goal. 4. New tax expenditure . Enacting a new tax exemption results in foregone revenue, which requires cuts in spending or higher taxes, all else equal. Tax credits do not pay for themselves: the state's last effort of "dynamic revenue analysis" indicates that while dynamic effects are definitely present and visible, their effects are generally relatively modest.<1> The Committee may wish to consider whether the benefits resulting from this incentive are worth the tradeoff of cuts in spending or taxes on other activities. 5. Reverse nonconformity . Generally, when the federal --------------------------- <1> "Whatever Happened to Dynamic Revenue Analysis in California?" John David Vasche, prepared for the Federation of Tax Administrators, September, 2006. SB 1149 (Stone) 2/18/16 PageF of? government changes its tax laws, California catches up by enacting its own legislation the following year to reduce differences between the two codes, thereby easing the tax preparation burden on taxpayers, tax preparers, and the Franchise Tax Board. SB 1149 would enact an income exclusion and deduction for contributions to individual homeownership savings accounts which wouldn't have similar treatment, which would increase the difference between state and federal, and potentially confuse affected taxpayers. The Committee may wish to consider whether the measure's savings incentives are worth the lack of conformity it creates. 6. Current subsidies . SB 1149 would add an additional tax benefit to subsidize home ownership above and beyond those found in existing law. In the United States, federal and state governments offer substantial tax subsidies for owning or selling a home, such as: Mortgage Loan Interest: Taxpayers may deduct interest payments on up to $500,000 single/$1 million joint of indebtedness used to purchase a first and second home. Taxpayers may also deduct interest payments on up to $100,000 in home improvement loans. Capital Gains Exclusion: Taxpayers may exclude up to $250,000 single/$500,000 joint in income resulting from the sale of their principal residence. Deductibility of Property Taxes: Taxpayers may deduct property taxes and some other real estate taxes from federal income, although California's low property tax rates limit the benefit for Californians compared to residents of other states. Excluded Imputed Rent. Unlike returns from other investments, the return on homeownership-called "imputed rent"-is excluded from taxable income. In contrast, landlords must count as income the rent they receive, and renters may not deduct the rent they pay. Property tax. The California Constitution limits taxes to 1% of assessed value, which is generally the purchase price plus annual inflation, capped at 2%, and precludes assessors from revaluing property unless it's newly SB 1149 (Stone) 2/18/16 PageG of? constructed or changes ownership. The Constitution also allows a homeowners' exemption that subtracts $7,000 per year in taxable value. 7. Suggested amendments . FTB and Committee Staff recommend amendments to: Use "qualified individual home ownership development expenses" and "individual homeownership savings expenses" consistently, utilizing the definition for the former. Specifying the individual paragraphs of Internal Revenue Code 408 which should apply to homeownership savings accounts, Refine the definition of "qualified taxpayer" to preclude each spouse from opening an account and take advantage of the tax benefits. Add "claw back" provisions if the taxpayers sells or ceases to occupy the property, Delete the term "a qualified taxpayer who is married filing a joint return," and instead use "qualified taxpayers filing a joint return" Add "within the meaning of Section 121 of the Internal Revenue Code" after the term "principal residence." Delay the inflation adjustment until the taxable year following the first taxable year after the measure is effective. Support and Opposition (4/21/16) Support : California Association of Realtors, California Building Industry Association. Opposition : Unknown. SB 1149 (Stone) 2/18/16 PageH of? -- END --