BILL ANALYSIS Ó SB 1216 Page 1 Date of Hearing: June 20, 2016 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Sebastian Ridley-Thomas, Chair SB 1216 (Hueso) - As Amended May 4, 2016 SUSPENSE SENATE VOTE: 39-0 SUBJECT: Income taxes: credits: qualified employees SUMMARY: Establishes an income tax credit, under both the Personal Income Tax (PIT) and the Corporation Tax (CT) laws, for employers that hire certain young individuals who are ex-offenders convicted of a felony, as defined. Specifically, this bill: 1)Allows an income tax credit, for taxable years beginning on or after January 1, 2017, and before January 1, 2022, to a "qualified taxpayer" equal to 20% of the "qualified wages" paid to a "qualified full-time employee." SB 1216 Page 2 2)Provides that the amount of credit may not exceed $15,000 per qualified taxpayer per taxable year. 3)Defines a "qualified taxpayer" as a person or entity engaged in a trade or business within California that, during the taxable year, pays or incurs qualified wages. 4)Specifies that a "qualified taxpayer" does not include any of the employers that: a) Provide temporary help services, as described in the North American Industry Classification System (NAICS) Code 561320 published by the United States Office of Management and Budget, 2012 edition; b) Provide retail trade services, as described in the NAICS Section 44-55; c) Are primarily engaged in providing food services, as described in NAICS Code 711110, 722513, 722514, or 722515; d) Are primarily engaged in services in casinos, casino hotels, or drinking places, as described in NAICS Code 713210, 721120, or 722410; or, e) Are "sexually oriented businesses," as defined. 5)Defines "qualified wages" as wages that meet all of the following requirements: SB 1216 Page 3 a) That portion of the wages paid or incurred by the qualified taxpayer that exceed 150% of minimum wage, but does not exceed 350% of minimum wage. However, if a qualified full-time employee is employed in a designated pilot area, as defined, qualified wages must exceed $10 per hour or an equivalent amount for salaried employees, instead of the 150% minimum wage requirement. b) Paid or incurred during the 60-month period beginning with the first day the qualified full-time employee commences employment with the qualified taxpayer. In the case of any employee who is reemployed, including a regularly occurring seasonal increase, in the trade or business operations of the qualified taxpayer, this reemployment would not be treated as constituting commencement of employment. 6)Defines a "qualified full-time employee" as an individual who meets all of the following requirements: a) Receives starting wages that are at least 150 percent of the minimum wage; b) Is an ex-offender previously convicted of a felony who is, at the time of hiring, between 18 and 25 years of age, and who demonstrates completion of a work readiness program; c) Is hired by the qualified taxpayer on or after January 1, 2017; and, d) Satisfies either of the following conditions: SB 1216 Page 4 i) Is paid qualified wage by the qualified taxpayer for services not less than an average of 35 hours per week. ii) Is a salaried employee and was paid compensation during the taxable year for full-time employment by the qualified taxpayer. 7)Defines a "work readiness program" as a program offered by a job training provider that offers vocational job training, education opportunities, and life skills. 8)Requires a work readiness program to include all of the following: a) Paid or unpaid on-the-job training opportunities, pre-apprenticeship programs, vocational instruction or internship placement; b) The opportunity for academic advancement; c) The opportunity to earn at least one industry recognized certification; and, d) A life-skills training component. 9)Requires a qualified employee to be employed full-time for at least 36 months in order for the qualified taxpayer to receive the credit. SB 1216 Page 5 10)Provides for a recapture of the credit claimed by the qualified taxpayer if the qualified full-time employee is terminated at any time during the first 36 months after commencing employment with the taxpayer. However, this recapture provision would not apply to any of the following types of termination of employment: a) The employee voluntarily leaves the employment of the qualified taxpayer; b) Before the close of the 36 month-period, the employee becomes disabled and unable to perform the services of that employment, unless that disability is removed before the close of the 36 months and the qualified taxpayer fails to offer reemployment to that employee; c) The employee was terminated due to the misconduct, as defined; d) The employee was terminated due to a substantial reduction in the trade or business operations of the qualified taxpayer, including reductions due to seasonal employment; e) The employee was replaced by other qualified full-time employees so as to create a net increase in both the number of employees and the hours of employment; or f) Employment is considered "seasonal employment" and the qualified employee is rehired on a seasonal basis. SB 1216 Page 6 11)Requires a qualified taxpayer to claim the credit only a timely filed original return of the qualified taxpayer. 12)Requires a qualified taxpayer to receive a tentative credit reservation from the Franchise Tax Board (FTB) for each qualified full-time employee within 30 days of complying with the Employment Development Department's new hire reporting requirements as provided, in the form and manner prescribed by the FTB. 13)Requires FTB to do all of the following: a) Approve a tentative credit reservation with respect to a qualified full-time employee hired during a calendar year; b) Determine the aggregate tentative reservation amount; and, c) Provide as a searchable database on the Internet Web site, for each taxable year beginning on or after January 1, 2017, and before January 1, 2022, the employer names, amounts of tax credit claimed, and number of new jobs created for each taxable year, as provided. 14)Provides that in the case of a taxpayer that is a pass-thru entity, the determination of whether the taxpayer is a qualified taxpayer would be made at the entity level and any credit would be allowed to pass through to the partners and shareholders. SB 1216 Page 7 15)Defines a "pass-thru entity" as any partnership or "S" corporation. 16)Disallows any other credit to the taxpayer who is allowed the credit for qualified wages paid to a qualified employee, with respect to any wage consisting in whole or in part of those qualified wages. 17)Provides that any excess credit may be carried over to reduce the tax, as defined, for the succeeding four years, until the credit is exhausted. 18)Requires the FTB to provide annually to the Joint Legislative budget Committee, by no later than March 1, a report of the total dollar amount of the credits claimed with respect to the relevant fiscal year. If the total dollar amount of credits claimed for the fiscal year is less than the FTB's estimate for that fiscal year, the report shall identify options for increasing annual claims of the credit so as to meet estimated amounts. 19)Declares that Revenue and Taxation Code (R&TC) Section 41shall not apply. 20)Takes effect immediately as a tax levy. EXISTING LAW: 1)Allows taxpayers engaged in a trade or business to deduct all expenses that are considered ordinary and necessary in conducting that trade or business. SB 1216 Page 8 2)Allows, under the CT and the PIT Law, an income tax credit to qualified taxpayers that hire a qualified full-time employee, have an overall net increase in employment, and pay or incur qualified wages attributable to work performed by a qualified full-time employee in a designated census tract or former Enterprise Zone (the New Employment Credit). The qualified taxpayer must receive a tentative credit reservation from the Franchise Tax Board (FTB) for the qualified full-time employee. 3)Provides that a qualified full-time employee must meet at least one of the following conditions upon commencement of employment: a) Unemployed for six months immediately preceding employment; b) Veteran separated from the Armed Forces in the preceding 12 months; c) Recipient of the Earned Income Tax Credit in the previous taxable year; d) Ex-offender convicted of a felony; and, e) Current recipient of California Work Opportunity and Responsibilities to Kids (CalWORKS) or general assistance. 4)Provides that, as of January 1, 2016, state minimum wage is generally $10 per hour, but employees classified as "learners" may be paid a lesser wage. Specifies that the minimum wage requirements do not apply to the wages paid by an employer to SB 1216 Page 9 the employees who are the employer's parents, spouse, or children. 5)Applies performance measurement standards to any new tax credit under either the PIT or CT Law if enacted by a bill introduced on or after January 1, 2015. Specifically, existing law requires the all of the following: a) Specific goals, purposes, and objectives that the tax credit will achieve; b) Detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives stated in the bill; and, c) Data collection requirements to enable the Legislature to determine whether the tax credit is meeting, failing to meet, or exceeding those specific goals, purposes, and objectives, including a requirement to specify both of the following: i) The baseline data, to be collected and remitted in each year the credit is effective, for the Legislature to measure the change in performance indicators; and, ii) The taxpayers, state agencies, or other entities required to collect and remit data. FISCAL EFFECT: The FTB staff estimates that this bill will result in an annual General Fund (GF) loss of $0.3 million in SB 1216 Page 10 fiscal year (FY) 2016-17, $1.1 million in FY 2017-18, and $1.8 million in FY 2018-19. COMMENTS: 1)Author's Statement . The author has provided the following statement in support of this bill: "In recent decades, the number of Americans who have come in contact with the criminal justice system has increased exponentially. Between 1980 and 2009, California's prison population increased 583%. As a direct result of the state's increasing incarceration rate the number of Californians with a criminal record has soared. Currently, there are nearly eight million individuals in the state's criminal history file. "Upon release, many Californians have found it increasingly difficult to find employment. As these Californians have learned a felony conviction or a prison or jail term on an individual's record can have a substantial negative impact on future job procurement for numerous reasons. Specifically, incarceration or a felony conviction imparts a negative societal stigma that makes employers less likely to hire ex-offenders. "Overwhelmingly, ex-offenders have tenuous relationships to the labor market. Approximately 70% have dropped out of high school, contributing to their un-employability. Moreover, time spent incarcerated can make the matter worse by depriving those incarcerated the chance to develop the job skills and social capital necessary for success in the labor market later in life. "Statistics demonstrate that younger felons have a more SB 1216 Page 11 difficult time reintegrating into society post incarceration. A recent California Department of Corrections and Rehabilitation (CDCR) outcome evaluation report indicated that younger felons recidivate at the highest rates. Inmates released at age 24 or younger return to prison at a rate of 67.2 percent.' "The Franchise Tax Board has estimated that SB 1216's employer tax incentive will cost the state $600,000 in lost revenue for the 2016-17 fiscal year. However, it is important to note that analysts estimate that it costs California nearly $60,000 annually to incarcerate an inmate in California prisons. "If SB 1216's employer tax incentive program keeps 10 high risk-youth from re-offending then this program will cost the state nothing in net revenue (10 x $60,000 = $600,000). Additionally, there are a multitude of additional social benefits associated with an ex-offender successfully reintegrating back into society ultimately resulting in greater savings.' "SB 1216 is a much needed bill that seeks to help a fragile and disadvantaged demographic group successfully transition back into society post-incarceration by reducing the barriers to employment these individuals frequently face." 2)Arguments in Support . The proponents state that this bill "aims to remove a significant barrier to successful re-entry from the lives of young ex-offenders by implementing a tax incentive" and to provide "opportunities for young ex-offender to find employment that pays above minimum wage." The proponents argue that approximately 70% of ex-offenders "have dropped out of high school" and lack the job skills necessary "for success in the labor market later in life." This bill increases the opportunity for these disenfranchised youth to find employment after incarceration and the training necessary for them to succeed in the future employment. The proponents contend that this bill would increase real job placement for young ex-offenders and would help "improve their lives." SB 1216 Page 12 3)California's Existing Hiring Tax Credit Programs: Background . In 2014, Governor Brown signed legislation that reformed California's economic development policies. [AB 93 (Committee on Budget) Chapter 69, Statutes of 2014.] The new law eliminated enterprise zones and other geographically targeted economic development areas and, instead, created three new economic development tax incentives: (a) a temporary tax credit for wages paid by taxpayers to qualified employees within former enterprise zones, and other areas that suffer from high levels of poverty and unemployment (the "New Employment Credit"); (b) a temporary sales and use tax exemption on purchases of manufacturing equipment made by qualified taxpayers, capped at $200 million annually per taxpayer; and (c) the California Competes Tax Credit program - a negotiated incentive administered by the Governor's Office of Business and Economic Development (GO-Biz). The total annual amount of these three tax incentives - the wage credit, the sales and use tax exemption, and the California Competes Tax Credit - was limited to $750 million. Existing law also requires that each fiscal year at least 25% of the aggregate credit amount be reserved for small businesses, i.e., a business with $2 million or less in gross receipts, minus returns and allowances. 4)The New Employment Credit Program . Pursuant to AB 93, the hiring tax credit is established under both the PIT and CT laws, from January 1, 2014 to January 1, 2021, for additional hiring of employees in defined geographic areas (DGAs) in California. The hiring credit is generally available in the geographic areas largely covered by the former enterprise zones (EZs), except certain census tracts with low unemployment, two recently expired EZs, and in designated census tracts that have a civilian unemployment rate and a poverty rate in the top 25% of all census tracts in the state. In order to qualify for the credit, the taxpayer must have experienced an increase in total jobs throughout the state SB 1216 Page 13 from one year to the next. Taxpayers are only allowed the credit for the number of new jobs provided in California. The New Employment Credit is available for wages paid by taxpayers to full-time employees, including ex-offenders convicted of a felony, who perform at least 50% of their activities in the designated areas. The credit percentages are 35% per year for five years, for wages between 150% and 350% of the minimum wage. For a qualified employee working in a pilot area, the applicable wages are those wages exceeding $10 per hour, up to 350% of the minimum wage. Pilot areas are areas within the DGA that have been designated by GO-Biz. Up to five pilot areas may be designated for a period of four calendar years. On April 24, 2014, GO-Biz designated three pilot areas: (a) Fresno Pilot Area, which is the former Fresno City Enterprise Zone, except within census tracts with the lowest unemployment and poverty; (b) Merced Pilot Area, which is the former Merced Enterprise Zone, except within census tracts with the lowest unemployment and poverty, and (c) Riverside Pilot Area - census tracts 303, 401.01, 402.03, 429.04, and 467 in Riverside County. These pilot areas are in effect until December 31, 2017. However, the pilot area designation may be extended by GO-Biz for an additional period of up to three calendar years. Except for small businesses, certain employers otherwise qualified for the New Employment Credit are prohibited from receiving this credit. For example, excluded businesses consist of those in temporary help services, as defined in the NAICS Code 561320, retail trades services (NAICS Sector 44-45), and those primarily engaged in food services (Codes 722511, 722513, 722514, and 722515). In addition, theater companies and dinner theaters (Codes 711110), drinking places (alcoholic beverages) (Code 722410) and casinos and casino hotels (Codes 713210, 721120) are disqualified as well. Finally, all sexually-oriented businesses are excluded from being a qualified taxpayer regardless of their status as a SB 1216 Page 14 small business. A sexually oriented business includes a nightclub, bar, or similar commercial enterprise that provides for an audience of two or more individuals live nude entertainment or live nude performances where the nudity is a function of everyday business operations and where nudity is a planned and intentional part of the entertainment or performance. 5)What Does this Bill Do ? This bill would create a new income tax credit for employers who hire an ex-offender previously convicted on a felony, who at the time of hiring is between 18 and 25 year of age, and who demonstrates documented completion of a work readiness program. The worker must be paid at least 150% of the state minimum wage during the taxable year. The proposed credit amount would equal 20% of the difference between 150% and 350% of minimum wage. However, in the case of a qualified employee employed in a pilot area the credit would be allowed for wages that exceed $10 per hour or an equivalent amount for salaried employees. The 350% of minimum wage cap would still apply. The total amount of credit available per qualified taxpayer per taxable year is limited to $15,000. Similarly to the existing New Employment Credit program, the qualified employer must receive a tentative credit reservation from the FTB and must claim the credit on an original filed timely return. 6)How Different Is the Proposed Hiring Credit ? The New Employment Credit already provides a hiring tax credit to employers who employ ex-offenders convicted of a felony, among others. However, the proposed credit program is targeted towards hiring only young ex-offenders convicted of a felony who have completed a work readiness program. Furthermore, this bill would make the credit available to qualified employers on a statewide basis, instead of limiting it only to former enterprise zones, local agency military bases, designated pilot areas, and designated census tracts. Both SB 1216 Page 15 credit programs require a qualified employee to work full time and require a qualified employer to pay wages between 150% and 350% of minimum wage, unless the qualified employee is working in a designated pilot area. The existing credit percentage is 35% of qualified wages in contrast to 20% proposed by this bill. The aggregate annual amount of the credit is further limited by this bill to $15,000 per qualified taxpayer per taxable year. Finally, unlike the New Employment Credit, the new tax incentive would target individuals between 18 and 25 years of age and does not require qualified employers to show a net increase in employment. Stated differently, an otherwise eligible employer would be not disqualified to receive the proposed credit if the employer hires a qualified ex-offender and fires another employee. 7)A Subsidy or an Incentive ? According to the author's office, between 1980 and 2009, California's prison population increased 583%. As a result, the number of Californians with a criminal record has soared. Currently, there are nearly eight million individuals in the state's criminal history file. It appears that younger felons have a more difficult time reintegrating into society post incarceration. A recent California Department of Corrections and Rehabilitation outcome evaluation report indicates that inmates released at age 24 or younger return to prison at a rate of 67.2%. The author also points out that the majority of incarcerated individuals have fewer marketable skills and less education than the general population. As a way of encouraging the hiring of ex-offenders and consequently helping them to rehabilitate, this bill proposes a tax incentive. It is unclear, however, whether this bill would create an incentive for employers to hire individuals who otherwise would not be hired or a subsidy for hiring individuals who would have been hired even in the absence of SB 1216 Page 16 this credit. The Committee may wish to consider whether this credit is an effective tool in incentivizing additional hiring of young individuals with criminal record. 8)Do Hiring Tax Credits Work ? In previous years, some have advocated job creation tax credits as a means of revitalizing the struggling economy. The question, however, is whether such credits actually work, and whether they are an appropriate tool in light of substantial declines in unemployment over the last five years. Mr. Daniel Wilson, assistant director of the Center for the Study of Innovation and Productivity at the Federal Reserve Bank of San Francisco, attempted to answer this question. In a paper co-authored with Robert Chirinko of the University of Illinois at Chicago, Wilson examined the period between January 1990 and August 2009 and found that among states where employers could qualify for credits immediately after enactment of the credit legislation there was a slight employment increase of 0.12%. These findings suggest that hiring credits, at least at the state level, have some impact but appear to be very a blunt tool for stimulating job growth. Additionally, it is unclear if the hiring tax credit provides an incentive or reward. The state's unemployment rate has been steadily declining over the last few years to a rate of 5.4%, as of March 2016. An improved economy is more likely to lead to additional hiring of all individuals in all industries, irrespective of state incentives such as a hiring tax credit. As a result, a hiring tax credit could potentially provide an employer with a windfall for actions that would have already taken place because of improvements in the economy and job market. 9)Excluded Businesses . According to the author's office, this bill is written to be consistent with the policy underlying the New Employment Credit and therefore is drafted to emulate - albeit on a broader scale - the New Employment Credit. Thus, this bill excludes certain otherwise qualified employers from receiving the proposed credit for hiring youth ex-offenders unless those employers are "small businesses." Similar to the New Employment Credit, excluded businesses SB 1216 Page 17 would be those in temporary help services, retail trade services, and those primarily engaged in food services. Furthermore, theater companies and dinner theaters, drinking places, casinos and casino hotels, and all sexually oriented businesses would be disqualified. However, the proposed credit targets only those employers who hire youth ex-offenders under the age of 25 and it is unclear how many businesses - besides food and retail services - would employ this group of individuals in large numbers. It seems that allowing the "excluded businesses" to qualify for the new credit may provide more jobs opportunities to this demographic group. At the same time, it is questionable how many of these "excluded businesses" (such as for example, "big box" retailers or fast-food chains) would hire these individuals at more than 150% of minimum wage. 10)Double Dipping: Allowing Credit and Deduction . Existing law already provides a tax incentive, in the form of a deduction for business expenses, for wages and benefits paid by employers to employees. A deduction decreases the taxpayer's gross income and its value depends on the taxpayer's tax bracket. For example, if a taxpayer is in the 25% bracket, a $1,000 deduction would lower the taxpayer's tax bill by $250. In contrast, a $1,000 credit decreases the tax liability by the full $1,000, regardless of the tax bracket. Thus, the value of a tax credit is the same, regardless of the tax rate and, therefore, it is generally more appealing to taxpayers. A tax credit is more valuable because it lowers the tax liability dollar-for-dollar. This bill does not prohibit an employer from deducting qualified wages as a business expense, as well as obtaining the credit for the same wages. The Committee may wish to consider disallowing a deduction for the wages paid or incurred by a qualified employer if the employer claims the new tax credit SB 1216 Page 18 for the same wages. 11)R&TC Section 41 . SB 1335 (Leno), Chapter 845, Statutes of 2014 added R&TC Section 41, which recognized that the Legislature should apply the same level of review used for government spending programs to tax preference programs, including tax credits. Thus, Section 41 requires any bill that is introduced on or after January 1, 2015 and allows a new PIT credit to contain specific goals, purposes, and objectives that the tax credit will achieve. In addition, Section 41 requires detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives so-identified. This bill creates a new tax credit program but does not articulate its objective or goal. Nor does this bill include the performance indicators to measure the effectiveness of the credit. Since performance indicators are critical in measuring the effectiveness of the tax credit, the Committee may wish to consider amendments to articulate the specific goal, purpose or objective of the proposed tax credit as well as the performance indicators to measure its effectiveness. 12)California Wages . This bill fails to specify that qualified wages must be paid to qualified employees for work performed in California. As such, an employer that pays non-California wages to the otherwise qualified employees would be eligible for the credit. In practice, it is unlikely that many qualified employees who completed a "work readiness program" administered in California would be hired to perform services outside of California. Nonetheless, the absence of clarity may lead to disputes between the FTB and taxpayers. Therefore, the Committee may wish to consider amendments to SB 1216 Page 19 ensure that California does not subsidize wages paid for work performed outside California. 13)Implementation Concerns . The bill has several requirements for FTB to administer this credit, including a searchable database and a tax credit reservation system. These requirements would result in substantial administrative costs for the FTB. The FTB staff has also noted that the phrase "employed in a pilot area" is undefined. It is unclear whether an hour of employment in a pilot area would be enough to allow a taxpayer to qualify for the credit. The absence of definitions could lead to disputes with taxpayers and would complicate the administration of this credit. The Committee may wish to consider defining this phrase to ensure that the qualified wages incurred by the taxpayer are for services performed in a pilot area. REGISTERED SUPPORT / OPPOSITION: Support Anti-Recidivism Coalition (ARC) Children's Defense Fund - California California Association of Local Conservation Corps (CALCC) SB 1216 Page 20 Opposition None on file Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916) 319-2098