BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 11 - DeLeon
Amended: April 23, 2009
Hearing: July 8, 2009 Fiscal: No
SUMMARY: Provides that IRS Notice 2008-83 Does Not Apply
for California Purposes
EXISTING FEDERAL LAW provides for net operating losses
(NOLs); taxpayers may carry forward losses in the current
taxable year for twenty years, or carry back for two years,
to reduce past or future taxable income. California mostly
conforms to the federal law for net operating losses, and
recently authorized NOL carry backs beginning in the 2010
tax year (AB 1452, Committee on Budget, 2008).
Current federal law limits the amount of a taxpayer's
taxable income that may be offset by NOLs generated by a
corporation acquired by the taxpayer - so-called "built-in"
losses. Generally, the taxpayer may use the losses of the
acquired corporation to offset income in an amount equal to
the value of the acquired corporation, measured by the
value of its stock immediately before the acquisition,
multiplied by the long-term tax exempt rate, a base
interest rate computed by the IRS. The effect of the
limitation reduces the ability of a taxpayer to shelter
income gained in the regular course of business, thereby
reducing taxes due, by acquiring a corporation with
significant losses. Federal law allows the Treasury
Secretary to issue regulations to carry out the section.
California law conforms to this section as of January 1,
2005.
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On October, 20, 2008, the IRS issued notice 2008-83,
which indicated that it is studying the proper treatment
under the federal law guiding built-in losses after an
ownership change for a corporation that is a bank. The
notice further stated that the limitation for built-in
losses under federal law does not apply to banks with
respect to losses on loans or bad debts, including any
deduction for a reasonable addition to a reserve against
bad debts, thereby allowing banks to fully offset income
when acquiring loss corporations. IRS stated that
taxpayers may rely on the notice, which applies to bank
acquisitions before and after the date of the notice. IRS
did not consult with Congress prior to issuing the notice.
This Bill makes legislative findings and declarations
that California conformed to the built-in loss limitation
as of January 1, 2005. The bill states that when
California conformed, the limitation applied to banks, and
state law contains no specific authority that allows for an
exemption for banks. The bill states that the Legislature
finds that notice 2008-83 is inconsistent and in conflict
with existing California law, and that the notice, and any
similar guidance from the U.S. Treasury in the future shall
not apply either.
FISCAL EFFECT:
According to FTB, AB 11 does not impact revenues or
costs.
COMMENTS:
A. Purpose of the Bill
According to the Author, "On December 1, 2008, I
introduced AB 11 to protect California's budget from the
recent guidance letter by the U.S. Treasury Department
designed to provide a new federal tax break for bank
mergers. While then-Secretary Paulson may have had
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substantial reason to unilaterally rewrite federal tax law
to facilitate the takeover of failing banks, our state's
General Fund should not be adversely impacted by that
decision. Unfortunately, state law requires the State to
conform with Internal Revenue Service (IRS) tax
regulations. California should take explicit action to
ensure that the Franchise Tax Board does not conform to
this ruling. According to Franchise Tax Board (FTB)
estimates, if we were to conform with this federal tax
break, the state would lose approximately $300 Million in
tax revenue during the current fiscal year, and up to $2
Billion in future years. California was not consulted on
this breathtaking tax break. Although recently enacted
federal statute (HR 1) now asserts that Treasury exceeded
its legal authority in issuing IRS Notice 2008-83, and
declares that the ruling shall have no force or effect
after January 16, 2009, AB 11 will ensure that our state's
budget is absolutely protected from the massive corporate
tax give away. It is anticipated that FTB will adopt
regulations to affirm that California will not comply with
IRS Notice 2008-83; AB 11 would add assurances that FTB's
actions cannot be challenged."
B. Fitting In
California statutes generally allow FTB to
automatically conform to regulations issued by the
Secretary of the Treasury as well as notices; however, IRS
issued notice 2008-83 without accompanying regulations, and
the scope and effect of the notice greatly exceed any past
item to which California automatically conformed.
California conforming to the notice means that banks could
apply losses from acquired companies to reduce income for
California tax purposes. Generally, tax practitioners
interpret the federal law to apply to all corporations
prior to IRS issuing the notice, and considered the notice
to constitute a major revision of the federal law.
Newspaper reports indicate that IRS made the change to
persuade Wells Fargo & Co. to acquire Wachovia because the
change in law made by the notice allowed Wells to deduct up
to $75 billion of Wachovia's losses. Additionally, should
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FTB determine that California law requires conformity to
the IRS notice, such conformity would create a significant
precedent because of the significant policy and fiscal
implications. Conformity to the notice means that the
federal government subsidized bank purchases with state
revenues, and enacted powerful incentives for banks to
purchase loss corporations solely to shelter income without
input from the Legislature.
C. Do the Right Thing?
Despite strong words from the media and members of
Congress regarding the merits and legality of notice
2008-83, Congress essentially blessed the notice that
enabled bank trafficking in loss carryovers by providing in
the American Recovery and Reinvestment Act that the notice
did not apply for acquisitions on or before January 16,
2009 unless the ownership change takes place under a
written binding contract entered into on or before January
1, 2009, or under a written agreement entered into on or
before January 16, 2009 if the agreement was described in
an SEC filing. Banks will be able to acquire loss
corporations to offset gains, and amend previous returns to
apply NOL carrybacks for bank acquisitions after the IRS
issued the notice and before January 16th. In California,
FTB acted on December 4th, 2008 to direct staff to draft a
regulatory proposal to make the notice inapplicable for
California law. On March 19th, FTB approved the
regulation. Unless California conforms to the recent
federal changes, banks will only be able to apply losses
from acquired companies to reduce income for federal
purposes, but not for state purposes.
D. Why is AB 11 necessary?
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FTB acted on December 4th, 2008 to direct staff to
draft a regulatory proposal to make the notice inapplicable
for California law. On March 19th, FTB approved the
regulation. Banks will not be able to apply losses from
acquired companies to reduce California tax, so why is AB
11 necessary? The measure implies that FTB is unable to
sort out good IRS notices from bad ones (not to mention the
legal versus the illegal), by substituting the
Legislature's judgment for FTB's. In the future, FTB may
wait for legislative cover before decoupling from federal
direction of questionable legality. The Legislature did
previously attempt to enact measures similar to this one
before FTB acted (ABx3 4, Laird, 2008), but the measures
failed passage, further muddying any direction from the
Legislature to FTB. The Committee may wish to consider
whether AB 11 hurts more than it helps.
E. Picking Favorites.
The Committee will also hear AB 692 (Calderon) at its
July 8, 2009 hearing. That measure has different findings
and also bolsters FTB's legal authority for declining to
conform to notices that conflict with state law or lack
sufficient legal authority.
Support and Opposition
Support:California School Employees Association,
California Tax Reform Association, American Federation of
State, County, and Municipal Employees, California Church
IMPACT
Oppose:None received.
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Consultant: Colin Grinnell