BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 692 - Calderon
Amended: May 4, 2009
Hearing: July 8, 2009 Fiscal: No
SUMMARY: Provides that IRS Notice 2008-83 Does Not Apply
for California Purposes; Allows FTB to Reject
Federal Direction Lacking Legal Authority or
Conflicting with State Law
EXISTING FEDERAL LAW provides for net operating
losses; 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.
AB 692 - Calderon
Page 4
California law conforms to this section as of January 1,
2005.
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 measure declares that IRS notice
2008-83 constitutes a substantive change not contemplated
at the time the Legislature conformed to the section. The
findings continue to state that the American Recovery and
Reinvestment Act made findings that limit the force,
effect, and legal authority of the notice, but because
taxpayers relied on the guidance, legislation is necessary
to clarify the proper application of the notice.
THIS BILL additionally provides that the state shall
conform to federal administrative guidance to the extent is
does not conflict with state law or regulations issued by
FTB, similar to IRS regulations. The measure specifies the
federal directions which constitute administrative
guidance, and states that direction outside that definition
does not constitute administrative guidance, and therefore
do not apply to state law. The bill states that conflict
with state law means any temporary or final federal
direction that constitutes a substantive change in federal
AB 692 - Calderon
Page 4
law or falls outside the scope of the U.S. Secretary of the
Treasury's authority.
FISCAL EFFECT:
According to FTB, AB 692 does not impact revenues or
costs.
COMMENTS:
A. Purpose of the Bill
According to the Author, "the purpose of this bill is
to ensure that, in the future, the Legislature's authority
to enact laws is not impinged by any federal notice or
guidance of doubtful legal authority and to protect
California's General Fund from losing revenue."
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
AB 692 - Calderon
Page 4
change in law made by the notice allowed Wells to deduct up
to $75 billion of Wachovia's losses. Additionally, should
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 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 after January 1, 20009, or
under such an 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 loss carrybacks
for 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 to essentially implement the
notice, banks will be able to apply losses from acquired
companies to reduce income for federal purposes, but not
for state purposes.
D. Why is AB 692 necessary?
FTB acted on December 4th, 2008 to direct staff to
AB 692 - Calderon
Page 4
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
692 necessary? The measure implies that FTB is unable to
sort out the good IRS notices from the bad one (not to
mention legal versus illegal), despite FTB's actions that
largely accomplished the purpose of this measure. While AB
692 states legislative intent that notice 2008-83 did not
and should not apply for California purposes, thereby
substituting legislative judgment for FTBs, the measure
does set forth a legal framework for FTB to reject future
notices of questionable authority or conformity with state
law. In this regard, AB 692's changes clarify FTB powers
and make it less likely for California to conform to rogue
notices.
E. Picking Favorites.
The Committee will also hear AB 11 (DeLeon) at its
July 8, 2009 hearing. That measure is very similar to AB
692 but lacks this measure's grant of authority to FTB to
not conform to IRS directions that conflict with state law
or are based on questionable legal authority.
AB 692 - Calderon
Page 4
Support:California School Employees Association,
California Tax Reform Association, American Federation of
State, County, and Municipal Employees, California Church
IMPACT
Oppose:None received
---------------------------------
Consultant: Colin Grinnell