BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 1511 - DeLeon
Amended: July 15, 2010
Hearing: August 11, 2010 Tax Levy Fiscal: Yes
SUMMARY: Repeals Net Operating Loss Carrybacks; Suspends
Taxpayers Ability to Claim Net Operating Loss
Deductions for
the 2010 and 2011 Taxable Years, Delays Credit
Sharing; and
Delays and Makes Mandatory Elective Sales
Factor-Only
Apportionment of Income for Corporate Taxpayers
I. Net Operating Losses
EXISTING LAW provides that a net operating loss (NOL)
is incurred when a business taxpayer has negative taxable
income in a taxable year. In the past, taxpayers could
deduct income for the next ten taxable years by a
percentage of the past NOL, until the Legislature allowed
100% NOL deductions for 2004 taxable year and thereafter as
part of a measure that suspended taxpayers from applying
NOLs in the 2002 and 2003 taxable years (AB 2065, Oropeza,
2002). Until 2008, taxpayers could only apply NOLs as a
deduction against income realized in future taxable years,
called a "carry forward." However, in addition to
extending carry forwards from ten to 20 years, the
Legislature authorized NOL "carry backs" beginning in the
2011 taxable year, where taxpayers take losses from the
current year and use them as a deduction against past
income, receiving a refund for previous taxes paid (AB
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1452, Committee on Budget, 2008). AB 1452 provided for
two-year NOL carry backs according to the following
restrictions:
For NOLs generated in the 2011 taxable
year, taxpayers may carry back 50% of the loss to
the 2009 and 2010 taxable years.
For NOLs generated in the 2012 taxable
year, taxpayers may carry back 75% of the loss to
the 2010 and 2011 taxable years.
For NOLs generated in the 2013 taxable
year and thereafter, taxpayers may carry back
100% of the loss to the 2011 taxable year and
thereafter.
THIS BILL repeals the ability of taxpayers to use NOL
carrybacks for both personal income tax and corporation
taxpayers. The measure also suspends the ability of
taxpayers to apply NOLs in the 2010 and 2011 taxable years,
and extends the period of time taxpayers may apply those
losses to future taxable years to account for the two year
suspension. The bill also provides that five-year disaster
loss carrybacks recently enacted by Congress do not apply
for state purposes.
II. Tax Credit Assignment
EXISTING LAW allows a taxpayer to make an irrevocable
election to assign a corporation tax credit to an
affiliated corporation within its unitary group in any
taxable year on or after July 1, 2008, subject to specified
requirements (AB 1452, Committee on Budget, 2008).
THIS BILL repeals the ability of taxpayers to share
credits, and reinstates the ability effective in the 2012
taxable year in a new section of the Revenue and Taxation
Code.
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III. Sales Factor-Only Apportionment
EXISTING LAW determines the portion of a multi-state
or multi-national corporation's net income taxable by
California using "formulary apportionment," under which
three apportionment factors are computed: a property factor
(the amount of property the corporation has in California
divided by its total (nation-wide or world-wide property);
a payroll factor (California payroll divided by total
payroll); and a sales factor (California sales divided by
total sales). The actual amount of income apportioned to
California using this formula is computed by adding the
payroll factor, the property factor and twice the sales
factor, then dividing that sum by four (the so-called
"double-weighted sales factor"). The formula serves to
calculate a corporation's tax due in an amount that
approximates its demand on public services, assuming that
taxpayers derive profits from the effective marshalling of
labor and capital in the presence of a market. The
formula comes from the Universal Division of Tax Purposes
Act (UDITPA), a model statute developed by the National
Conference on Uniform State Laws in 1957. California
adopted UDITPA and the apportionment formula in 1966 (AB
11, Petris), and double weighted the sales factor in 1993
(SB 1176, Kopp). In California, all multi-state businesses
must apportion income according to the double-weighted
sales factor, except for trades or businesses that derive
more than 50% of its gross receipts from agriculture,
extractive business, savings and loans, or banks and
financial activities.
Notwithstanding the above, beginning in the 2011
taxable year, taxpayers may make an annual, irrevocable
election to determine its California apportionment by using
either the existing double-weighted sales factor or by
using only the sales factor, effective in the 2011 tax year
(ABx3 15 Krekorian, SBx3 15 Calderon).
THIS BILL repeals the ability of taxpayers to elect
sales-factor only apportionment of corporate business
income. The measure requires firms to apportion income
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using only the sales factor in the 2012 taxable year in a
new section of the Revenue and Taxation Code.
FISCAL EFFECT:
According to FTB, AB 1511 has the following revenue
effect:
---------------------------------------------------------------
| Estimated Revenue Impact of AB 1511 |
| |
| Enactment assumed after 6/30/2010 |
| |
| $ Millions |
| |
---------------------------------------------------------------
|---------------------------------+-------+------+------+------|
| |2010-11|2011-1|2012-1|2013-1|
| | | 2 | 3 | 4 |
| | | | | |
| | | | | |
| | | | | |
|---------------------------------+-------+------+------+------|
|Suspend Use of NOL Carryforwards |$1,500 | $400 |-$400 | -$44 |
|for 2010 and 2011, Repeal NOL | | | | |
|Carrybacks | | | | |
| | | | | |
|---------------------------------+-------+------+------+------|
|Repeal Elective Single Sales | $270 | $850 |$1,000| $850 |
|Factor. Adopt Mandatory Single | | | | |
|Sales Factor Apportionment | | | | |
|operative for tax years | | | | |
|beginning on or after 1/1/2012 | | | | |
| | | | | |
|---------------------------------+-------+------+------+------|
|Repeal Credit Sharing Provision. | $24 | $23 | -$3 | -$6 |
| Create new provision operative | | | | |
|for tax years beginning on or | | | | |
|after 1/1/2012 | | | | |
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| | | | | |
|---------------------------------+-------+------+------+------|
|Interaction between these | $44 | $72 | -$4 | -$1 |
|provisions | | | | |
| | | | | |
|---------------------------------+-------+------+------+------|
|Total Revenue Impact |$1,838 |$1,345|$593 |$799 |
| | | | | |
| | | | | |
--------------------------------------------------------------
COMMENTS:
A. Purpose of the Bill
According to the Author, "AB 1511 seeks to generate
$2.1 Billion in the current fiscal year, and upwards of
$1 Billion annually thereafter in desperately-needed tax
revenues, through the temporary suspension of corporate tax
reductions, the permanent repeal of a corporate tax break
that allows for Net Operating Loss (NOL) "carrybacks," and
the implementation of a mandatory single sales factor in
the calculation of corporate taxes owed to the state.
Extending the temporary suspension of NOL
carryforwards, delaying the assignment of tax credits, and
preventing NOL carrybacks and the elective Single Sales
Factor from taking effect in 2011, would provide a partial
solution to our ongoing state budget crisis in the current
fiscal year. The permanent tax reform proposals in this
legislation would raise revenues beginning on January 1,
2012.
On the issue of corporate tax apportionment, the trend
around the country is states moving towards the "single
sales factor" method for the calculations of taxes owed to
the state. However, in California's adoption of this
method last year, instead of adopting a mandatory single
sales factor like the vast majority of other
states-including Texas, New York, Michigan, Illinois,
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Oregon, and just last April, Washington state-our tax law
has an annual elective single sales factor.
Allowing corporations this yearly choice-whether to
use the single sales factor or long-standing three-factor
formula-creates a perverse incentive that actually rewards
out-of-state companies for continuing to base the bulk of
their payroll and property investments out-of-state.
In order to eliminate this competitive advantage and
level the playing field for California-based companies, we
need to make the single sales factor mandatory. This tax
proposal is about putting California first-we should be
encouraging job creation and greater investment here in our
home state, instead of rewarding out-of-state corporations.
According to the recent Legislative Analyst's Office (LAO)
report, Reconsidering the Optional Single Sales Factor
(2010), adoption of a mandatory single sales factor would
result in a net gain of about 40,000 jobs in California.
AB 1511 would also repeal one of the new tax breaks
enacted as part of the 2008 state budget-NOL carrybacks.
For the first time in California's history, starting in the
2011 tax year, corporations will be allowed to write-off
their losses to offset their income in the prior two tax
years.
This means that corporations will be allowed to amend
previous year's tax returns-thereby interjecting
substantial, unwanted volatility into our budget process
and costing our state millions of dollars. This is yet
another corporate tax break we simply cannot afford at this
time.
AB 1511 would prevent the loss of critically-needed
tax revenue as our state's economy rebounds, and as we try
to avoid deeper budget cuts to education and safety net
services.
B. Second Thoughts
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AB 1511 substantively changes two bills that
implemented tax changes from the last two State Budget
agreements: AB 1452 (Committee on Budget, 2008) and ABx3 15
(Krekorian, 2009)/SBx3 15 (Calderon, 2009). The two
measures represented the most significant changes in the
history of California corporation tax since its inception,
and were enacted as part of a series of bills that
implemented the State Budget and made several other changes
to other parts of law that reflected agreement among
legislative leaders and Governor Arnold Schwarzenegger.
Specifically, AB 1511 repeals AB 1452's provisions that
allow taxpayers to begin to carry back net operating losses
in the first two years, growing to 100% carrybacks in the
third year, and stalls taxpayers' current ability to share
tax credits within the unitary group until the 2012 tax
year. Additionally, this bill repeals elective single
sales factor apportionment, instead requiring firms to
apportion using only the sales factor beginning in 2012.
AB 1511 does not affect four changes to the Corporation Tax
Law also made by those bills regarding the sourcing of
intangible sales, changes to nexus standards, the
definition of gross receipts, and changes to throwback
rules. While the state's fiscal woes continue, and AB 1511
results in needed revenue to the state by delaying,
repealing, and altering controversial tax benefits, the
Committee may wish to consider to reverse these budget
agreements that were a result of considerable negotiation
and compromise.
C. Taking the Initiative
Proposition 24 on the November General Election
ballot, the "Repeal Corporate Tax Loopholes Act," repeals
the three tax benefits affected by AB 1511 by striking the
sections of law allowing the benefits, with some conforming
changes. The initiative also repeals taxpayers' ability to
carry forward net operating losses for twenty years,
reverting to the prior law's 10-year period. However,
because AB 1511 repeals the Revenue and Taxation Code
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sections allowing credit sharing and elective single sales
factor enacted by the Legislature, then adds credit sharing
and mandatory sales factor-only apportionment into two
different sections with later effective dates, the
Legislature would be reenacting or revising the benefits
repealed by the initiative should both the Legislature
enact AB 1511 and the voters approve Proposition 24.
Making AB 1511 law before the election would change the
impact of the voters decisions: taxpayers would enjoy the
benefits of credit sharing only a year later than they
normally would have, and would be required instead of
allowed to apportion income using only the sales factor
instead of reverting to the former three-factor double
weighted method, although enacting AB 1511 would repeal
provisions allowing NOL carry backs. The Committee may
wish to consider waiting for the voters to issue their
judgment prior to changing the tax benefits.
D. Do I Have a Choice?
In February 2009, California joined Missouri as the
only state in the nation to allow firms to annually elect
to apportion income according to the traditional
three-factor, double-weighted formula, or solely using the
sales factor. Elective single sales factor ensures that
almost all firms are winners; they can simply choose the
formula that works best for them, although some firms will
pay more than before because of the other four corporate
tax law changes embedded in the implementing legislation.
The author points to a Legislative Analyst's Office (LAO)
publication, "Reconsidering the Elective Single Sales
Factor" published in May 2010, which recommends that the
Legislature require sales factor-only apportionment. The
LAO states that optional formulas benefit firms without a
clear rationale, and allow taxpayers to switch formulas
annually to either minimize tax or generate significant
NOLs to apply against future tax liabilities. The LAO
states that mandatory single sales factor raises needed
revenue, puts California into conformity with other large
states that currently use mandatory single sales, thereby
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preventing California firms from being put at a
disadvantage to its out-of-state competitors. Opponents
counter that changing to mandatory single sales would not
just penalize out-of-state firms; the change would
negatively affect some California based firms with
specialized products that sell primarily to other
California based firms, producing a sales factor which
exceeds its property and payroll factors, resulting in an
increase in tax.
E. The Piggy Bank
In addition to repealing or delaying the controversial
tax benefits, AB 1511 also seeks to revoke a taxpayers'
ability to use NOLs in the 2010 and 2011 tax year.
California has twice before limited taxpayers' ability to
apply NOLs, first for the 2002 and 2003 tax years (AB 2065,
Oropeza, 2002), then again in AB 1452 for the 2008 and 2009
tax years. Unlike AB 2065, AB 1452's suspension did not
apply to businesses with less than $500,000 in gross
receipts or income. However in both cases, the Legislature
increased the value of the NOL for taxpayers in future
years in exchange for the short-term revenue resulting from
suspension. In AB 2065, the Legislature increased the
percentage of the NOL that taxpayers could carry forward
from 60% to 100% for taxable years after 2004, only two
years after it had increased the long-standing 50% to 55%
for the 2001 and 2002 taxable years, and 60% for taxable
years thereafter (AB 1774, Lempert, 2000). In AB 1452,
the Legislature allowed taxpayers to carry back the losses,
a provision which AB 1511 repeals. Should the Legislature
consider a similar counterweight to suspending NOLs for the
2010 and 2011, which would negatively affect many
businesses that have not been able to apply NOLs since the
2007 tax year, there are few additional benefits the state
could additionally grant, unless it fully conformed to the
federal five-year NOL carryback enacted by Congress earlier
this year, as called for by SB 1239 (Wyland), which is
currently on the Committee's suspense file.
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F. NOL Carrybacks
An NOL is incurred when a business taxpayer has negative
taxable income. An NOL can be used to obtain a refund for
taxes paid in the past and/or to reduce future tax
obligations. The process of using an NOL to refund
previously paid taxes is known as an NOL carryback, whereas
the process of using an NOL to reduce future taxes is known
as a carryforward. Under federal law, nearly every taxpayer
is allowed to carry back an NOL from a trade or business to
apply as a deduction against income in prior taxable years.
Generally, NOLs can be carried back to the two years
preceding the loss year and then forward to the 20 years
following the loss year. Recently, the federal carryback
period was extended from two to five years for specified
losses (as noted above.) The basic rationale for allowing
losses to be carried back flows from recognition that
businesses are established with the goal of making a profit
over a business cycle rather than in any particular year.
Economic theory demonstrates that a suitably long carryback
period for NOL deductions helps to smooth out income and
taxes paid over a business cycle, thereby allowing a
business to make efficient decisions regarding financing
and investment. A 2009 Congressional Research Service
(CRS) Report entitled Net Operating Losses: Proposed
Extension of Carryback Period, indicates that the majority
of the tax burden falls on risky investments. As a way of
easing this burden, NOLs are allowed to be carried back,
effectively creating a partnership between the taxpayer and
the government. This allows the government to share both
the return on investment (tax revenue) and the risk of
investment (revenue loss). A refund, as a means of sharing
investment risk, provides a firm with cash flow, which
helps pay for business expenses during tough economic
times. The ability to carryback an NOL is particularly
important for businesses that have historically generated
taxable income, but may currently be experiencing losses.
Additionally, an NOL carryback may provide for a cheap
source of funds in an economy with restrictive credit.
A recent Assembly Revenue and Taxation analysis points
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out that while there is strong justification for a
carryback provision as a method of averaging business
income over time and as a way of reducing investment risk,
there is disagreement over its ability to stimulate the
economy. In terms of economic stimulus, it is important to
understand the differences between the state and federal
governments. The federal government, unlike the state
government, is able to stimulate the economy because of its
ability to run deficits. Because of this, the federal
government is able to provide for a carryback deduction
without having to offset the cost. The state, on the other
hand, is required to fund a carryback deduction by
eliminating government spending in other areas. The
ability to run deficits allows the federal government to
maintain or increase spending, whereas the state government
simply shifts funds from one program to another.
Therefore, the stimulating effect that a carryback
provision would have at the federal level does not apply at
the state level.
It has been argued that a business benefits from state
programs, infrastructure, protection of property and other
activities that facilitate the operation of business, and
therefore, should compensate the government for services
rendered. Allowing NOLs to be carried forward and
backwards may be good tax policy, but should unprofitable
businesses be able to enjoy the services without
compensating the state for, at least a portion of, those
services? The sharp drop in state tax revenue has made it
difficult for California to fund the programs and services
needed for the operation of businesses. Therefore it may
be impossible for the state to maintain basic government
services while providing refunds to businesses.
F. Stay Tuned
The Budget Conference Committee's recent actions
affect many of the same tax benefits that AB 1511 seeks to
change:
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NOL suspension for 2 years (2010 and 2011).
Delay single sales factor for two years, beginning
in 2013, and retain the four changes to Corporation
Tax Law made by ABx3 15/SBx3 15.
Suspend credit sharing for two years (begins 2012).
Stall NOL Carrybacks for 2 years (start phase-in
2012)
Support and Opposition
Support:California Immigrant Policy Center
Oppose:None received.
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Consultant: Colin Grinnell