BILL ANALYSIS
AB 1580
Page A
Date of Hearing: September 9, 2009
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Charles M. Calderon, Chair
AB 1580 (Calderon) - As Amended: September 1, 2009
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Taxation: federal conformity
SUMMARY : Changes California's specified date of conformity to
federal income tax law from January 1, 2005, to January 1, 2009,
and thereby, generally conforms to numerous changes made to
federal income tax law during that four-year period.
Specifically, this bill :
1)Conforms or partially conforms to, among other provisions,
the following federal provisions relating to the:
a) Federal tax treatment of certain disaster mitigation
payments. [The Disaster Mitigation Payments Act (Public
Law (P.L.) 109-7)].
b) Federal treatment of electric transmission property,
certain atmospheric pollution control facilities, nuclear
decommissioning cost, natural gas distribution lines,
natural gas gathering lines, and amortizable Internal
Revenue Code (IRC) Section 197 intangibles. [The Energy Tax
Incentives Act of 2005 (EITA) (P.L. 109-58)].
c) Effective date of exception from suspension rules for
certain listed and reportable transactions and tax
technical provisions of the GO Zone Act of 2005 (P.L.
109-135).
d) Modification of active business definition under IRC
Section 355, treatment of loans to qualified continuing
care facilities, distributions involving disqualified
investment companies, taxation of certain settlement funds,
capital gains treatment for certain self-created musical
works, amortization of expenses incurred in creating or
acquiring music or music copyrights, and the application of
earnings stripping rules to partners that are corporations.
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[The Tax Increase Prevention and Reconciliation Act of
2005 (P.L. 109-222) and the Tax Relief and Health Care Act
of 2006 (P.L. 109-432)].
e) Clarification of treatment of self-employment for
purposes of the limitation on state taxation of retirement
income. [The Clarification of Treatment of Self-Employment
for Purposes of the Limitation on State Taxation of
Retirement Income (P.L. 109-264)].
f) Reform of funding for self-employed defined benefit
pension plans, funding rules for multiemployer defined
benefit pension plans, and general reforms of charitable
contribution reporting. [The Pension Protection Act of
2006 (PPA) (P.L. 109-280)].
g) Inflation indexing of gross income limitations on
certain retirement savings incentives and allowance of
additional Individual Retirement Account (IRA) payments in
certain bankruptcy cases. (PPA, P.L. 109-280).
h) Waiver of the early withdrawal penalty for distributions
made from a governmental plan to a qualified public safety
employee and penalty-free withdrawals from retirement plans
for individuals called to active duty. (PPA, P.L.
109-280).
i) Frivolous tax submissions, sale of property by judicial
officers, and exclusion of gain from sale of principal
residence by certain employees of the intelligence
community. (PPA, P.L. 109-432).
j) Federal penalty on erroneous refund claims, modified to
provide an exemption for individuals with adjusted gross
income of less than $250,000 (in the case of a married
individual filing jointly or a surviving spouse), and
$125,000 in any other case. [The Small Business Work
Opportunity Act of 2007 (SBWOTA), P.L. 110-28, Section
8247].
aa) Federal extension of mortgage debt forgiveness until
January 1, 2013, modified to increase the state's
limitation on the amount that can be excluded from gross
income from $250,000 (or $125,000 in the case of a married
individual filing a separate return) to $500,000 (or
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$250,000 in the case of a married individual filing a
separate return). [The Mortgage Forgiveness Debt Relief
Act (MFDRA), P.L. 110-343, Division A, Title III, Section
303 and the Emergency Economic Stabilization Act of 2008
(EESA), P.L. 110-343)].
bb) Exclusion from income for benefits provided to Emergency
Medical Services volunteers and firefighters. (SBWOTA,
P.L. 110-28).
cc) Increase in age of minor children whose unearned income
is taxes as if it is parents' income. (SBWOTA, P.L.
110-28).
dd) Federal penalty on understatement of a taxpayer's
liability by a tax return preparer, in modified conformity,
to incorporate the federal rule that the penalty will be
the greater of a base amount ($250 for the first-tier
penalty and $5,000 for the second-tier penalty) or 50% of
the income derived (or to be derived) by the tax return
preparer. (EESA, P.L. 110-343, Division C, Title V,
Subtitle A, Section 506).
ee) Special rule encouraging contribution of capital gain
real property for conservation purposes, dedication of
endangered species recovery expenditures, depreciation
schedule for race horses, and information reporting for
commodity credit corporation transactions. (Heartland,
Habitat, Harvest, and Horticulture Act of 2008, P.L.
110-246).
ff) Special tax treatment of distributions, contributions,
exclusions, and disposition of amounts paid to, or made by,
individuals called to active duty, other service members,
and employees of the Intelligence Community. (The Heroes
Earnings Assistance and Relief Tax Act of 2008, P.L.
110-245).
gg) Various tax incentives related to the low-income housing
tax credit. (The Housing and Economic Recovery Act of
2008, P.L. 110-289).
hh) Special rules for tax treatment of executive
compensation of employers participating in the Troubled
Assets Relief Program, modified tax treatment of certain
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payments to controlling exempt organizations, and
charitable contributions of property. (EESA, P.L.
110-343).
ii) Treatment of certain reimbursements from governmental
plans for medical care and modification of penalty for
failure to file partnership and "S" corporation returns.
[The Worker, Retiree, and Employer Recovery Act of 2008,
P.L. 110-458].
2)Provides that the state shall not conform to certain federal
provisions, including, among others:
a) The seven-year recovery period for motor sports racing
track facilities. (EESA, P.L. 110-343, Division C, Title
III, Section 317).
b) The five-year recovery period for certain farming
business machinery and equipment. (EESA, P.L. 110-343,
Division C, Title V, Section 505).
c) The enhanced charitable deductions for contributions of
food inventory. (EESA, P.L. 110-343, Division C, Title
III, Section 323).
d) The enhanced charitable deductions for contributions of
book inventory. (EESA, P.L. 110-343, Division C, Title
III, Section 324).
e) The federal changes made to the determination of a small
refiner for purposes of the depletion deduction. (EITA,
P.L. 109-58, Section 1328).
3)Corrects erroneous cross-references and contains double
jointing language to avoid chaptering out problems with AB 692
(Charles Calderon), of the current legislative session, which
passed both the Assembly and the Senate, and SB 401 (Wolk),
which is pending in the Assembly.
4)Takes effect immediately as a tax levy.
EXISTING LAW conforms the state's tax code, in many instances,
to provisions contained in the federal IRC. California does not
automatically conform to new federal legislation. Rather,
California may conform to specific enactments at the federal
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level or may conform to the IRC as of a specified date. The
last IRC to which California conformed was that in effect as of
January 1, 2005.
FISCAL EFFECT : According to the Franchise Tax Board (FTB)
staff, AB 1580 has the below revenue effect:
-------------------------------------------------------------------
| Summary Revenue Estimates for AB 1580 As Updated August 18, 2009 |
|-------------------------------------------------------------------|
| Assumed Enactment After June 30, 2009 |
-------------------------------------------------------------------
|----------------------------+--------+---------+---------+---------|
|Conformity Provisions |2008-09 | 2009-10 | 2010-11 | 2011-12 |
|----------------------------+--------+---------+---------+---------|
|Tax Revenue Totals | |-$9,528,0|-$4,654,0|-$633,000|
| | | 00 | 00 | |
-------------------------------------------------------------------
|Penalty and Interest Totals |$2,600,0|$14,100,0|$17,650,0|$21,500,0|
| | 00 | 00 | 00 | 00 |
|----------------------------+--------+---------+---------+---------|
| Totals of |$2,600,0|$4,572,00|$12,996,0|$20,867,0|
|Conformity Provisions | 00 | 0 | 00 |00 |
-------------------------------------------------------------------
COMMENTS :
1)According to the author's office, the purpose of this bill is
to conform to numerous changes in federal law to simplify the
preparation of California income tax returns and to reduce
taxpayers' compliance costs. AB 1580 is a comprehensive
federal tax conformity bill that incorporates various items
form 17 federal tax acts enacted since the last California
conformity date of January 1, 2005. This bill is a "good
government" measure and represents the Legislature's most
recent attempt to simplify the tax code for both taxpayers and
practitioners by narrowing the gap between the federal and
state tax laws. Last year, the conformity bill, AB 1561
(Charles Calderon), resulted in an increase in state taxes and
failed on the Senate Floor.
2)The importance (and conundrum) of conformity . When changes
are made to the federal income tax law, California does not
automatically adopt such provisions. Instead, state
legislation is needed to conform to most of those changes.
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Conformity legislation is introduced either as individual tax
bills to conform to specific federal changes or as one omnibus
bill to conform to the federal law as of a certain date with
specified exceptions, a so-called "conformity" bill.
The last California-federal conformity bill was enacted in 2005
[AB 115 (Klehs), Chapter 691, Statutes of 2005], and for the
last three years, businesses, tax practitioners and state tax
agencies have been advocating for a new bill to conform state
tax laws to ever-changing federal tax laws. Businesses,
generally, prefer conformity to federal tax laws because it
reduces their state tax compliance costs. The tax
practitioners have argued that there are significant costs
associated with federal non-conformity. As stated in the
support letter from Spidell Publishing, Inc., "[s]ome
California taxpayers avoid the compliance burden created by
nonconformity by simply following federal law when completing
their California tax returns? Some taxpayers are [unaware] of
the state and federal differences and unknowingly complete
their tax returns incorrectly." Failure to conform to federal
law in some areas may lead to improper tax reporting to
California and extra costs to the taxpayers. As an example, a
taxpayer may roll-over balances in an Archer Medical Savings
Account to a new Health Savings Account without triggering
liability at the federal level, but will unknowingly face
penalties for the transfer since it constitutes a disqualified
distribution for state purposes. Finally, conformity
legislation is also important to state agencies. Conformity
eases the burden, and reduces the costs, of tax administration
because the state may rely on federal audits, federal case
law, and regulations.
While state conformity to federal income tax provisions offers
certain advantages and reduces tax compliance costs, it can
also significantly impact state revenues. Thus, it would be
difficult to achieve complete conformity with federal income
tax rules. Often, the Legislature needs to increase tax rates
to find funding to adopt a new or expand an existing credit or
deduction allowed for federal income tax purposes. Tax
credits, deductions, and exemptions are designed to provide
incentives for taxpayers that incur certain expenses or to
influence behavior, including business practices and
decisions. Both the Federal and state governments often use
tax policy to influence taxpayers' behavior. However, federal
tax incentives may not necessarily produce the same effect on
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the taxpayer's behavior at the state level, if adopted by the
state government, as they do on the federal level.
Furthermore, unlike the Federal government, California cannot
print money to subsidize its budget. Therefore, the
Legislature must be mindful of fiscal effects of conforming to
federal tax laws, even if those may not trigger significant
fiscal concerns in Congress.
Last year, the conformity bill, AB 1561, required a 2/3 vote of
the membership in each house and the measure did not advance
from the Senate Floor because it failed to secure 27 Senate
votes. AB 1580 is the most recent attempt to ease the
hardship on taxpayers and tax practitioners by bringing the
two tax codes closer together.
3)Mortgage Debt Forgiveness . Last year, the Legislature
approved SB 1055 (Machado), which provided modified conformity
to the MFDRA for discharge of mortgage indebtedness in the
2007 and 2008 tax years. This year, Senate Revenue and
Taxation Committee held SB 97 (Calderon), which extended
modified conformity to discharge of mortgage indebtedness in
the 2009 and 2010 tax years. This Committee held AB 111
(Niello), which provided full conformity to MFDRA. AB 1580
provides homeowners greater assistance not only by extending
the mortgage debt forgiveness provisions until January 1,
2013, but also by increasing the amount of forgiven mortgage
indebtedness excludable from taxpayer's gross income from
$250,000 ($125,000 in the case of a married individual filing
a separate return) to $500,000 ($250,000 in case of a married
individual filing a separate return). Conformity to federal
mortgage debt is reasonably inexpensive and affects
individuals who likely must leave their homes with no cash or
no equity, or both.
4)Waiver of the early withdrawal penalty for public safety
employees. Existing federal tax law imposes a 10% withdrawal
penalty tax on early distributions made from a qualified
retirement plan to a taxpayer under the age of 59 , unless
an exception applies. For distributions made after August 17,
2006, Section 882 of the PPA of 2006 amended IRC Section 72(t)
to provide an exception from the 10% penalty for distributions
from a governmental defined benefit pension plan to a
qualified public safety employee who separates from service
after the age of 50. The exception applies to distributions
made to public safety employees after December 31, 2006.
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Existing federal law also provides tax relief from the penalty
to public safety officers who use distributions received from
governmental plans to pay for health and long-term care
insurance for himself/herself or his/her spouse or dependents
(IRC Section 402, as amended by Section 845 of the PPA).
This exception from the 10% penalty tax applies to
distributions made after December 31, 2006.
Existing state law conforms to federal law, as of January 1,
2005, with respect to taxation of qualified retirement plans,
except that California imposes the early withdrawal penalty at
2 %, rather than 10%. This bill provides partial
conformity to federal tax laws by allowing relief from the 2
% penalty for early distributions made to public safety
employees. Due to the nature of their jobs, public safety
employees often retire early, well before age 59 . However,
those retired employees are unable to access all of their
retirement funds without paying the penalty under California
law.
While some federal law changes relating to qualification of
federal plans are automatically incorporated into California
tax laws, specific state legislation in other areas is
required for federal law enacted after the last conformity
date to apply for California tax purposes. Thus, existing
state law provides that federal changes to Part I of
Subchapter D of Chapter 1 of IRC Sections 401 through 420,
inclusive, relating to pension, profit-sharing, stock bonus
plans, other employee benefit plans, and IRC Section 457,
relating to deferred compensation plans of state and local
governments and tax-exempt organizations, automatically apply
without regard to taxable years to the same extent as
applicable for federal income tax purposes. All federal
changes made to those IRC sections are automatically adopted
by California without regard to the specified date.
Therefore, as of December 31, 2006, California automatically
conformed to the PPA changes to IRC Section 402 relating to
employee benefits plans and already allows public safety
officers to use up to $3,000 of distributions from
governmental plans to pay for qualified health insurance
premiums or qualified long-term care insurance contracts. In
addition, California also conforms to the PPA provision
providing an exclusion from gross income for distributions
from eligible governmental plans to be used to pay qualified
health insurance premiums and long-care costs and, therefore,
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no state legislation is needed to conform to that provision.
5)Erroneous Refund Penalty . Recently, Congress decided that on
and after May 25, 2007, taxpayers filing an erroneous claim
for refund should face a penalty equal to 20% of the
disallowed amount of the claim, unless the taxpayer shows a
reasonable basis for the refund. The penalty does not apply
to any part of the disallowed amount of the claim that relates
to the earned income credit or on which the accuracy-related
or fraud penalties are charged. The purpose of penalties is
to encourage voluntary compliance. Taxpayers often take
aggressive tax positions, and with taxpayers petitioning FTB
for hundreds of millions of dollars in refund claims each
year, failing to conform to the erroneous refund penalty may
encourage California taxpayers to continue to make tenuous
refund claims, especially, since the Internal Revenue Service
(IRS) and many other states apply the penalty.
When Congress was debating whether or not to enact the erroneous
refund penalty, the Treasury Assistant Secretary for Tax
Policy, Eric Solomon was asked to testify regarding the
penalty before the Senate Finance Committee on Ways to Reduce
the Tax Gap in 2007. In his testimony, he explained that,
under current law, the accuracy-related penalty that a
taxpayer might pay, generally, depends on the amount of
underpayment of tax. If a taxpayer wrongfully claims a
refund, however, there is no penalty as long as no additional
tax liability is attributable to the wrongful claim, as often
happens when there has been over withholding. Mr. Solomon
stated that "the IRS has observed aggressive behavior that is
undeterred by the tax code's current accuracy-related penalty
framework, which is geared toward deterrence of reported tax
deficiencies. As a practical matter, some taxpayers and their
advisors may be taking advantage of the existing penalty
structure by aggressively claiming credits that generate
refunds, in an effectively risk-free gamble." To address this
problem, the IRS suggested an imposition of a penalty on an
unreasonable claim for refund or credit. As emphasized by Mr.
Solomon, the erroneous refund penalty creates "a parallel
system of deterrence applicable even if the taxpayer is in a
refund, rather than a deficiency, procedural posture, thus
stemming the tide of aggressive claims that are made without
reasonable basis or reasonable cause, regardless of the
procedural context." ("Testimony of Treasury Assistant
Secretary for Tax Policy, Eric Solomon, Before the Senate
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Finance Committee on Ways to Reduce the Tax Gap",
http://www.treas.gov/press/releases/hp360.htm ).
AB 1580 seeks to implement a similar penalty to deter taxpayers
from filing aggressive claims for refund. Opponents of the
erroneous refund penalty, however, assert that the terms of
the penalty, such as "reasonable basis" and "excessive amount"
are undefined, that the penalty disproportionately punishes
taxpayers compared to the amount of noncompliance, and that no
reasonable cause exception exists, among other arguments. To
alleviate the burden of this penalty on individuals, who,
generally, are not sophisticated in complicated tax matters,
AB 1580 provides an exemption for the vast majority of
individuals. Thus, individuals with adjusted gross income of
less than $250,000 (in the case of married filing jointly
taxpayers) or $250,000 (in any other case) are not subject to
the erroneous refund penalty under this bill.
6)"Kiddie" Tax . AB 1580 would conform to federal law by
increasing the age of minor children for purposes of the
"kiddie" tax. This tax requires unearned income (e.g.,
interest, dividends, etc.) of children under a specified age
to be taxed at the parents' tax rate. The federal law was
initially introduced to address certain practices whereby
wealthy taxpayers would transfer assets like stocks or bonds
to their children, who usually paid tax at a lower rate. In
2005, the federal law was changed to apply to children under
the age of 18, and in 2007, those rules were changed again to
apply to dependent children under the age of 24.
7)Inflation-indexing of gross income limitations on retirement
savings incentives . For taxable years beginning on or after
January 1, 2007, the PPA indexes the income limits for
Individual Retirement Account (IRA) contributions beginning in
2007. The indexing applies to the income limits for
deductible contributions for active participants in an
employer-sponsored plan,<1> the income limits for deductible
contributions if the individual is not an active participant
but the individual's spouse is, and the income limits for Roth
IRA contributions. Indexed amounts are rounded to the nearest
multiple of $1,000. AB 1580 would conform the Personal Income
---------------------------
<1> Under the PPA, for 2007, the lower end of the income phase
out for active participants filing a joint return is $80,000, as
adjusted to reflect inflation.
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Tax Law to those provisions.
REGISTERED SUPPORT / OPPOSITION :
Support
Spidell's Publishing, Inc.
Opposition
California Taxpayer's Association
California Bankers Association
California Chamber of Commerce
California Manufacturers and Technology Association
TechAmerica
Western States Petroleum Association
Analysis Prepared by : M. David Ruff and Oksana G. Jaffe / REV.
& TAX. / (916) 319-2098