BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 2671 - Cook
Amended: June 16, 2010
Hearing: June 23, 2010 Tax Levy Fiscal: yes
SUMMARY: Minimum Franchise Tax Exemption for Corporations
and Limited Liability Companies (LLCs) that are
Small Businesses Solely Owned by a Deployed
Member of the US Armed Forces
EXISTING LAW imposes an 8.84% franchise tax on the net
income (profits) of corporations for the privilege of
exercising the corporate franchise and doing business in
the state of California. For corporations with little or
no income from California operations, California imposes a
"minimum franchise tax" of $800, which is imposed each year
the corporation continues in existence, whether or not it
earns income. LLCs that are doing business in California,
registered or qualified to do business in California, or
formed in this state are subject to annual tax in an amount
equal to the minimum franchise tax.
THIS BILL exempts corporations and LLCs that are small
businesses solely owned by a deployed member of the United
States Armed Forces from the minimum franchise tax and the
annual LLC tax, respectively, if the corporation or LLC
ceases operation or operates at a loss. This bill requires
FTB to promulgate regulations to provide for a definition
of "ceases operation" for purposes of this bill.
THIS BILL provides the following definitions:
"Deployed" means being called to active duty or active
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service during a period when a Presidential Executive order
specifies that the United Sates in engaged in combat or
homeland defense. "Deployed" does not include temporary
duty for the sole purpose of training or processing or a
permanent change of station.
"Operates at a loss" means negative net income as defined
in Section 24341.
"Small business" means a corporation or LLC with total
income of two hundred fifty thousand dollars ($250,000) or
less.
THIS BILL would take effect immediately as a tax levy
and applies to taxable years beginning on or after January
1, 2010 and would sunset for taxable years beginning on or
after January 1, 2018.
FISCAL EFFECT: FTB staff estimates a negligible revenue
loss of less than $100,000 per tax year.
COMMENTS:
A. Purpose of the Bill
The author states, "The Franchise Tax Board's minimum
annual tax for all corporations, including S-corps,
C-corps, partnerships, and LLC's is set at $800 per fiscal
year. Regardless of the profitability of the business
entity, this annual tax is a "cost of doing business in
California" fee, no matter the circumstance. Present law
does not account for the unique situations that arise from
deployments of service members answering the call of duty
to country. Military service members on active or reserve
duty who are either major share holders of these business
entities, are self employed by the corporation but are
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deployed and cease to do business, or operate in the
negative during the span of their deployment, or any
combination thereof, are equally (and unfairly) required to
pay the $800 minimum franchise tax fee.
B. Background
The minimum franchise tax was enacted to ensure that
all corporations pay at least a minimum amount of franchise
tax for the privilege of doing business in this state,
regardless of the corporation's income or loss. Thus, the
minimum franchise tax is not technically an "income tax",
but rather it is a tax on the right to exercise the powers
granted to a corporation doing business in California.
Even when a corporation earns no income, it still receives
the benefits of its corporate status, including the limited
liability protection under the laws of this state.
California's minimum tax was increased from $100 to
$200 in 1972. It was increased to $300 in 1987, to $600 in
1989, and to $800 in 1990. Limited exceptions exist with
respect to imposition of the minimum franchise tax. For
instance, credit unions and nonprofit organizations are not
subject to the minimum franchise tax and a corporation is
not subject to the minimum franchise tax for its first
taxable year. However, even though a corporation is not
subject to the minimum tax in its first taxable year, it
will be subject to franchise tax in its first taxable year
based on its taxable income.
Limited partnerships and limited liability
partnerships that are doing business in California,
registered or qualified to do business in California, or
formed in this state are also subject to the $800 annual
tax. Like LLCs and S-corporations, these are
"pass-through" entities and are not subject to any tax
based on their taxable income. Rather, the items of
income, gain, loss, deduction and credit are passed-through
to the owners and reported on their respective income or
franchise tax returns. However, by definition,
partnerships cannot be "solely owned" small businesses and
subsequently are excluded from this bill.
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C. Treating Similar Taxpayers Differently
Generally, tax law applies equally to all taxpayers
regardless of a taxpayer's individual circumstances: a
soldier's income, business or nonbusiness, would be taxed
in the same way and according to the same laws that would
apply to subprime lenders. While the California
Constitution allows for specified property tax exemptions
for veterans and disabled veterans, and some benefits
specific benefits exist in the income tax world for members
of the military, AB 2671 provides a very specific tax
benefit for only one group of taxpayers, actively deployed
soldiers, that differs from the treatment any other
taxpayer would get. Soldiers put their lives on the line
to defend their county and advance its interest overseas;
however, they do so in exchange for a salary and in
performance of a contract signed when they were inducted
into the service. AB 2671 provides a benefit in
recognition to these brave men and women, but the Committee
may wish to consider the precedent of carving out one group
of worthy individuals who form their own businesses will be
subject to the same rules as everyone else.
D. Implementation, Technical, and Legal Concerns
FTB and committee staff recommends the following
amendments:
1. This bill would require the FTB to promulgate
regulations to define the term "ceases operation." The FTB
recommends the author change "shall" to "may" and provide
that the FTB may prescribe regulations as necessary or
appropriate to carry out the purposes of this selection,
including a definition for "ceases operation."
2. The bill's reference to "the limited liability company
operates at a loss" is technically incorrect because an LLC
that is not classified as a corporation would compute the
income or loss at the "owner" level and not at the LLC
"entity" level. The measure should be amended to correct
this problem.
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3. The bill limits the application of its provisions to a
small business with "total income of $250,000 or less."
"Total income "would include worldwide income earned from
within and outside of the state. The author may want to
include after "total income" the phrase "from all sources
derived from or attributable to the state" to limit the
threshold to California receipts in order to avoid possible
constitutional challenges in the future from using sources
outside of the state to determine a California limitation.
4. On page three, line fourteen, change "operation"" to
operates.
Support and Opposition
Support: None received
Oppose:None received.
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Consultant: Mary Beth Faulkner