BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 16 - Lowenthal
Amended: January 8, 2009
Urgency
Hearing: February 4, 2009 Tax Levy Fiscal: Yes
SUMMARY: Makes the Low-Income Housing Tax Credit (LIHTC)
Refundable; Disconnects of Federal Partnership
Rules for LIHTCs awarded in 2008
EXISTING LAW allows state tax credits against the
gross premiums tax, personal income tax, and corporation
tax for low-income housing constructed in California, known
as Low-Income Housing Tax Credit (LIHTCs or "lee-teks").
Credits are computed in modified conformity with similar
credits authorized by federal law, and allocated to
low-income housing developers by the California Tax Credit
Allocation Committee (CTCAC) according to specified
criteria up to a cap set in statute ($85 million in 2009).
CTCAC is comprised of the State Treasurer, the State
Controller, and the Director of Finance. Three non-voting
members also sit on CTCAC.
EXISTING LAW provides that individual credit amounts
are based on when the housing was built, and whether it was
federally subsidized or at risk of conversion. The
taxpayer can also receive cash distributions from the
project operations. Projects constructed using these
credits are rent-restricted and must be occupied by a
certain percentage of low-income occupants.
SB 16 - Lowenthal
Page 7
I. Refundable LIHTCs
EXISTING LAW allows taxpayers a non-refundable LIHTC
and a four-year carry-forward period, as opposed to ten
years for the federal LIHTC.
EXISTING LAW establishes the Tax Relief and Refunds
Account, which is continuously appropriated, and is used to
make payments to taxpayers.
THIS BILL provides that taxpayers who receive a
preliminary reservation for LIHTCs on or after July 1, 2008
and before January 1, 2010 may receive a refund in the
amount of the credit after offsetting any tax liability,
penalties, interest, and fees, making the credit
refundable. The bill requires the Tax Relief and Refund
account to make payments to taxpayers. LIHTCs are not
refundable for projects in which "final closing" occurs
between July 1, 2008 and December 31, 2008, and defines
"final closing" as the date the deeds of trust for all
construction financing have been recorded, or in the case
of no construction lender is involved, the equity partner
has been admitted to the ownership entity. The measure
amends both the personal income tax and corporation tax
laws which authorize LIHTCs.
II. Retroactive Disconnection of Federal Partnership Rules
EXISTING FEDERAL LAW requires partnership agreements
to allocate income, gains, losses, deductions, or credits
in accordance with the partner's interest in the
partnership if the agreement does not provide as to the
partner's distributive share or the allocation does not
have substantial economic effect. Tax experts generally
interpret this provision to mean that a partner may only
receive a tax credit based on his or her ability of a
partner to depreciate the building.
EXISTING LAW disconnects these federal partnership
SB 16 - Lowenthal
Page 7
rules to allow partnership agreements to allocate state
LIHTCs to partners regardless of the manner in which the
partnership agreement awards federal LIHTCs (SB 585,
Lowenthal, 2008). Effective for credits approved by CTCAC
on or after January 1, 2009, SB 585 allowed investors to
offset state tax incurred as a result of other economic
activity in exchange for the low income housing project
capital, thereby increasing the attractiveness of
low-income housing project investments to investors with
state tax liability but little to no federal liability.
This provision allows for partnership allocations of
credits normally precluded by federal law, which generally
provides that a tax credit in a partnership agreement would
be allowed only for the partner who has depreciation rights
to the building. Additionally, an LIHTC investor receives
a double benefit when he or she leaves the partnership with
negative basis in the investment, providing another offset
to other capital gains, although SB 585 required that the
capital loss be deferred until the tax year after the
federal credit expires when partnership agreement allocate
tax credits in violation of federal partnership rules,
delaying the double-benefit for ten years.
THIS BILL provides that partnership agreements may
allocate state LIHTCs to partners regardless of whether the
allocation has substantial economic effect for LIHTCs
allocated during the 2008 calendar year. The measure also
defers a partner's capital loss until the tax year after
the federal credit expires when partnership agreement
allocate tax credits in such a manner. The bill does not
allow similar treatment for any project for which final
closing has occurred before the bill's effective date
(which due to the bill's urgency clause, could be before
January 1, 2010). The measure amends sections of the Gross
Premiums Tax, Personal Income Tax, and Corporation Tax
which authorize the LIHTC.
FISCAL EFFECT:
According to FTB, SB 16 results in revenue losses to
the general fund of $0.2 million in 2011-12, $1.8 million
SB 16 - Lowenthal
Page 7
in 2012-13, and $6.2 million in 2013-14 due to accelerated
foregone revenues attributable to making the LIHTC
refundable; however, these losses are offset by reductions
in future losses incurred when taxpayers carry forward
nonrefundable credits, resulting in no revenue loss over
eight years. FTB does identify a one-time cost of $521,000
to implement the measure.
COMMENTS:
A. Purpose of the Bill
According to the Author, "Low-income housing tax
credits are the primary source of capital to construct
affordable housing. In the past, banks and insurance
companies have been the major investors in low-income
housing tax credits, but as their profits and tax
liabilities have disappeared in the current economic
meltdown, so have their investments. Essentially, the
market for tax credits has crashed. This means that where
investors can be found at all, the tax credit pricing (the
level of investor contribution per dollar of tax credit)
has dropped dramatically, causing large gaps in project
funding. Shovel-ready affordable housing projects are
falling apart or are required to seek large amounts of
additional funding from state and local sources, where they
exist. Lower pricing from investors also means that the
state is getting much less public benefit per dollar of
state tax expenditure.
SB 16 will bring equity investors back in to the tax
credit market by making state credits awarded in late 2008,
2009, and 2010 refundable. This will attract investors
because they can take advantage of the credits regardless
of their tax liability. Increased competition among
investors will raise the pricing for tax credits and result
in millions of dollars in additional private equity
investment for the exact same amount of state tax
expenditure. This bill provides a short-term fix to
reflect the reality of the current economic crisis.
While there are some one-time implementation costs,
this bill is essentially revenue neutral. Under current
SB 16 - Lowenthal
Page 7
law, some of the credits are being used now (albeit for a
much lower price), and those that cannot be used now roll
over and will be re-awarded by TCAC in future years.
Either way, all of the credits will be fully claimed. By
ensuring that the credits can be used now, SB 16 changes
the timing of tax credit claims but not the overall amount
of revenue loss.
In summary, SB 16 provides an economic stimulus by
keeping shovel-ready projects on track, increases the
efficiency and public benefit of the program by attracting
additional private equity for each dollar of state tax
expenditure, and doesn't ultimately affect the general
fund. "
B. A Different Kind of Tax Credit
Low-Income housing projects face many barriers in
California: high costs of land, labor, and capitol; other
investments that provide better returns; NIMBYism (Not In
My Back Yard); and state and local laws and policies
protecting the environment, to name a few. To address this
problem, lawmakers at the federal and state level crafted
the LIHTC, which functions differently from any other tax
credit due to the unique nature of the problem: a shortfall
of housing for individuals and families of moderate and low
incomes.
The LIHTC stands in stark contrast to other tax
credits, where a certain class of individuals or businesses
may claim a credit based on membership in a certain
industry or business location, functioning more like a
grant program than a typical tax credit. Because the
credit is capped and allocated, CTCAC awards tax credits to
projects on a competitive process based on an evaluation of
the most effective use of the tax credits. Investors
design projects in response to CTCAC's specified criteria
when seeking a tax credit, then CTCAC decides whether the
project proposals meet those standards, and allocates the
credit accordingly.
SB 16 - Lowenthal
Page 7
Currently, housing sponsors, often non-profit
organizations, form partnership agreements with investors,
who provide capital to fund the housing construction in
exchange for the allocated tax credits. First, the
developer designs a project based on CTCAC's criteria, then
applies to CTCAC for the credit. If the application is
successful, CTCAC awards the taxpayer a reservation for the
credit. The taxpayer then forms partnership agreements
with private investors, who provide project capital so the
taxpayer can construct the housing project in exchange for
discounted tax credits.
SB 585 enhanced the value of state tax credits by
allowing investors to enter partnership agreements where
they can purchase state tax credits without the
corresponding federal credits. Under SB 585, investors
with no federal tax liability, but sufficient state tax
liability have an incentive to invest in a low-income
housing project, setting up a sanctioned tax shelter that
allows taxpayers to offset unrelated state income tax
liability with LIHTCs. For example, a partnership
agreement may give tax credits to an investor to provide
99% of the necessary project funding, in exchange for
possibly a much smaller ownership share in the project; the
value of the tax credits to offset income from another
source is sufficient to draw interest from the investor.
With SB 585, the Legislature determined that the benefits
of increased project capital exceeded the tax policy
concerns of sanctioning a state tax shelter. SB 16 extends
this treatment for credits CTCAC allocated last year, but
not yet used in a housing project, thereby enhancing the
value of the credits to possible future investors.
C. Collateral Damage
The country and the world are facing the largest
financial and economic crisis since the global economy
developed. The U.S. has lost $13 trillion in household
wealth in little more than a year, the balance sheets of
the world's largest businesses compress by the day, and 30%
SB 16 - Lowenthal
Page 7
of the nation's manufacturing capacity sits idle, among
other measures. Not surprisingly, the global economic
crisis has reduced demand in tax credits for low-income
housing, as investors have both less capital to invest in a
project, and less profits to offset with LIHTCs. According
to a recent article in the San Diego Union Tribune, the
Wakeland Housing and Development Corporation, a San Diego
County nonprofit, stalled 26 projects accounting for more
than 2,000 units due to a lack of investor interest in the
credit. The article stated that the lack of interest in
the credit stalled 32,000 units statewide, and that the
Federal National Mortgage Association (FNMA or "Fannie
Mae") and the Federal Home Loan Mortgage Corporation (FHLMC
or "Freddie Mac") were larger purchasers of LIHTCs, but
have now pulled out, leading to a nationwide decline in
tax-credit investment from $9 billion in 2007 to $4.5
billion last year. Developers state that LIHTCs are the
primary reason that low-income housing is built in
California
While construction project delays and interruptions
due to a lack of capital are now much more common in both
the public and private sector, proponents of SB 16 state
that the measure will help invigorate LIHTC investment in
three ways. First, disconnecting federal partnership rules
for credits assigned by CTCAC but not yet awarded as part
of a partnership agreement, and allowing refundable LIHTCs
may increase the pool of investors that can provide project
capital. Second, non-profit developers may take the
refundable state credit themselves, and receive direct
funds (or borrow against the credit) to build more
projects. Lastly, if the non-profit takes the state
credit, then the federal credit that may be marketed to
investors increases in value because the investor receiving
the credit need not deduct less taxes paid on his or her
federal tax return, thereby increasing the value of the
credit (applying the state credit to reduce state tax
reduces the deduction against federal income for state
taxes paid; proponents state that this inherent interaction
between state and federal tax credits diminishes the value
of state LIHTCs to approximately $0.65 of value for each $1
in credit).
SB 16 - Lowenthal
Page 7
Given the economic turmoil across the globe, how much
difference can SB 16 make? Capital scarcity infects
markets for almost every investment vehicle, and government
interventions in other markets have not yet yielded
demonstrable success, meaning that any benefits of SB 16
may be overwhelmed by larger forces. In its defense, SB 16
only applies for CTCAC allocation for 2008, 2009, 2010, so
the Legislature would have to reauthorize its provisions
for tax credits awarded in 2011 and after, at which time it
may consider whether the measure's provisions increased
demand for LIHTCs. If SB 16 does not help draw additional
investment, the Legislature can let its provisions expire
after 2010.
D. Refundable versus Non-Refundable Credits
In tax law, tax credits are either non-refundable,
where the taxpayer may reduce tax liability only to zero,
and can usually carry forward the value of the credit for a
certain number of years to offset future tax liability, or,
refundable, which requires the state to refund the
remaining value of the credit after tax due is reduced to
zero. Currently, California has only one refundable
credit: the Child and Dependent Care Expense Credit. The
most notable refundable credit, the renter's credit,
existed in the past as refundable and is now
non-refundable. Non-refundable credits rarely help
lower-income taxpayers because they pay little to no tax to
offset the value of the credit. The more income (and
therefore tax due) a taxpayer has, the more a taxpayer can
make use of non-refundable credits. Legislatively,
refundable credits must be approved by a 2/3 vote of each
house of the Legislature because they are appropriations,
whereas nonrefundable credits may be enacted by a majority
vote.
Because refundable credits often result in direct
checks from the government, some individuals and
organizations believe that they invite fraud. The IRS has
SB 16 - Lowenthal
Page 7
long battled fraudulent claims for the federal Earned
Income Tax Credit, and LAO reported fraud concerns and
suggested reporting requirements for the Child and
Dependent Care Expense Credit as recently as 2006.
However, proponents contend that the state LIHTC is not
prone to fraud because of oversight by CTCAC, and the
requirement that credits cannot be claimed until the
building is placed in service, so that any marginal
increase in fraud concerns resulting from converting the
credit to refundable is misplaced.
Proponents hope that refundable credits address the
slide in investor interest in LIHTCs. Taxpayers receiving
refundable credits may claim the credit themselves and
receive a refund (even if organized as a non-profit), or
market the credit to investors with the added incentive of
allowing the investor to receive a refund of the credit's
value if he or she cannot offset other liability. Usually,
the investor would have to apply the credit to reduce tax
liability over the following four years, but under SB 16,
the investor can receive a refund in the first year in
which he or she uses the credit. Fiscally, the state will
incur losses earlier as the state pays refunds, but will
lose less future revenue as those taxpayers will no longer
carry over credits to reduce future liabilities.
E. FTB Suggested Amendments
FTB raises the following concerns, and provides
amendments the Committee may wish to consider to address
those concerns:
1. This bill is silent regarding whether this
refundable business tax credit could be assigned.
Beginning on or after July 1, 2008, a taxpayer that is
a member of combined reporting group can assign
business tax credits to taxpayers within that group.
Assigned credits can only be applied to reduce a tax
liability in taxable years beginning on or after
January 1, 2010. Consequently, under existing law any
SB 16 - Lowenthal
Page 7
assigned refundable credit would not be refundable
until taxable years beginning on or after January 1,
2010. The absence of clarity could lead to disputes
with taxpayers and would complicate the administration
of this credit. Additionally, FTB asked for the bill
to clarify that refund amounts are not income for
state tax purposes:
On page 4, after line 16, insert: "(c)
Any credit refunded to a taxpayer pursuant to
this section shall not be included in income
subject to tax under this part or Part 10
(commencing with Section 17001)."
On page 5, at the end of line 31, insert:
"Notwithstanding any other law to the contrary,
any amount refundable under this section may not
be carried over under subdivision (l) of section
23610.5."
On page 6, after line 5, insert: "(c)
Notwithstanding any other law to the contrary,
credits for a project referred to in paragraph
(1) of subdivision (a) may not be assigned
pursuant to Section 23633.
(d) Any credit refunded to a taxpayer pursuant to
this section shall not be included in income
subject to tax under this part or Part 11
(commencing with Section 23001)."
1. This bill could be interpreted to allow any unused
LIHC to be refunded and carried forward. Because this
bill is making the LIHC refundable, any unused credit
would be refunded to the taxpayer in the same taxable
year the credit is claimed. To prevent this
interpretation, the author may wish to amend the bill
to prevent this result and eliminate ambiguity.
On Page 4, end of line 2, on Page 5, end
of line 31, and on page 6, between lines five and
six, insert: "Notwithstanding any other law to
the contrary, any amount refundable under this
SB 16 - Lowenthal
Page 7
section may not be carried over under subdivision
(l) of section 17058."
1. FTB suggests the following technical amendments:
To eliminate a potentially troublesome
definition, on page 2, line 26 strike "For
purposes" and strike lines 27-30; on page 3, line
26 strike "For purposes" and strike lines 27-30;
on page 4, line 12 strike "For purposes" and
strike lines 13-16; on page 6, line 1 strike "For
purposes" and strike lines 2-5; and on page 6,
line 31 strike "For purposes" and strike lines
32-35.
Insert ", as determined by the Tax Credit
Allocation Committee," after "occurred" on page
2, line 25, page 3, line 25, page 4, line 11,
and Page 6, line 30.
Support and Opposition
Support: Housing California, Mid-Peninsula Housing
Corporation; The Pacific
Companies; Self-Help Enterprises; California Coalition for
Rural Housing; Mercy Housing California; Napa Valley
Community Housing; Non-Profit Housing Association of
Northern California; California Alliance for Retired
Americans; Central Coast Residential
Builders; Cabrillo Economic Development Corporation; San
Luis Obispo County Housing Trust Fund; Housing California;
California Rural Legal Assistance Foundation;
Western Center on Law and
Poverty; Burbank Housing Development Corporation Charis
Youth Center
Oppose: California Taxpayers' Association;
California Housing Consortium
SB 16 - Lowenthal
Page 7
---------------------------------
Consultant: Colin Grinnell
February 2, 2009