BILL ANALYSIS
SB 401
Page A
Date of Hearing: April 6, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
SB 401 (Wolk) - As Amended: April 5, 2010
REVISED
SENATE VOTE : Vote not relevant
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 Gulf Opportunity 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
SB 401
Page B
earnings stripping rules to partners that are corporations.
[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) Modified treatment of certain charitable contributions
and reporting by exempt organizations. (PPA, P. L.
109-280).
j) 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).
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/RDP filing a separate return) to $500,000 (or
$250,000 in the case of a married individual/RDP filing a
separate return). [The Mortgage Forgiveness Debt Relief
Act (MFDRA), P.L. 110-343, Division A, Title III, Section
SB 401
Page C
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 taxed 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
payments to controlling exempt organizations, and
charitable contributions of property. (EESA, P.L.
110-343).
SB 401
Page D
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].
jj) Exclusion from gross income for energy property grants
provided to a taxpayer by the Secretary of Treasury for
qualified property placed in service during either 2009 or
2010 year.
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)Takes effect on or after January 1, 2011.
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
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.
SB 401
Page E
FISCAL EFFECT : Unknown.
COMMENTS :
1)Author's Statement . According to the author's office, "SB 401
is a vital measure conforming state tax law to federal tax,
and includes provisions that provide needed relief to
struggling homeowners, ensure that renewable energy projects
are not unduly taxed on federal grants, and provides needed
conformity to federal tax law, easing tax preparation for
taxpayers and tax preparers alike. This measure works to
prevent onerous taxation of distressed Californians who are
already struggling to protect their homes, their largest
investment, as many Californians face foreclosure and are
forced to walk away from their homes; the last thing they
should have to think about is paying taxes on debt they
couldn't repay. This measure puts an end to this onerous
application of tax law. Additionally, since tax credits are
never considered income, taxing renewable energy production
grants would treat the renewable energy production industry
inequitably and would add additional costs onto these projects
need for job creation and energy sustainability. It is
important that we avoid this kind of unnecessary roadblock to
economic growth as our state works to rebuild its financial
prosperity."
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.
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 four 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. Failure to conform to
federal law in some areas may lead to improper tax reporting
SB 401
Page F
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
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.
In 2008, AB 1561 (Charles Calderon), a conformity bill, required
a 2/3 vote of the membership in each house. AB 1561 did not
advance from the Senate Floor because it failed to secure 27
Senate votes. Last year, the Legislature approved AB 1580
(Charles Calderon), but the Governor vetoed it because of a
"single provision inserted at the last minute" that he could
not support. This year, the Legislature, in the 8th
Extraordinary Session, passed SB x8 32 (Wolk), which was
similar to AB 1580, but the Governor also vetoed that bill for
the same reason. The Legislature continues to struggle with
tax conformity and SB 401 represents the most recent attempt
to ease the hardship on taxpayers and tax practitioners by
bringing the two tax codes closer together.
SB 401
Page G
3)Conformity Decisions . Full descriptions of each of the
conformity items in SB 401 are included in the FTB's annual
report to the Legislature, "Summary of Federal Income Tax
Changes," that are available on the FTB's website.
4)Mortgage Debt Forgiveness . The Legislature approved SB 1055
(Machado), Chapter 282, Statutes of 2008, which provided
modified conformity to the MFDRA for discharge of mortgage
indebtedness in the 2007 and 2008 tax years. Last year,
Senate Revenue and Taxation Committee held SB 97 (Ron
Calderon), which extended modified conformity to discharge of
mortgage indebtedness in the 2009 and 2010 tax years, and this
Committee held AB 111 (Niello), which would have provided full
conformity to MFDRA. AB 1580, which was vetoed by the
Governor in 2009, would have provided 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/RDP filing a
separate return) to $500,000 ($250,000 in case of a married
individual/RDP filing a separate return). The same mortgage
debt forgiveness provisions were included in SB 32 x8 and,
now, are part of this bill, tying California law to federal
law until 2013. In addition, SB 401, similar to SB 32 x8,
provides for a retroactive application of those provisions for
cancellation of debt income arising from mortgage debt
forgiveness until the 2012 tax year.
5)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.
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
SB 401
Page H
(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%. SB 401 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,
no state legislation is needed to conform to that provision.
6)"Kiddie" Tax . SB 401 would conform to federal law by
increasing the age of minor children for purposes of the
SB 401
Page I
"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. SB 401 would conform the Personal Income
Tax Law to those provisions.
8)Grants for qualified energy property . Federal law allows a
renewable electricity income tax credit for the production of
electricity from qualified energy resources at qualified
facilities. Qualified energy resources, generally, include
wind, biomass, solar energy, geothermal energy, small
irrigation power, municipal solid waste, qualified hydropower
production and marine and hydrokinetic renewable energy. To
be eligible for this credit, electricity produced from the
qualified energy resources at qualified facilities must be
sold by the taxpayer to an unrelated person. The production
tax credit for electricity produced from renewable resources
is generally claimed over a 10-year period and is not
refundable.
In addition to the renewable electricity production tax credit,
under federal tax law, a taxpayer is allowed to claim a credit
for the investment in certain property. The investment tax
credit includes an energy credit that is allowed for certain
---------------------------
<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.
SB 401
Page J
qualifying energy property placed in service. The qualifying
energy property includes certain fuel cell, solar, geothermal
power production, small wind energy property, combined heat
and power system, and geothermal heat pump property. The
energy credit is generally equal to 30% of the taxpayer's
basis in qualified fuel cell property, certain solar energy
property, and wind energy property. It is 10% of the
taxpayer's basis in all other types of qualifying energy
property. The investment tax credit may be claimed entirely
in the year the facility is placed in service.
In February of 2009, Congress enacted, and the President signed,
the American Recovery and Reinvestment Act (ARRA), which,
among other things, allows taxpayers to make an irrevocable
election to treat certain qualified property that is part of a
qualified investment credit facility placed in service in 2009
through 2013 as energy property eligible for a 30% investment
credit. The investment tax credit option may be attractive
to tax investors that are not sure of their tax liability in
the future (the 10-year period). Furthermore, the ARRA
authorizes the Secretary of Treasury to provide a grant to
each person who places in service during 2009 or 2010 energy
property that is either: 1) an electricity production
facility otherwise eligible for the renewable electricity
production credit; or, 2) qualifying property otherwise
eligible for the energy investment tax credit. The grant
amount is up to 30% of the basis of the qualified property.
In other words, a taxpayer that elects to receive the
investment tax credit can also elect to receive a 30% grant
rather than the 30% tax credit. The ability to receive the
credit or grant in the year in which property is placed in
service helps owners to finance the project.
Congress excluded the grant proceeds from a taxpayer's income
but required that the basis of the property be reduced by 50%
of the amount of the grant. In addition, some or all of each
grant is subject to recapture if the grant eligible property
is disposed of by the grant recipient within five years of
being placed in service. The provision also permits
taxpayers to claim the credit with respect to otherwise
eligible property that is not placed in service in 2009 and
2010 so long as construction begins in either of those years
and is completed prior to 2013 (in the case of wind facility
property), 2014 (in the case of other renewable power facility
property eligible for credit under IRC Section 45), or 2017
SB 401
Page K
(in the case of any specified energy property described in IRC
Section 48). Under the program, if a grant is paid, no
renewable electricity credit or energy credit may be claimed
with respect to the grant eligible property.
The grant program was created to help developers of renewable
energy projects to finance these projects. Often, developers
seek investors that are usually allocated 99% of the income,
gains, losses, deductions and tax credits of the project.
However, in the current economic environment the potential
investors may not have enough tax liability to utilize those
deductions and credits. The creation of the grant program
allows developers to receive a federal subsidy to continue
with the renewable energy projects.
In absence of an authorized statute, taxpayers must include the
grant proceeds as income for state purposes. SB 401 excludes
these grants from income for 2009 and 2010 tax years because
an unexpected tax could cause project developers to terminate
or delay the projects, causing job losses and less renewable
power for the state. SB 401 also conforms to federal law by
excluding these grants from taxpayer's income, requiring the
50% basis adjustment, and incorporating the recapture
provisions of Section 1603(f) of the ARRA.
9)Operative Date . Unlike all of the previous conformity bills,
SB 401 is not a tax levy, nor is it an urgency bill. As such,
it will take effect on January 1, 2011. The question arises,
therefore, as to whether the taxpayers would be able to
exclude cancellation of debt income when they file their 2009
tax returns this month, or whether they will have to pay the
tax and file amended returns in 2011, once the provisions of
this bill become effective.
10)Similar legislation . SB 32 x8 (Wolk), introduced in the 8th
Extraordinary Session, is identical to SB 401 but for one
provision - an erroneous refund claim penalty. SB 32 x8 was
passed by both the Assembly and the Senate but was vetoed by
the Governor on March 25, 2010.
REGISTERED SUPPORT / OPPOSITION :
Support
California Wind Energy Association
SB 401
Page L
Solar Alliance
The Large-scale Solar Association
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098