BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 876 - Florez
Amended: January 10, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Conforms California Law to Federal Law to Allow
Taxpayers to Carry Back and Carry Forward Net
Operating Losses from Investment Fraud Schemes.
EXISTING LAW authorizes net operating loss deductions,
where taxpayers that generate a loss in one taxable year
may use that loss to deduct income from another taxable
year. Current law allows limited net operating loss (NOL)
carrybacks to the preceding two taxable years, and extended
carry-forwards to 20 years for net operating losses
attributable to 2010 and later (AB 1452, Committee on
Budget, 2008). Also, that measure limited a taxpayer with
net business income greater than $500,000 from applying
deductions for net operating loss carryforwards and tax
credits to 50% of liability for the 2008 and 2009 taxable
years.
EXISTING FEDERAL LAW provides, in general, that a NOL
can be carried back 2 years and forward 20 years and
deducted. Special rules are provided for the carryback of
NOLs relating to issues such as specified liability losses,
casualty or theft losses, disaster losses of a small
business, and farming losses.
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Recent changes in federal law extend the carryback
period up to five years for specified losses. The American
Recovery and Reinvestment Act allows certain taxpayers to
make an irrevocable election to carry back applicable 2008
losses for up to 5 years. The Worker, Homeownership, and
Business Assistance Act of 2009 allows taxpayers, other
than taxpayers that received benefits under the Troubled
Asset Relief Program, with business losses to make an
irrevocable election to carry back losses incurred in one
year (ending after 2007 and beginning before 2010) for up
to 5 years.
In March, 2009 the Internal Revenue Service (IRS)
issued Revenue Ruling 2009-9 and Revenue Procedure 2009-20.
Revenue Ruling 2009-9 defines losses on fraudulent
investment schemes as business losses; a NOL resulting from
a fraudulent investment loss is eligible for the extended
NOL carryback period. Revenue Procedure 2009-20 provides a
safe-harbor method of computing and reporting the losses.
THIS BILL would conform California to federal law with
respect to the net operating loss carryback and
carryforward treatment currently allowed under the Internal
Revenue Code for Ponzi-like scheme investment fraud.
Specifically, this bill:
Allows the "safe harbor" treatment for determining
a fraudulent investment loss as set forth in the IRS's
Revenue Procedure 2009-20, when the same procedures
are applied for both state and federal purposes.
Allows a state NOL resulting from the application
of the terms of the Revenue Procedure the same
carryback and carryforward periods as would be allowed
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by federal law for the same tax year and would conform
by reference to the federal statute of limitations
rules with respect to NOL carrybacks for losses
attributable to application of the Revenue Procedure.
Exempts NOLs arising from a fraudulent investment
loss from the existing suspension period.
Precludes the Franchise Tax Board (FTB) from
challenging the treatment of a loss determined under
the terms of the Revenue Procedure.
FISCAL EFFECT:
The Franchise Tax Board (FTB) estimates that this bill
would result in a revenue loss of $9.9 million in fiscal
year (FY) 2009-10, $8.7 million in FY 2010-11, $500,000 in
FY 2011-12 and $30,000 in FY 2012-13.
COMMENTS:
A. Purpose of Bill
The author provides the following statement:
"SB 876 is a tax relief measure that will return
erroneously paid tax dollars back to victims of Ponzi
schemes.
During these tough economic times, several people have
fallen victim to fraudulent money schemes. The most
prevalent being the Bernard Madoff Ponzi scheme. While
there has been much attention given to the prominent names
of investors who were hurt by the Madoff scandal, there are
many people of average means in California who invested
with Bernard Madoff Investment Securities and are now
facing devastating financial futures.
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The other untold story is that several of these
victims paid taxes on income they never received.
The IRS has recognized the additional losses suffered
by these victims and has provided major tax relief to
qualified investors that paid taxes on phantom income -
income they never received due to fraud. Unfortunately,
California's tax code does not afford similar relief.
SB 876 would conform California's tax code to the
federal rulings and procedures so that victims in
California will be treated similarly on their state tax
returns as they would on their federal returns. In
essence, this tax relief measure will ensure that the State
does not victimize these folks once again."
B. Background
On March 17, 2009, in response to the losses
resulting from the collapse of Bernard Madoff's
decades-long Ponzi scheme, the IRS issued Revenue Ruling
2009-9 and Revenue Procedure 2009-20 to provide guidance
to taxpayers who are victims of fraudulent investment
schemes.
The Revenue Ruling clarifies the income tax law
governing the treatment of losses from such schemes,
including the nature of such losses (theft losses), the
amount of such losses to be allowed, and the year of
deductibility. The Revenue Procedure simplifies
compliance procedures for taxpayers by providing an
optional safe-harbor means of determining the year in
which the losses are deemed to occur, and a simplified
method of computing the amount of the loss.
Federal and state laws are generally the same with
respect to the deduction of theft losses. In general,
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where state law is in substantial conformity with the
Internal Revenue Code, federal regulations, rulings and
procedures are applicable for state purposes.
Accordingly, Revenue Ruling 2009-9 and Revenue Procedure
2009-20 are applicable for state purposes to the extent
federal and state laws are the same.
However, California law does not currently allow
carrybacks of NOLs generated prior to the 2010 tax year,
and carryforwards of such losses have been suspended
until the 2010 tax year. (NOL carrybacks to the
preceding two taxable years will be allowed for
operating losses attributable to 2010 and later.)
Consequently, victims of Ponzi schemes that claim net
operating loss carrybacks on their federal returns in
accordance with Revenue Ruling 2009-9 and Revenue
Procedure 2009-20 cannot claim comparable carrybacks for
California purposes, and may be unable to use
carryforwards as allowed under Federal law until 2010.
SB 876 would conform California to Federal law with
respect to the NOL carryback and carryforward treatment
currently allowed under the Internal Revenue Code.
C. Slippery Slope?
Under the recently issued IRS rules, victims of the
Madoff Ponzi scheme are receiving some favorable federal
tax treatment that is allowing them to recover at least
some of their losses. This kind of relief is unusual, as
in most cases where people lose property in a casualty or
theft-related loss there aren't special exceptions and new
rules that apply under the tax code. There have been many
Ponzi schemes, including the eponymous Charles Ponzi and
the match-king of Sweden, Ivar Krueger, before which
cheated many people out of money, reporting fake income,
and now have nothing to show but their losses. Also,
ordinary taxpayers who haven't necessarily invested in a
Ponzi scheme, but have lost money in cases like AIG,
suffered capital losses that appeared theft-like. It is a
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slippery slope to pass laws and rules intended to protect
just one class of taxpayers. The committee may wish to
consider if SB 876 amends the California tax code to favor
one group of taxpayers over another, thereby making the tax
code less fair overall.
Support and Opposition
Support: None received.
Oppose:None received.
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Consultant: Meg Svoboda