BILL ANALYSIS �
AB 1369
Page 1
ASSEMBLY THIRD READING
AB 1369 (Gatto and Perea)
As Amended May 18, 2011
2/3 vote. Tax levy
REVENUE & TAXATION 8-0 APPROPRIATIONS 17-0
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|Ayes:|Perea, Donnelly, Beall, |Ayes:|Fuentes, Harkey, |
| |Charles Calderon, | |Blumenfield, Bradford, |
| |Fuentes, Gordon, Harkey, | |Charles Calderon, Campos, |
| |Nestande | |Davis, Donnelly, Gatto, |
| | | |Hall, Hill, Lara, |
| | | |Mitchell, Nielsen, Norby, |
| | | |Solorio, Wagner |
| | | | |
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SUMMARY : Disallows deductions for expenses attributable to
income derived by a taxpayer from specified illegal activities.
Specifically, this bill :
1)Expands existing law by additionally denying deductions for
expenses, including deductions for costs of goods sold,
attributable to the taxpayer's gross income directly derived
from certain criminal profiteering activities. Specifically:
a) Describes the criminal profiteering activities to
include any act or omission punishable under the
"California Control of Profits of Organized Crime Act" of
Penal Code (PC) Section 186.2, dealing with a controlled
substance enumerated in the Health and Safety Code, and
unlawful referrals (insurance fraud) specified in the
Insurance Code; and,
b) Denies deductions to any taxpayer from gross income
earned from any activity that directly tends to promote or
to further, or are directly connected or associated with,
those specified acts or omissions of criminal profiteering
activity.
2)Specifies that a prior, final determination by a court of
competent jurisdiction in any criminal proceedings, or any
proceeding in which the state, county, city, or other
political subdivision was a party on the merits of the
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legality of the taxpayer's activities, is required in order
for this bill's provisions to apply.
3)Applies to taxable years that have not been closed by a
statute of limitations, res judicata, or otherwise, as of the
effective date of this bill. Specifies that the existing
provisions would apply to taxable years that have not been
closed as of September 14, 1982, except as otherwise provided.
4)Repeals existing law that denies a taxpayer deductions related
to illegal activities, as described by reference to certain
crimes.
5)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW :
1)Provides that all income, from whatever source derived, is
included in a taxpayer's gross income, including income
obtained from illegal business activities, actual crimes or
unethical or immoral business practices.
2)Allows a taxpayer to deduct from the gross income all ordinary
and necessary business expenses, including expenses
attributable to an illegal business. Notwithstanding the
general rule, illegal payments such as bribes and kickbacks
are not deductible, nor are losses from illegal activities
allowed if there is a clear public policy that supports
denying the deductions. Special rules apply in the case of
business activities involving drug trafficking. In those
cases, all deductions are expressly disallowed.
EXISTING STATE LAW is similar to federal law but further denies
deductions from gross income if the income is directly derived
from or directly tends to promote or further illegal activities
relating to lotteries, gaming, or horse racing. Similar
restrictions apply to disallow deductions, including cost of
goods sold, from gross income for other specified illegal
activities including pimping or pandering, larceny, obscene
matter, robbery, burglary, illegal sales of controlled
substances, embezzlement, and indecent exposure.
FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates
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that this bill would result in an annual gain of $50,000 in
fiscal year (FY) 2010-11, $150,000 in FY 2011-12, $250,000 in FY
2012-13, $350,000 in FY 2013-14, and $450,000 in FY 2014-15.
COMMENTS :
Author's Statement . The author states that, "This legislation
would amend Sections 17282 and 24436.1 and repeal Sections 17281
and 24436 of the Revenue and Taxation �C]ode to allow the
Franchise Tax Board to deny a deduction for expenses, including
costs of goods sold, derived from criminal profiteering activity
or illegal profits against insured property and insurers. This
bill expands the definition of illegal activities subject to the
disallowance of claimed expenses or the cost of goods sold.
This bill would ensure public expenditures provided through the
state tax system are reserved for legitimate business expenses
and remove loopholes that allow criminals to avoid paying taxes
for "business" conducted while engaged in illegal activities.
"The purpose of this bill is to prohibit taxpayers that
perpetrate crimes from claiming deductions on their tax return
for expenses incurred in criminal behavior. Although existing
law denies deductions for certain criminal activities, recent
tax evasion cases prosecuted on behalf of the Franchise Tax
Board highlighted the need to expand the list of covered
activities."
Arguments in Support . The proponents of this bill argue that
fraudulent claims "account for a significant portion of all
claims received by insurers, and cost billions of dollars
annually," and that those who commit insurance fraud "should not
be able to profit from a tax deduction for expenses attributed
to income derived from their criminal activities."
Background . On December 4, 2002, FTB voted 2-0 to support the
language included in this bill, with the Director of Finance
abstaining. Existing law already denies deductions for certain
criminal activities; however, tax evasion cases prosecuted on
behalf of the FTB in recent years highlighted the need to expand
the denial of deduction to other criminal activities. In cases
involving crimes against the elderly and insurance fraud, FTB
investigators were required to allow deductions for expenses
directly related to the income from the illegal activity to
determine taxable income. State attorneys prosecuting the cases
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were frustrated and concerned about the limited nature of
California's existing disallowance provisions. Absent specific
inclusion of the crime charged in the list of crimes for which
deductions are denied, the penalties available to prosecutors
with respect to the tax due from the criminal endeavors might be
limited.
The scope of this bill . Existing state law provides an
inconsistent tax treatment of income derived from, or related
to, illegal activities. Thus, the law specifically prohibits a
taxpayer from deducting expenses, including the costs of goods
sold, from income derived from certain criminal activities, such
as pimping or pandering, larceny, obscene matter, robbery,
illegal sales of controlled substances, embezzlement and
indecent exposure. Similarly, a deduction of ordinary and
necessary business expenses is disallowed if it is claimed to
offset income derived from illegal activities related to
lotteries, gaming, gambling or horse racing. However, a
taxpayer is entitled to claim a deduction for the costs of goods
sold in an illegal business related to lotteries, gaming,
gambling and horse racing. Furthermore, a taxpayer may claim
deductions for expenses attributable to other illegal
activities, not specifically enumerated in the statute.
This bill would expand current rules disallowing deductions for
expenses attributable to certain crimes or criminal activities
to include all crimes punishable under the "California Control
of Profits of Organized Crime Act (PC Section 186.2) as well as
illegal activities involving insurance fraud. Crimes enumerated
in the California Control of Profits or Organized Crime Act
include arson, child pornography, kidnapping, murder, corporate
securities violations, money laundering, human trafficking,
theft of personal identifying information, theft of motor
vehicles, and abduction or procurement by fraudulent inducement
for prostitution, among others. By providing the same
consistent tax treatment to taxpayers involved in all types of
criminal profiteering activities, this bill would further the
legislative intent of punishing and deterring crimes and would
reserve state funds to assist legitimate businesses and/or
various state programs.
Related legislation . AB 1746 (Revenue and Taxation Committee),
introduced in the 2007-08 legislative session, is almost
identical to this bill. AB 1746 failed passage on the Assembly
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Floor.
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098
FN: 0000966