BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 1369 HEARING: 7/6/11
AUTHOR: Gatto FISCAL: Yes
VERSION: 5/18/11 TAX LEVY: Yes
CONSULTANT: Miller
PERSONAL & CORPORATE INCOME TAXES: DEDUCTIONS:
ILLEGAL ACTIVITIES
Denies deductions for expenses incurred from illegal
activities.
Background and Existing Law
Existing federal law 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. Federal law 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.
Proposed Law
AB 1369 -- 5/18/11 -- Page 2
Assembly Bill 1369 disallows deductions for income derived
by a taxpayer from specified illegal activities. This bill
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.
This bill 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.
The bill also 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.
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
legality of the taxpayer's activities, is required in order
for this bill's provisions to apply.
AB 1369 takes effect immediately and applies to any taxable
year that has not been closed by a statute of limitations,
res judicata, or otherwise.
State Revenue Impact
The Franchise Tax Board (FTB) staff estimates that this
bill would result in an annual gain of $50,000 in 2010-11,
$150,000 in 2011-12, $250,000 in 2012-13, $350,000 in
2013-14, and $450,000 in 2014-15.
Comments
1. Purpose of the bill . According to the author, this
bill expands the definition of illegal activates subject to
the disallowance of claimed expenses or the cost of goods
AB 1369 -- 5/18/11 -- Page 3
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.
2. Insurance Fraud . According to the proponents of this
measure, insurance fraud is a $5 billion business in this
state and the Department of Insurance estimates that fraud
adds an additional $500 to the cost of an insurance policy.
Insurance fraud is deliberate and seriously undermines the
insurance business. The proponents claim that this bill
will act as a disincentive to these criminals and mitigate
some of the costs associated with fraud.
AB 1369 -- 5/18/11 -- Page 4
Assembly Actions
Assembly Revenue & Taxation Committee: 8-0
Assembly Appropriations Committee:17-0
Assembly Floor: 75-0
Support and Opposition (6/30/11)
Support : Association of California Insurance Companies;
Liberty Mutual Group.
Opposition : Unknown.