BILL ANALYSIS �
Senate Appropriations Committee Fiscal Summary
Senator Christine Kehoe, Chair
AB 1423 (Perea)
Hearing Date: 08/15/2011 Amended: 07/12/2011
Consultant: Mark McKenzie Policy Vote: G&F 9-0
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BILL SUMMARY: AB 1423, an urgency bill, would conform state laws
to recent federal changes that affect the tax treatment of
regulated investment companies, which are mutual funds and other
similar investment companies.
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Fiscal Impact (in thousands)
Major Provisions 2011-12 2012-13 2013-14 Fund
Net revenue impacts $925 $384 $74 General*
(see chart below for a full
breakdown of estimated revenue impacts)
____________
* FTB estimates revenue gains of $36,500 in 2014-15 and $156,500
in 2015-16, with additional gains through 2017-18. Beginning in
2018-19 there would be ongoing revenue losses of approximately
$10 million annually.
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STAFF COMMENTS: This bill meets the criteria for referral to the
Suspense File.
Under federal and state law, mutual funds pass through gains and
losses on its investments to the individuals owning its shares,
instead of paying tax on its earnings, so long as they meet the
definition and requirements for Regulated Investment Companies
(RICs) set forth under Subchapter M of the Internal Revenue
Code. Generally, as long as a RIC pays out 90% of its earnings
in dividends to its shareholders, the RIC deducts all the
dividends it pays to its shareholders from its taxable income.
Shareholding taxpayers report the distributed income on their
own personal income tax returns, and retain the character of the
income, such as tax-exempt interest or long or short-term
capital gains. Whenever a fund fails to comply with Subchapter
M, federal and state law applies the corporate income tax to the
fund, and its shareholders must include RIC earnings
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distributions as ordinary income, which federal law taxes at a
higher rate than capital gains income. California taxes all
income at the same rate.
In December, 2010, Congress enacted the RIC Modernization Act of
2010 (Public Law 111-325), which comprehensively recast and
restructured tax laws guiding mutual funds. AB 1423 would
conform California law to the following changes in the RIC Act:
Capital loss carryovers (Section 101 of RIC Act)
Savings provisions related to failure of RIC to satisfy gross
income and asset tests (Section 201, conform with
modifications)
Modification of dividend designation requirements and
allocation rules (Section 301)
Earnings and profits (Section 302)
Pass-through of exempt-interest dividends and foreign tax
credits in fund of funds structure (Section 303)
Modification of rules for spillover dividends (Section 304)
Return of capital distributions (Section 305)
Distributions in redemption of stock (Section 306)
Repeal of preferential dividend rule (Section 307)
Elective deferral of specified late-year losses (Section 308)
Exception to holding period requirement for certain
exempt-interest dividends (Section 309)
Modification of sales load basis deferral rule (Section 502)
FTB estimates the following fiscal impact of each provision:
---------------------------------------------------------------
|Provision | 2011-12 | 2012-13 | 2013-14 |
|---------------------------------+---------+---------+---------|
|Capital Loss Carryovers of | $0 |$250,000 |$450,000 |
|Regulated Investment Companies | | | |
|---------------------------------+---------+---------+---------|
|Savings Provisions for Failures |Negligibl|Negligibl|Negligibl|
|of Regulated Investment | e gain | e gain | e gain |
|Companies to Satisfy Gross | | | |
|Income and Asset Tests | | | |
|---------------------------------+---------+---------+---------|
|Modification of Dividend | -$1,000 | -$500 | -$500 |
|Designation Requirements and | | | |
|Allocation Rules for Regulated | | | |
|Investment Companies | | | |
|---------------------------------+---------+---------+---------|
|Earnings and Profits of | -$3,000 | -$2,000 | -$2,000 |
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|Regulated Investment Companies | | | |
|---------------------------------+---------+---------+---------|
|Pass-Thru of Exempt-Interest |-$100,000|-$80,000 |-$70,000 |
|Dividends and Foreign Tax | | | |
|Credits in Fund of Funds | | | |
|Structure | | | |
|---------------------------------+---------+---------+---------|
|Modification of Rules for |Negligibl|Negligibl|Negligibl|
|Spillover Dividends of Regulated | e | e | e |
|Investment Companies | Loss | Loss | Loss |
|---------------------------------+---------+---------+---------|
|Return of Capital Distributions |Negligibl|Negligibl|Negligibl|
|of Regulated Investment | e | e | e |
|Companies | Gain | Gain | Gain |
|---------------------------------+---------+---------+---------|
|Distributions in Redemption of |-$450,000|-$350,000|-$350,000|
|Stock of a Regulated Investment | | | |
|Company | | | |
|---------------------------------+---------+---------+---------|
|Repeal of Preferential Dividend |Negligibl|Negligibl|Negligibl|
|Rule for Publicly Offered | e | e | e |
|Regulated Investment Companies | Loss | Loss | Loss |
|---------------------------------+---------+---------+---------|
|Elective Deferral of Certain | -$1,000 | -$1,000 | -$1,000 |
|Late-Year Losses of Regulated | | | |
|Investment Companies | | | |
|---------------------------------+---------+---------+---------|
|Exception to Holding Period |Negligibl|Negligibl|Negligibl|
|Requirement for Certain | e | e | e |
|Regularly Declared | Loss | Loss | Loss |
|Exempt-Interest Dividends | | | |
|---------------------------------+---------+---------+---------|
|Modification of Sales Load Basis |-$370,000|-$200,000|-$100,000|
|Deferral Rule for Regulated | | | |
|Investment Companies | | | |
|---------------------------------+---------+---------+---------|
| Totals: |-$925,000|-$383,500|-$73,500 |
| | | | |
---------------------------------------------------------------
Staff notes that the Franchise Tax Board's (FTB) report titled
"Summary of Federal Income Tax changes - 2010" includes a
detailed discussion of the federal and state tax laws affected
by this bill ( http://www.ftb.ca.gov/law/legis/10FedTax.pdf ).
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Generally, when changes are made to federal tax laws, state
legislation is needed to conform to those federal changes. The
purpose of conformity is to simplify both the preparation of
California income tax returns and the administration of state
income tax laws. Current state law provides modified conformity
to the Internal Revenue Code as of January 1, 2009 for federal
laws enacted after January 1, 2005 and before January 1, 2009
�SB 401 (Wolk), Chapter 14 of 2010].
Staff notes that the administrative benefits to the state and
taxpayers as a result of conformity must be weighed against the
General Fund impacts. Prior to the passage of Proposition 26 in
November of 2010, conformity legislation usually contained
numerous provisions to update state tax laws with federal
changes that had been enacted since the previous state omnibus
tax conformity bill. While individual provisions may have had a
positive or negative revenue impact, the bills were generally
designed to be net revenue neutral overall so that they could be
passed on a majority vote. Proposition 26 requires that any
bill that imposes increased taxes on any taxpayer requires
passage by a two-thirds vote of both houses of the Legislature.
With the political difficulties associated with achieving a
two-thirds vote on a bill that includes tax increases, it is
likely that most, if not all conformity bills introduced after
the passage of Proposition 26 will be subject-specific and
result in net tax revenue losses. It will be much more
difficult to include any tax conformity provisions that result
in revenue gains, which is likely to complicate the state tax
code for both taxpayers and the FTB as state tax laws diverge
from federal laws in future years.
Staff notes that the bill would result in a three-year revenue
loss, followed by four years of revenue gains, and more
significant revenue losses of approximately $10 million annually
beginning in 2018-19. These out-year revenue losses are a
result of the provisions that change the carry over rules for
RIC losses. Under current law, RIC losses may be carried over
for up to 8 years. Under the RIC Act, however, RIC losses may
be carried over indefinitely, which is similar to net capital
loss carryovers applicable to individual taxpayers. For losses
realized in 2011, the new law would not affect carryover loss
claims until 2019, when the current eight year window would
expire. Since the losses no longer expire under current federal
law, conformity to this provision would allow RICs to use
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remaining losses to offset capital gains income and reduce tax
liabilities beginning in 2019.
Numerous mutual fund companies have operations in California;
there are over 1,150 California-based mutual fund companies,
accounting for over one quarter of the $14.5 trillion in assets
under management by U.S.-based mutual fund companies. The
impacts of non-conformity would impose a clear and costly
disadvantage on those companies, as most other states
automatically conform to the RIC Act. For example,
California-based companies would be subject to different rules
related to the calculation of RIC-level income, shareholder
distributions and the tax treatment of those distributions, and
the timing and character of shareholder gains and losses on the
disposition of RIC shares. Additional costs for RICs to
maintain segregated accounting systems could impact profit
margins and investment returns. Non-conformity would also
impact California taxpayers who are RIC investors. While FTB
does not calculate the costs of non-conformity, the independent
taxpayers' rights advocate indicates that a lack of conformity
to federal tax laws leads to low taxpayer self-compliance and
greater costs of administering and enforcing income tax laws.
Staff notes that, absent the bill, FTB would likely experience a
higher volume of amended returns. The magnitude of state
impacts as a result of non-conformity are unknown.