BILL ANALYSIS �
AB 1605
Page 1
Date of Hearing: May 14, 2012
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 1605 (Garrick) - As Amended: April 10, 2012
VOTE ONLY
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Minimum annual tax: exemptions.
SUMMARY : Exempts a small business, as defined, that first
commences business operations on or after January 1, 2013, from
the minimum franchise tax (MFT) or an annual tax, whichever is
applicable, and reduces that tax from $800 to $99 for each
taxable year thereafter. Specifically, this bill :
1)Exempts a corporation, limited partnership (LP), limited
liability partnership (LLP), and limited liability company
(LLC) that it is a small business that first commences
business operations on or after January 1, 2013 from the $800
MFT for the first taxable year.
2)Reduces the annual MFT imposed on that small business from
$800 to $99 for each taxable year thereafter.
3)Defines a "small business" as a corporation, LP, LLP, or LLC
that, for the previous taxable year, had gross receipts, less
returns and allowances, reportable to this state of $1 million
or less.
4)Defines "gross receipts" as the gross amounts realized on the
sale or exchange of property, the performance of services, or
the use of property or capital in a transaction that produces
business income, as specified. Excludes from the definition
of "gross receipts," even if business income, amounts received
from transactions in intangible assets held in connection with
a treasury function of the taxpayer's business, amounts
received from hedging transactions involving intangible
assets, damages received as the result of litigation, and
other specified amounts.
5)Defines a "hedging transaction" as a transaction related to
the taxpayer's trading function involving futures and options
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transactions for the purpose of hedging price risk of the
products or commodities consumed, produced, or sold by the
taxpayer.
6)Does not apply to any corporation, LP, LLP, or LLC that
reorganizes solely for the purpose of reducing its MFT.
7)Applies to taxable years beginning on or after January 1,
2013.
8)Takes effect immediately as a tax levy.
EXISTING LAW:
1)Imposes a franchise tax on all corporations doing business in
California equal to 8.84% of the taxable income attributable
to California. A minimum franchise tax of $800 is imposed on
all corporations that are incorporated under the laws of
California, qualified to transact intrastate business in
California, or are doing business in California. Corporations
must pay the minimum franchise tax only if it is more than
their regular franchise tax liability.
2)Provides limited exceptions from the imposition of the MFT.
For instance, credit unions and nonprofit organizations are
not subject to the MFT and a corporation is not subject to the
MFT for its first taxable year, provided that it incorporates
or qualifies to do business in this state on or after January
1, 2000. However, even though a corporation is not subject to
the MFT in its first taxable year, it will be subject to the
franchise tax in its first taxable year based on its taxable
income. According to the Franchise Tax Board (FTB), for
taxable years beginning on or after January 1, 1997, only
taxpayers with net income of approximately $9,040 or less pay
the MFT because the amount of measured tax owed would be less
than $800 ($9,039 x 8.84% = $799).
3)LPs, LLPs, and LLCs that are doing business in California,
registered or qualified to do business in California, or
formed in this state, are subject to an annual tax in an
amount equal to the MFT, currently set at $800. These
entities (known as 'pass-through entities') are not subject to
any tax, i.e., a franchise tax, based on taxable income.
Rather, the items of income, gain, loss, deduction and credit
are passed-through to the owners and reported on their
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respective income or franchise tax returns.
4)Real estate mortgage investment conduits (REMICs) and
financial asset securitization investment trusts (FASITs) are
subject to, and are required to pay, MFT. Regulated
investment companies (RICs) and real estate investment trusts
(REITs) organized as corporations are also subject to, and are
required to pay, the MFT. RICs, REITs, REMICs, and FASITs are
entities authorized by the federal government for special tax
treatment. California conforms in large part to federal tax
provisions but subjects each entity to payment of the annual
minimum tax.
5)LPs, LLCs not classified as corporations, LLPs, charitable
organizations, RICs, REITs, REMICs, and FASITs are not exempt
from the MFT for the first taxable year of existence.
FISCAL EFFECT : The FTB staff estimates that this bill will
result in an annual General Fund revenue loss of $50 million in
fiscal year (FY) 2013-14, $120 million in FY 2014-15, and $170
million in FY 2015-16.
COMMENTS :
1)Author's Statement . The author states that, "California's
franchise tax is a minimum of $800 after the first year - even
if a business is operating in the red and struggling to keep
its doors open. With this tax, businesses are subjected to an
excessive tax that is not consistent with the tax of
neighboring states.
"According to a study released in 2007, only 17 percent of
businesses are able to turn a profit after the second year of
operations. In other words, 83% of companies are either
unable to make a profit or went out of business. Although the
majority of new companies do not even have a net income,
California's harsh tax code still forces these companies to
pay an $800 tax each year.
"When deciding where to locate a business, entrepreneurs have to
look no further than Nevada, Oregon, Arizona or Utah, which
all charge $150 or less.
"AB 1065 will remove one of the several barriers to doing
business in California and begin to level the playing field
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with other states by reducing the minimum franchise tax to $99
for new businesses.
"Reduction of this tax encourages small businesses, especially
struggling businesses operating from the home or garage, to
file the proper paperwork and comply with existing state laws
governing the workplace.
"If AB 1065 becomes law, California can once again begin to
attract employers to do business in this state. Ultimately,
it will assist with lowering the unemployment rate and putting
Californians back to work."
2)Arguments in Support . The proponents argue that AB 1605
"would encourage job growth through reducing the minimum
annual tax on "small business" corporations, limited liability
partnerships, and limited liability companies." They state
that this bill "will allow �small businesses] to place more
capital upfront towards expanding their business rather than
as a prepayment to taxes they may never owe" and "will help
position California for economic recovery."
3)Arguments in Opposition . The opponents argue that the state's
MFT is "a nominal fee paid to the state for the privilege of
doing business in the state," and there is no evidence that
the MFT "provides a disincentive to doing business" in
California. They believe that there is "no justification for
reducing this fee for these business entities, many of which
will become quite profitable and many of which are
subsidiaries or affiliates of larger corporations," especially
in light of the state's $10 billion plus budget deficit.
4)Other States . According to the FTB staff, the following
states currently impose a minimum franchise tax:
a) Illinois has a minimum 1% tax based on "paid-in" capital
(calculated using the shares of stock issued by the
corporation as disclosed in the annual statement reported
to the Illinois Secretary of State). The tax ranges from a
minimum of $25 to a maximum of $1 million.
b) Massachusetts imposes the greater of a corporate excise
tax of 9.5% based on taxable income or a minimum tax equal
to $456.
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c) Beginning January 1, 2008, Michigan taxpayers are
subject to the Michigan Business Tax. The Michigan
Business Tax is composed of two taxes - a business income
tax of 4.9% on every taxpayer with business activity in the
state, and a modified gross receipts tax of 0.80% on every
taxpayer having nexus with Michigan. Michigan does not
have a minimum tax.
d) Minnesota imposes a franchise tax on a corporation's
taxable income at the rate of 9.8%. In addition, a minimum
franchise tax, ranging from $0 to $5,000, is imposed based
on the sum of the property determined by property, payroll,
and sales in the state.
e) New York imposes a franchise tax of 7.1% based on net
income plus a fixed dollar minimum tax based on gross
payroll. The fixed dollar minimum tax ranges from $100 to
$1,500.
5)Committee staff notes all of the following :
a) The minimum franchise tax was enacted to ensure that all
corporations pay at least a minimum amount of franchise tax
for the privilege of doing business in this state,
regardless of the corporation's income or loss. Thus, the
minimum franchise tax is not technically an "income tax",
but rather is a tax on the right to exercise the powers
granted to a corporation doing business in California.
Even when a corporation earns no income, it still receives
the benefits of its corporate status, including the limited
liability protection under the laws of this state.
b) California's minimum tax was increased from $100 to $200
in 1972. It was increased to $300 in 1987, to $600 in
1989, and to $800 in 1990.
c) It has never been shown that the MFT discourages
businesses, particularly, since small businesses can always
organize as sole proprietorships to avoid paying the MFT.
Many large corporations hold a number of inactive
subsidiaries on which they readily pay the MFT. Because
the franchise tax is the greater of the MFT or tax of 8.84%
on the corporations' taxable income, the actual
beneficiaries of this bill are corporations that report
minimal taxable income and all pass-through entities, which
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are small businesses, regardless of the amount of income
earned. Profitable entities that are formed as LLCs, LPs
or LLPs will receive tax savings of $701 every taxable
year.
d) Under existing law, a corporation that incorporates or
qualifies to do business in this state on or after January
1, 2000, is already exempt from the MFT for its first
taxable year. Nonetheless, this bill includes a similar
provision for a corporation that first commences business
operation on or after January 1, 2013. It is unclear
whether the existing tax relief would be available to
corporations that first incorporate between the effective
date of this bill and January 1, 2013. Committee staff
suggests that this bill be amended to delete this provision
in order to avoid any confusion and also to ensure that the
relief is still available before January 1, 2013.
e) The definition of "small business" in the case of a
corporation should be amended to reference the amount of
"total income from all sources derived from or attributable
to the state", instead of "gross receipts." A corporation
is not a pass-through entity and its income and tax
liability are calculated at the entity level.
f) This bill lacks a sunset date to allow periodic
legislative review of the proposed exemption. The Committee
staff recommends an amendment to add a sunset date.
6)FTB's Suggestions.
a) The FTB staff identified all of the following
implementation issues:
i) The phrase "first commences business operations" is
undefined and, therefore, "could be broadly interpreted
to include businesses that move from one location in
California to another, move from outside of California
into the state, or businesses that change their entity
structure to qualify for the reduced MFT or annual tax."
FTB staff recommends amending this bill "to provide
specific criteria that would define commencing business."
ii) This bill is silent regarding the tax liability of
REITs, RICs, REMICs, and Q-Subs. It is recommended that
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the bill be amended if the author intends to exclude
these types of entities from the reduced MFT.
iii) The definition of "small business" may be
interpreted to include the subsidiaries of large
corporate taxpayers that file a combined return as "small
businesses." If the author's intent is to disallow this
reduction specifically for the subsidiaries of large
businesses, it is recommended this bill be amended to
specify this disallowance.
b) This bill uses the term "minimum franchise tax" for LPs,
LLCs, and LLPs, which should be changed to "annual tax"
since technically MFT is not imposed on those entities. In
its analysis of AB 1605, the FTB staff provides a set of
technical amendments to address this problem.
7)Related legislation .
AB 166 (Cook), introduced in the 2011-12 Legislative Session,
would have repealed the MFT. AB 166 was held under submission
in this Committee.
AB 2126 (Garrick), introduced in the 2009-10 Legislative
Session, would have allowed new small businesses to pay no
annual minimum franchise tax in the first year and would have
reduced the amount of that tax from $800 to $100 for nine
years thereafter. AB 2126 was held under submission in the
Assembly Appropriations Committee.
AB 2671 (Cook), Chapter 394, Statutes of 2010, exempts from
the annual minimum franchise tax any corporation or an LLC
that is solely owned by a deployed member of the U.S. Armed
Forces, provided that the corporation operates at a loss or
ceases operation
AB 327 (Garrick), introduced in the 2009-10 Legislative
Session, would have reduced the minimum franchise tax for
corporation as well as pass-through entities from $800 to
$100. AB 327 was held under submission in this Committee.
AB 2178 (Garrick), introduced in the 2007-08 Legislative
Session, would have reduced the minimum franchise tax from
$800 to $200. AB 2178 was held under submission in this
Committee.
AB 1605
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AB 1179 (Garrick), introduced in the 2007-08 Legislative
Session, is similar to AB 327. AB 1179 was held in this
committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Chamber of Commerce
Bill Horn, Supervisor, 5th District, San Diego County Board of
Supervisors
Oxnard Chamber of Commerce
Southwest California Legislative Council
Opposition
American Federation of State, County and Municipal Employees
California Federation of Teachers
California Professional Firefighters
California Tax Reform Association
Service Employees International Union
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098