BILL ANALYSIS �
AB 1645
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Date of Hearing: May 13, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 1645 (Alejo) - As Amended: April 21, 2014
Majority vote. Fiscal committee. Tax levy.
SUBJECT : Business entities: minimum franchise tax: annual
tax: exemption
SUMMARY : Exempts limited partnerships (LP), limited liability
companies (LLC) and limited liability partnerships (LLP) from
the minimum franchise tax in the first two taxable years, and
exempts corporations from the minimum franchise tax in the
second taxable year. Specifically, this bill :
1)Exempts LPs, LLCs, and LLPs that are doing business in the
state on or after January 1, 2015, from the minimum franchise
tax in the first and second taxable year.
2)Exempts corporations that are doing business in the state, on
or after January 1, 2015, from the minimum franchise tax in
the second taxable year.
3)Provides that the exemption from the minimum franchise tax may
not apply to charitable organizations, regulated investment
companies (RIC), real estate investment trusts (REIT), real
estate mortgage investment conduits (REMIC), and qualified
subchapter S subsidies.
4)Takes effect immediately as a tax levy.
EXISTING LAW :
1) Imposes 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. Taxpayers must pay the minimum franchise tax
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only if it is more than their regular franchise tax
liability.<1>
2) Provides exceptions with respect to imposition of the
minimum franchise tax. For instance, credit unions and
nonprofit organizations are not subject to the minimum
franchise tax and a corporation is not subject to the
minimum franchise tax for its first taxable year. However,
even though a corporation is not subject to the minimum tax
in its first taxable year, it will be subject to franchise
tax in its first taxable year based on its taxable income.
3) Provides that 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 annual tax in an amount equal to the minimum
franchise tax, currently set at $800. These entities
(known as 'pass-through entities') are not subject to any
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 respective income or franchise
tax returns.
4) Provides that REMICs and financial asset securitization
investment trusts (FASITs) are subject to and are required
to pay the minimum franchise tax. RICs and REITs organized
as corporations are also subject to and are required to pay
the minimum franchise tax. 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) Provides that LLCs and certain small corporations,
solely owned by a deployed member of the United States
--------------------------
<1> According to the FTB, for taxable years beginning on or
after January 1, 1997, only taxpayers with net incomes of less
than approximately $9,040 pay the minimum franchise tax because
the amount of measured tax owed would be less than $800 ($9,039
x 8.84% = $799).
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(U.S.) Armed Forces, are exempted until January 1, 2018
from the $800 annual tax and minimum franchise tax.
FISCAL EFFECT : FTB estimates that this bill will decrease
General Fund revenue by $40 million in fiscal year (FY)
2014-15, $130 million in FY 2015-16, and $180 million in FY
2016-17.
COMMENTS :
1)Author's Statement . The author has provided the following
statement in support of this bill:
In order to spur economic growth and remain competitive in
a global market, California needs to address the fact that
we have one of the highest minimum franchise taxes in the
nation. Notwithstanding a lack of income, businesses are
still required to pay the minimum franchise tax. In 2011,
the [FTB] stated that 266,969 businesses reported a net
loss in income, and another 53,423 had no net income at
all. Additionally, a third of all businesses fail within
their first two years. AB 1645 eliminates the minimum
franchise tax for the second taxable year, which will lower
startup costs and remove a significant tax burden on our
small businesses.
2)Arguments in Support . Proponents argue that "[w]hile the
economy may have improved slightly in some areas, the reality
is that times are still difficult overall, especially for
working families. The unemployment numbers are still poor and
do not reflect the even worse underemployment numbers nor
those who have given up looking for work altogether." Because
of this, proponents state "[i]t's time for California to enact
business friendly legislation to make us a magnet once again
for business, which will in turn create new opportunities for
the citizens of this state to find jobs that will help them
and their families prosper."
3)Supply-Side Economics . Generally, advocates for tax
incentives, such as Arthur Laffer and N. Gregory Mankiw, argue
that reduced taxes allow taxpayers to invest money that would
otherwise be paid in taxes, thereby creating additional
economic activity. "Supply-siders" posit that higher taxes do
not result in more government revenue; instead, they suppress
additional innovation and investment that would have led to
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more economic activity and, therefore, healthier public
treasuries, under lower marginal tax rates. Critics, however,
assert that tax incentives rarely result in additional
economic activity. Companies do business in California
because of its competitive advantages, namely its environment,
transportation infrastructure, access to ports, highways, and
railroads, as well as its highly skilled workforce and
world-class higher education system. The amount of minimum
franchise tax, even for a small business, appears to be
nominal. It is unclear to Committee staff if eliminating the
minimum franchise tax will produce the desired economic
activity.
4)Minimum Tax . The minimum franchise tax, the annual tax, and
annual fee were enacted to ensure that all corporations and
LLCs pay at least a minimum amount of tax for the privilege of
conducting business in California, regardless of the
businesses income or loss. Thus, the minimum tax is not an
"income tax", but rather a tax on the right to exercise the
powers granted to a corporation doing business in California.
Even when a business earns no income, it still receives the
benefits of its corporate status, including the limited
liability protection under the California law.
5)$800 for Limited Liability . By providing limited liability to
certain entities (e.g., LLCs and LLPs), California is
essentially allowing a business owner to transfer part of the
cost of doing business onto creditors and tort victims.
(Jonathan Macey, The Limited Liability Company: Lessons for
Corporate Law, Washington University Law Review, Vol. 73,
Issue 2, 1995.) As an example, if an owner of a construction
company, having limited liability, injures an individual
during the course of business, the victim's redress is limited
to the assets of the company. If the company is insolvent,
part of the cost of the injury is borne by the victim. Before
the advent of LLCs and LLPs, that small business owner would
have likely started the company as a sole proprietor or
general partnership, allowing the victim to go after the
personal assets of the owner.
As a public policy, California has decided that the risk borne
by creditors and potential tort victims is outweighed by the
need to encourage investment. Providing limited liability to
small businesses, presumably with little or no assets, may
cause owners of the business to only consider those marginal
AB 1645
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costs and benefits associated with the investments that they
will internalize. In other words, "limited liability allows
investors to pursue extremely risky projects and to profit
from the pursuit of a 'heads I win; tails you lose' strategy
of project finance." (Id.) The idea that people will take on
greater risk because someone else will pay for the costs is
known as "moral hazard." (Id.) This tends to occur when
businesses are shielded from liability, but also when
businesses lack financial resources to provide adequate
compensation to creditors. (Id.) It may be argued that
creditors, knowing that LLCs have limited liability, will
require higher borrowing costs or ask personal guarantees from
the individual owners. However, the person hit by a taxi cab
or the victim of a toxic spill did not assume the potential
risk of the company's insolvency and owner's limited
liability. (David Millon, Piercing the Corporate Veil,
Financial Responsibility, and the Limits of Limited Liability,
Emory Law Journal, Vol. 65, Number 5, 2007.) The goal of
providing limited liability appears to be the state's need to
promote investment by transferring risk from investors to
creditors. (Id.) Therefore, LLCs and other limited liability
structures provide a substantial benefit to entrepreneurs at a
nominal cost of $800 per year, even when insolvent or
operating at a loss.
6)Charitable Organizations . This bill provides that the
exemption from the minimum franchise tax may not apply to
charitable organizations. However, charitable nonprofit
organizations are currently exempt from the minimum franchise
tax. It is unclear if this provision also applies to
charitable for profit corporations. In order to eliminate
confusion, the author may wish to define "charitable
organization" in this bill.
7)Related Legislation :
a) AB 2086 (Calderon) would allow LLCs to pay the annual
minimum tax, fee, and estimated tax over time. AB 1889 is
currently hearing by the Assembly Appropriations Committee.
b) AB 2428 (Patterson) provides a deduction for income
derived from a qualified business, provides an exemption
from the minimum franchise tax, and extends the sunset date
of the minimum franchise tax for deployed armed forces. AB
AB 1645
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2428 is currently on this Committee's Suspense File.
c) AB 2466 (Nestande) reduces the minimum tax for new
veteran-owned businesses and eliminate the tax if the
business operates at a loss or ceases operation. AB 2466
is currently on this Committee's Suspense File.
d) AB 2495 (Melendez) exempts new qualifying corporations,
limited partnerships, limited liability partnerships, and
limited liability companies from the annual minimum tax for
the first five consecutive taxable years. AB 2495 is
currently on this Committee's Suspense File.
8)Prior Legislation :
a) AB 2671 (Cook), Chapter 394, Statutes of 2010, exempts,
until 2010, certain small corporations and LLCs solely
owned by a deployed member of the U.S. Armed Forces from
the annual minimum franchise tax.
b) AB 327 (Garrick), of the 2009-10 Legislative Session,
would have reduced the minimum franchise tax from $800 to
$100. AB 237 was held on this Committee's Suspense File.
c) AB 2178 (Garrick), of the 2007-08 Legislative Session,
would have reduced the minimum franchise tax from $800 to
$200. AB 2178 was held on this Committee's Suspense File.
d) AB 1179 (Garrick), of the 2007-08 Legislative Session,
is similar to AB 327. AB 1179 was held on this Committee's
Suspense File.
e) AB 1419 (Campbell), of the 1997-98 Legislative Session,
would have reduced the minimum franchise tax for a
qualified corporation from $800 to $100. AB 1419 failed
passage in the Senate Revenue and Taxation Committee.
REGISTERED SUPPORT / OPPOSITION :
AB 1645
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Support
Board of Equalization member, Michelle Steel
California Chamber of Commerce
Opposition
None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098