BILL ANALYSIS �
AB 1889
Page A
Date of Hearing: May 5, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 1889 (Hagman) - As Amended: April 3, 2014
Majority vote. Fiscal committee. Tax Levy.
SUBJECT : Minimum franchise tax: annual tax: small business
SUMMARY : Reduces the minimum franchise tax to $400 for a new
corporation in the second taxable year, and reduces the annual
tax to $400 for new limited partnerships (LP), new limited
liability partnerships (LLP), and new limited liability
companies (LLC) defined as small businesses in the first taxable
year. Specifically, this bill :
1)Provides, beginning on or after January 1, 2015, that every
new LP, LLC, and LLP defined as a small business shall pay an
annual tax of $400 for its first taxable year.
2)Provides, beginning on or after January 1, 2015, that every
new corporation defined as a small business shall pay a
minimum franchise tax of $400 for its second taxable year.
3)Defines a "small business" as an LP or LLP that has gross
receipts, less returns and allowances, reportable to this
state for the taxable year of $5,000 or less.
4)Defines a "small business" as a corporation and an LLC that
reasonably estimates that it will have gross receipts, less
returns and allowances, reportable to this state for the
taxable year of $5,000 or less.
5)Defines "gross receipts, less returns and allowances
reportable to this state" as the sum of gross receipts from
the production of business income and the gross receipts from
the production of nonbusiness income, as defined in Revenue &
Taxation Code (R&TC) Section 25120.
6)Defines a "new LP" as an LP that is organized under the laws
of this state or has qualified to transact intrastate business
AB 1889
Page B
in this state that begins business operations at or after the
time of its organization. A "new LP" does not include any LP
that began business operations as, or acquired its business
operations from, a sole proprietorship, a LLC, general
partnership, a corporation, or any other form of business
entity prior to its organization or that acquired its business
operations from a partnership. This reduction in the minimum
franchise tax shall not apply to any LP that reorganizes
solely for the purpose of reducing its annual tax.
7)Defines a "new LLC" as an LLC that is organized under the laws
of this state or has qualified to transact intrastate business
in this state that begins business operations at or after the
time of its organization. A "new LLC" does not include any
LLC that began business operations as, or acquired its
business operations from, a sole proprietorship, a
partnership, a corporation, or any other form of business
entity prior to its organization or that acquired its business
operations from an LLC. This reduction in the minimum
franchise tax shall not apply to any LLC that reorganizes
solely for the purpose of reducing its annual tax.
8)Defines a "new LLP" as an LLP that is organized under the laws
of this state or has qualified to transact intrastate business
in this state that begins business operations at or after the
time of its organization. A "new LLP" does not include any
LLP that began business operations as, or acquired its
business operations from, a sole proprietorship, an LLC, a
corporation, a partnership, or any other form of business
entity prior to its organization or that acquired its business
operations from an LLP. This reduction in the minimum
franchise tax shall not apply to any LP that reorganizes
solely for the purpose of reducing its annual tax.
9)Defines a "new corporation" as a corporation that is
incorporated under the laws of this state or has qualified to
transact intrastate business in this state that begins
business operations at or after the time of its incorporation.
A "new corporation" does not include any corporation that
began business operations as, or acquired its business
operations from, a sole proprietorship, a partnership, LLC, or
any other form of business entity prior to its incorporation
or that acquired its business operations from a corporation.
This reduction in the minimum franchise tax shall not apply to
any corporation that reorganizes solely for the purpose of
AB 1889
Page C
reducing its minimum franchise tax.
10)Provides that reduction in the annual and minimum franchise
tax shall apply to corporations, LPs, LLCs, or LLPs only if
they file a timely return.
11)Provides that if the LLC or corporation's gross receipts
exceed $5,000, an additional tax in the amount equal to $400
shall be paid on the due date of its return for the taxable
year, without regard to extension.
12)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 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
---------------------------
<1> According to the Franchise Tax Board (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).
AB 1889
Page D
passed-through to the owners and reported on their respective
income or franchise tax returns.
4)Provides that real estate mortgage investment conduits
(REMICs) and financial asset securitization investment trusts
(FASITs) are subject to and are required to pay the minimum
franchise tax. Regulated investment companies (RICs) and real
estate investment trusts (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 (U.S.) Armed
Forces, are exempted until January 1, 2018 from the $800
annual tax and minimum franchise tax
FISCAL EFFECT : The FTB estimates that this bill will reduce
general fund revenue by $2.7 million in fiscal year (FY)
2014-15, $6.8 million in FY 2015-16, and $9.7 million in
2016-17.
COMMENTS :
1)Author's Statement . The author has provided the following
statement in support of this bill:
In the midst of recovery, California cannot afford to lose
small businesses to other states. Any revenue lost by
reducing the minimum franchise tax would be offset by the
gains associated with encouraging entrepreneurs to open
businesses and hire employees.
2)Arguments in Support . Proponents state that "small businesses
in California are required to pay an annual minimum franchise
tax of $800 the first quarter of the year, which will
ultimately be applied towards the company's overall annual tax
liability. This $800 is owed and must be prepaid, regardless
of whether the company is active, inactive, or even makes a
profit." Proponents argue that this bill will help reduce the
burden on newly formed small businesses and, thereby,
encourage growth and will allow small businesses to place more
capital upfront towards expanding their businesses rather than
AB 1889
Page E
for the prepayment of taxes that they may never owe.
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
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. Reducing the minimum
franchise tax by $400, even for a small business, appears to
be a nominal amount. It is unclear to Committee staff if
reducing 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
doing 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, LLPs, and corporations),
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
AB 1889
Page F
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
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.
5)Cash Flow Problems . Both startups and established companies
may, at some point, face cash flow problems. A number of
things can put a strain on a business' cash flow: customers
can choose not to pay or pay late, cost of materials can
skyrocket, unforeseen acts of god can delay production, and
changes in interest rates can increase the costs of capital.
Additionally, once a business realizes that it is unable to
pay current debts, it may be difficult, if not impossible to
secure additional funding. This bill attempts to aid new
small businesses as they struggle to become profitable.
However, it is unclear to Committee staff if reducing the
AB 1889
Page G
minimum franchise tax by $400 will help struggling businesses
succeed.
6)Technical Issues . As noted by FTB's staff, "[a]n LP, LLP, LLC
or corporation that organized prior to the effective date of
this bill that meets the definition of a 'new LP, LLP, LLC or
corporation' would qualify for a reduced minimum franchise
tax. Therefore, existing business entities, not just new
business entities, could qualify for this bill's exemption."
Additionally, FTB's staff notes that references in this bill
to the Corporations Code are obsolete and should be deleted.
Specifically, on page 7, line 7, delete "corporation" and
insert "limited liability company."
7)Related Legislation :
a) AB 2086 (Calderon) would allow LLCs to pay the annual
minimum tax, fee, and estimated tax over time. AB 1889
will be heard in this Committee today.
b) AB 2244 (Chau) would reduce the minimum franchise tax to
$200 for a dormant business entity and to $50 for an
inactive business entity. AB 2244 will be heard in this
Committee today.
c) 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
2428 will be heard in this Committee today.
d) 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
will be heard in this Committee today.
e) 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 will be
heard in this Committee today.
8)Prior Legislation :
AB 1889
Page H
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 under submission in this Committee.
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 under submission in this Committee.
d) AB 1179 (Garrick), of the 2007-08 Legislative Session,
is similar to AB 327. AB 1179 was held in this committee.
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 :
Support
California Chamber of Commerce
La Verne Chamber of Commerce
Opposition
None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098