BILL ANALYSIS �
AB 2086
Page A
Date of Hearing: May 1, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 2086 (Calderon) - As Amended: April 21, 2014
Majority vote. Fiscal committee.
SUBJECT : Business entities: annual tax: minimum franchise
tax: fees
SUMMARY : Provides limited liability companies (LLC) with
several options to pay the minimum franchise tax and the annual
fee, and provides corporations with similar options to pay the
estimated minimum franchise tax. Specifically, this bill :
1)Provides that the minimum franchise tax may be paid by an LLC
in the following three ways:
a) On or before the 15th day of the fourth month of the
taxable year; or,
b) In three equal installments on or before the 15th day of
the fourth, the 15th day of the eighth month, and 15th day
of the twelfth month of the taxable year; or,
c) In two equal installments, with the first installment on
or before 15th day of the fourth month of the taxable year
and the second installment on or before 12 months of that
date.
2)Provides that the annual fee may be paid by an LLC in the
following three ways:
a) On or before the date the return is required to be filed
under Revenue and Taxation Code (R&TC) Section 18633.5; or,
b) In three equal installments on or before 15th day of the
fourth, the 15th day of the eighth month, and the 15th day
of the twelfth month from the date the return is required
to be filed under R&TC Section 18633.5; or,
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c) In two equal installments, with the first installment on
or before the 15th day of the fourth month from the date
the return is required to be filed under R&TC Section
18633.5 and the second installment on or before 12 months
of that date.
3)Allows a corporation to pay the estimated corporate tax, if
the estimated tax does not exceed the minimum franchise tax,
in the following three ways:
a) On or before the 15th day of the fourth month of the
taxable year; or,
b) In three equal installments on or before the 15th day of
the fourth, the 15th day of the eighth month, and the 15th
day of the twelfth month of the taxable year; or,
c) In two equal installments, with the first installment on
or before the 15th day of the fourth month of the taxable
year and the second installment on or before 12 months of
that date.
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.<1> Taxpayers
must pay the minimum franchise tax only if it is more than
their regular franchise tax liability.
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
---------------------------
<1> According to the Franchise Tax Board (FTB), for taxable
years beginning on or after January 1, 1997, only taxpayers with
net income 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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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 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 : FTB's staff states that "[t]he impact to the
general fund revenues cannot be estimated until the
implementation concerns have been resolved. For example, the
due date of taxes, and effective application dates for penalties
and interest are uncertain."
COMMENTS :
1)The author has provided the following statement in support of
this bill:
California has long been heralded as a role model for the
rest of the nation. From technological innovation to its
vibrant entertainment industry, California leads the way in
diverse economic opportunities and job creation. However,
the effects of the most recent recession are still being
felt throughout the State. While California's unemployment
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rate of 8.0% as of February, 2014, has decreased over the
past few years, it is still higher than the national
unemployment rate of 6.7%. In order to further reduce
California's unemployment rate and create jobs for its
citizens, the State must provide long term solutions and
incentives to businesses that wish to operate in
California. With one of the highest corporate taxes in the
nation, California's position as a leader in economic
opportunity and job creation is threatened. By addressing
the effects of high tax rates on companies, California can
move in the right direction to spur economic growth and
create jobs for its citizens.
2)Arguments in Support . Proponents of this bill state that
"[LLCs] are required to pay their annual taxes, fees, and
minimum franchise taxes on or before April 15 of each year,
even if they are operating at a loss. AB 2086 eases this
burden, however, by providing certain [LLCs] with the
following payment options: (1) on or before April 15 of year;
(2) in three equal installments due on or before April 15,
August 15, and December 15 of each year; or (3) in two equal
installments due on or before April 15, and within twelve
months of the date of the first installment." Additionally,
advocates state that "[h]aving a long term, permanent solution
to incentivize business, including family-owned and operated
businesses to both start up or stay in California is a
sensible policy."
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. It is unclear to
Committee staff if providing a payment plan for the minimum
franchise tax, the annual fee, and estimated tax will produce
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the desired economic activity and job growth. In the end, the
payments will have to be made, and any benefit received by the
business would likely be small.
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 this state, regardless of the businesses
income or loss. Thus, the minimum tax is not an "income tax",
but rather it is 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 laws of this state.
5)LLCs . Throughout American history, prospective business
owners had a choice of either a forming a general partnership
or a corporation. LLCs offer the benefits of both, providing
the limited liability of a corporation and the ease of a
general partnership. The combination of the two has made LLCs
the number one choice among businesses entities. In fact, in
2007, formation of LLCs in the U.S. outpaced the number of
corporations by a margin of two to one. Additionally, the
number of new partnerships, although difficult to track, has
also substantially decreased. According to Professor Howard
Freidman, the general partnership can easily be replaced by an
LLC, providing the informal benefits of a partnership along
with limited liability. (Rodney D. Chrisman, LLCs are the New
King of the Hill, Fordham Journal of Corporate and Financial
Law, Vol. 15, Issue 2, 2009.)
In general, LLCs provide limited liability, avoidance of
double taxation, flexibility of income distribution,
simplicity of formation and procedures, and no restrictions on
ownership. For a small business owner who has never
considered forming as a "C" corporation, the major benefit of
an LLC is the limited liability. Generally, members of an LLC
are not liable for the debts, liabilities, or obligations of
the firm. (Jonathan Macey, The Limited Liability Company:
Lessons for Corporate Law, Washington University Law Review,
Vol. 73, Issue 2, 1995.) Members are also not liable for tort
or contractual obligations of other members of the firm, even
if incurred during the course of the firm's business. (Id.)
The benefits associated with providing newly formed businesses
with limited liability should be weighed against the costs
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borne by others. (Id.) Specifically, LLCs allow the owner to
transfer the cost to creditors and tort victims. (Id.) As an
example, if an owner of a construction company, formed as an
LLC, injures an individual during the course of business, the
victim's redress is limited to the assets of the company. If
the LLC is insolvent, the cost of the injury is borne on the
victim. Before the advent of LLCs, that business owner would
have likely started the company as a sole proprietor, 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 LLC 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.) 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)Helping Profitable LLCs . Presumably, this bill is intended to
provide a payment plan for struggling LLCs. However, nothing
in this bill prevents an extremely profitable LLC from taking
advantage of the payment options. Unlike the minimum tax, the
annual fee is only paid by LLCs with income of more than
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$250,000. Those making more than $250,000 but less than
$500,000 pay an annual fee of $900. The fee increases to a
maximum of $11,790 for LLCs making more than $5 million in
income per year. It is unclear to Committee staff how a
payment plan provided to an LLC making more than $5 million
would increase economic activity under this bill. It is also
unclear to Committee staff as to how providing payment options
of two or three equal payments will increase jobs in
California. It would appear that the payment plans provided
for in this bill have less to do with hiring additional
employees and more to do with providing cash flow relief for
small businesses. If this is the case, it seems unnecessary
to provide a payment plan on annual fees to LLCs that make
more than $5 million in income per year. Therefore, the
author may wish to eliminate the payment plan for the annual
fee.
7)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 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. It appears that this bill would
provide LLCs with the ability to pay the tax over time,
allowing businesses to use cash on hand to pay other
obligations. Regardless of the benefit that may be provided
to struggling LLCs, $800 is a nominal amount, even for a small
business. Therefore, it is unclear to Committee staff if a
payment plan for an $800 obligation would help struggling
businesses succeed.
8)Technical Issues . FTB's staff states that this bill "lacks a
process for a taxpayer to select a payment option and report
that selection to the FTB. Generally, a taxpayer is required
to make a binding election to provide certainty for both the
taxpayer and the department. Additionally, a binding election
would provide the information needed to determine when
interest and a late or underpayment penalty would apply."
FTB's staff also explained that "[b]ecause the penalty and
interest provisions are unchanged, a taxpayer that made
payments as described in one of the payment options could be
subject to interest and penalties."
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9)Related Legislation :
a) AB 1889 (Hagman) would reduce the minimum franchise tax
in the second taxable year for a new corporation, and in
the first taxable year for a limited partnership, new
limited liability partnership, and new LLC with gross
receipts of $5,000. AB 1889 will be heard by 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 by 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 by this 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 by 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 by this Committee today.
10)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 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
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$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
Family Business Association
Opposition
None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098