BILL ANALYSIS �
AB 2466
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Date of Hearing: May 5, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 2466 (Nestande) - As Amended: March 27, 2014
Majority vote. Fiscal committee. Tax levy.
SUBJECT : Minimum annual tax: exemption: veteran-owned small
businesses
SUMMARY : Reduces the minimum franchise tax for a corporation
that is a new veteran-owned small business and eliminates the
tax if the business operates at a loss or ceases operation.
Specifically, this bill :
1)Provides that a corporation that is a new veteran-owned small
business shall pay annually a minimum franchise tax of $99,
for taxable years beginning on or after January 1, 2015, and
before January 1, 2018.
2)Provides that a corporation that is a new veteran-owned small
business shall not be subject to the minimum franchise tax for
taxable years in which the business operates at a loss,
beginning on or after January 1, 2015, and before January 1,
2018.
3)Defines a "new veteran-owned small business" as a
veteran-owned corporation that incorporated under the laws of
this state or has qualified to transact interstate business on
or after January 1, 2015, and begins business operations on or
after the its incorporation and has total income derived from
California of $250,000 or less. The definition does not
include a corporation that began business operations as a sole
proprietorship, a partnership, or any other form of business
entity prior to its incorporation. This reduction does not
apply to corporations that reorganize solely for the purpose
of reducing its minimum franchise tax.
4)Defines "operates at a loss" as negative income as defined by
Revenue and Taxation Code (R&TC) Section 24341.
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5)Defines a "veteran" as an individual honorably discharged from
the Armed Forces of the United States.
6)Defines a "veteran-owned corporation" as a corporation in
which stock representing more than 50% of the voting power of
the corporation and representing more than 50% value of the
stock of the corporation is owned by one or more veterans.
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
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
---------------------------
<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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(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 Franchise Tax Board (FTB) estimates that
this bill will reduce general fund revenue by $1.5 million in
fiscal year (FY) 2015-16, $6.6 million in FY 2016-17, and $5.6
million in FY 2017-18.
COMMENTS :
1)Author's Statement . The author has provided the following
statement in support of this bill:
Veterans of our armed forces are true heroes living in our
State but they face real challenges when returning home
after ending their active duty. Sadly, the unemployment
rate for veterans is far higher than for the civilian
population. One solution to this problem is to reduce some
of the costs of starting a new business. California's $800
minimum franchise tax is the highest in the country.
[This] bill would lower that to [$99] for any veteran owned
small business during its first three years of existence
during which it is not profitable. While these savings may
be modest, they could greatly help a small business during
its first few years when it is struggling to become
profitable. By doing this, California will be showing a
small token of appreciation for our veterans while also
helping small businesses become profitable which will serve
to create more jobs within our state.
2)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
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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 California law.
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. Regardless of the
benefits that may be provided to struggling veteran-owned
small companies, $800 is a nominal amount, even for a small
business. Therefore, it is unclear to Committee staff if
reducing or eliminating the minimum franchise tax would
achieve the desired result.
4)LLCs . For most of American history, business owners had a
choice of either a partnership or a corporation. Relatively
recently, however, the LLC business structure has become one
of the most popular choices for starting a new business
because it provides owners with the limited liability of "C"
corporations and the flow through tax status of partnerships.
In 2007, formation of LLCs in the U.S. outpaced the number of
corporations by a margin of two to one. As a result, 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. General partnerships that exists
today are either those that exist from the pre-LLC days or are
informal agreements that by default fall within the Uniform
Partnership Act. Professor Howard Freidman went on to say
that "[t]he once-elaborately drafted partnership agreement has
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gone the way of the buggy whip and slide rule. It has been
replaced by the LLC operating agreement." (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 the
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.) Despite the popularity of this
business structure, LLCs are not included in this bill.
Current law exempts the minimum franchise tax both LLC and
corporations that are solely owned by deployed veterans. In
order to remain consistent with these existing provisions, the
author may wish to amend the bill to include LLCs.
5)Technical Issues . As provided in FTB's staff analysis, the
term "total income derived from or attributable to the state"
is not defined. The absence of a definition could lead to
disputes with taxpayers and would complicate the
administration of this exemption.
6)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 1889 (Hagman) would reduce the minimum franchise tax
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in the second taxable year for a new corporation, and in
the first taxable year for a new LP, LLP and LLC with gross
receipts of $5,000. AB 1889 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.
7)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
$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), introduced in 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
None on file
Opposition
AB 2466
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None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098