BILL ANALYSIS �
AB 2495
Page A
Date of Hearing: May 5, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 2495 (Melendez) - As Amended: April 28, 2014
Majority vote. Fiscal Committee. Tax levy.
SUBJECT : Minimum franchise tax: annual tax: exemption
SUMMARY : Eliminates the minimum franchise tax for limited
partnerships (LP), limited liability Partnerships (LLP), Limited
Liability Companies (LLC), and corporations for the first five
consecutive taxable years. Specifically, this bill :
1)Provides, on or after January 1, 2015, that the following
shall not be subject to the minimum franchise tax for the
first five consecutive taxable years:
a) LPs that file a certificate of LP application or an
application for registration with the Secretary of State
(SOS);
b) LLCs that file a certificate of organization or an
application for registration with the SOS;
c) LLPs that register as an LLP with the SOS; and,
d) Corporations that are qualified new corporations.
2)Defines a "qualified new corporation" as a corporation that is
incorporated under the laws of this state or has qualified to
transact business in this state on or after January 1, 2015,
and that begins business operations at or after the time of
its incorporation. "Qualified new corporation" does not
include any corporation that began business operations as a
sole proprietorship, a partnership, or any other form of
business entity prior to its incorporation.
3)Provides that the exemption does not apply to businesses that
reorganize solely for the purpose of avoiding payment of its
annual tax.
AB 2495
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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 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
(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
---------------------------
<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).
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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 : Unknown
COMMENTS :
1)Author's Statement . The author has provided the following
statement in support of this bill:
California annually ranks near the bottom of business
friendly states due to over-regulation and high tax rates.
Small businesses continue to leave the state in search of
greener pastures. California currently has the highest
Minimum Franchise Tax in the nation. This creates a
disincentive for entrepreneurs who are contemplating
opening a new business or relocating their business to
California. The State Legislature should be doing
everything in its power to improve our business climate and
help get Californians back to work.
2)Arguments in Support . Proponents of this bill state that
California has the highest minimum franchise tax in the
country, charged whether or not the business is profitable and
serves as a barrier to entry. Specifically, proponents argue
that the minimum franchise tax, "coupled with myriad
regulations, unanticipated costs, and the threat of frivolous
lawsuits, gives the average small employer or entrepreneur
great pause to want to create or sustain a business and create
jobs in our state."
3)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
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its corporate status, including the limited liability
protection under California law.
4)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 new businesses, $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 substantially benefit new businesses.
5)$800 for Limited Liability . By providing limited liability to
certain entities, (e.g. LLCs, LLPs, 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,
the cost of the injury is borne on the victim. Before the
advent of LLCs and LLPs, that small business owner would have
likely started the company as a sole proprietor or
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
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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 their businesses are
insolvent or operating at a loss.
6)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 could
aid new businesses as they struggle to become profitable.
However, as noted earlier, $800 is a nominal amount, and it is
unclear if the elimination of the minimum tax would help
struggling businesses succeed.
7)Related Legislation :
a) AB 2086 (Calderon) provides payment options for an LLC
to pay the annual minimum tax, fee, and the estimated tax.
AB 2086 will be heard in this Committee today.
b) 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 limited partnership, new
limited liability partnership, and new LLC with gross
receipts of $5,000. AB 1889 will be heard in this
Committee today.
c) 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.
d) 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.
e) 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.
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), introduces in the 2009-10 Legislative
Session, would have reduced the minimum franchise tax from
$800 to $100. AB 237 was held in this Committee.
c) 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 in this Committee.
d) AB 1179 (Garrick), introduced in 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
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Taxation Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Chamber of Commerce
Michelle Steel, Vice Chair, State Board of Equalization
National Federation of Independent Business
Opposition
None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098