BILL ANALYSIS �
SB 1131
Page 1
Date of Hearing: June 9, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
SB 1131 (Walters) - As Introduced: February 20, 2014
Majority vote. Fiscal.
SENATE VOTE : 35-0
SUBJECT : Income taxes: withholding: limited liability
companies.
SUMMARY : Excludes a member of a limited liability company
(LLC), treated as a partnership under federal income tax laws,
from the definition of an "employee" for purposes of the
Personal Income Tax (PIT) withholding.
EXISTING LAW :
1)Requires employers to withhold taxes or make contributions for
purposes of unemployment insurance, employment training, state
disability insurance, and personal income taxes based on the
"wages" and contract earnings of "employees."
2)Defines "wages" as the remuneration for services performed by
the employee for his or her employer.
3)Provides that the term "wages" includes compensation that is
deductible under the U.S. Internal Revenue Code and paid to a
member of an LLC filing a federal corporate income tax return.
4)Defines an "employee" as any individual who, under the usual
common law rules applicable in determining the
employer-employee relationship, has the status of an employee.
The main factor in the common law rule is if the employer has
the right to control the manner and means of accomplishing the
results desired.
5)Includes in the definition of an "employee" any officer of a
corporation, among other individuals.
SB 1131
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6)Provides that, with regard to all payroll tax collections, any
member of an LLC, which is treated as a corporation, is deemed
to be an "employee."
7)Excludes from the definition of an "employee," but only for
purposes of the Unemployment Insurance (UI), Employment
Training Tax (ETT) and State Disability Insurance (SDI)
withholding, any member of an LLC if the LLC is treated as a
partnership for federal income tax purposes.
FISCAL EFFECT : Unknown
COMMENTS :
1)The Author's Statement . The author has provided the following
statement in support of this bill:
"In 2010, Senate Bill 1244 (Walters) was passed by the
legislature and signed by the Governor to provide federal
conformity for Limited liability Corporations (LLCs) by
exempting members of LLCs, taxed as partnerships, from being
considered employees for tax purposes involving unemployment
insurance (UI), employment training tax (ETT) and state
disability insurance (SDI).'
"After the passage of SB 1244, concerns were raised that
personal income tax was unintentionally excluded from the
federal conformity for LLCs.'
"Without conformity, the Employment Development Department
[EDD], under most circumstances, applies common law factors to
an LLC member to determine which wages should be withheld.'
"Accordingly, a member of an LLC who is treated as a partnership
for federal income tax purposes, is not considered an employee
for UI, ETT or SDI purposes, but could be an employee for PIT
wage withholding.'
"SB 1131 would add a provision to the Unemployment Insurance
Code in order to clarify that "Employee" does not include any
member of a limited liability company that is treated as a
partnership, for federal income tax purposes."
SB 1131
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2)Arguments in Support . The proponents of this bill argue that
this bill is needed to "resolve great concerns from the tax
practitioner community." While California currently "conforms
to the federal law by exempting members of LLCs taxed as
partnerships from being employees for UI, ETT and SDI tax
purposes," the personal income tax is excluded, which causes a
great deal of confusion amongst tax practitioners and
taxpayers alike. With this bill, "California will ? be in full
conformity with federal rules regarding remuneration of LLC
members," which will ease administration of the tax code and
"will resolve great concerns from the tax practitioner
community that PIT was excluded from federal conformity."
3)Background: What is an LLC ? SB 469 (Beverly), Chapter 1100,
Statutes of 1994, authorized the formation of LLCs in
California. An LLC is a business entity formed by members by
filing a document, usually called "Articles of Organization,"
with an officer designated by state law. An LLC combines
aspects of partnerships and corporations so an LLC is less
formal and more flexible than a typical corporation, yet
offers protection as well as certain advantages that are much
the same. For example, LLC owners have limited liability for
the entity's debts and obligations, similar to the status of
shareholders in a corporation. Their assets are separate from
the assets of the LLC so they cannot be seized. Members of
the LLC may choose to have the LLC be taxed as a regular
corporation or as a partnership, where the income and losses
are normally passed through to the owners. Flow-through
taxation is advantageous since members are only required to
pay taxes on their earnings once, instead of paying both
corporate and individual taxes.
4)LLCs and the Definition of "Employee ." Existing law requires
employers to withhold tax and make contribution amounts with
respect to unemployment insurance, disability insurance,
employee training funding, and personal income tax from the
wages paid to their employees. Thus, every employer who pays
wages to a resident employee for services performed either in
or outside California, or to a nonresident employee for
services performed in California, to deduct and withhold from
those wages, for each payroll period, a personal income tax,
computed in a specified manner. The personal income tax (PIT)
withholdings are deposited with the EDD, either by mail or
electronically, along with amounts for UI, ETT, and SDI.
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With specified exceptions, the determination of whether an
employer-employee relationship exists is made pursuant to
common law principles. Under both federal and state law, an
LLC may be treated as a sole proprietorship, partnership, or
corporation, depending on the circumstances. However, for
purposes of state payroll taxes, prior to 2011, the EDD was
required to disregard the federal or state designation of an
LLC and, instead, consider an LLC to be a unique entity.
Consequently, for purposes of the payroll taxes administered
by the EDD, an LLC was not an employer in the traditional
sense, did not have employees and did not pay unemployment
insurance taxes. As such, an LLC was unable to offset its
federal unemployment tax liability through the payment of
state unemployment insurance taxes.
In 2010, the Legislature passed SB 1244 (Walters), Chapter
522, Statutes of 2010, to conform the Unemployment Insurance
Code to federal regulations regarding LLCs in order to allow
LLCs to offset federal unemployment insurance tax costs.
Specifically, SB 1244 included any member of an LLC, which is
treated as a corporation for federal income tax purposes,
within that definition of "employee" for those purposes.
However, SB 1244 specifically excluded from that definition of
"employee" any member of an LLC that is treated as a
partnership for federal income tax purposes.
5)What Does this Bill Do ? While SB 1244 provided California
taxpayers with full conformity to the federal employment tax
rules for LLC members, as discussed, it failed to expressly
provide that a member of an LLC, which is treated as a
partnership for federal income tax purposes, is not an
"employee" for purposes of the PIT withholding. Consequently,
such a member may be treated as a non-employee for purposes of
UI, ETT, or SDI, but may be found to be an "employee" for
purposes of PIT withholding based on common law principles.
According to the author, this disparate treatment was
unintended and causes needless confusion and inefficiency in
the administration of employment taxes. This bill would fully
conform California to federal law with respect to the
definition of "employee," with regard to LLCs, by excluding a
member of an LLC, treated as a partnership for federal income
purposes, from the definition of "employee" for purposes of
PIT withholding.
6)The Benefits of Federal Conformity . When changes are made to
SB 1131
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the federal income tax law, California does not automatically
adopt such provisions. Instead, state legislation is needed
to conform to most of those changes. Conformity legislation
is introduced either as individual tax bills to conform to
specific federal changes or as one omnibus bill to conform to
the federal law as of a certain date with specified
exceptions, a so-called "conformity" bill.
Businesses generally prefer conformity to federal tax laws
because it reduces their state tax compliance costs. The tax
practitioners have argued that there are significant costs
associated with federal non-conformity. Failure to conform to
federal law in some areas may lead to improper tax reporting
to California and extra costs to the taxpayers. Finally,
conformity legislation is also important to state agencies.
Tax conformity eases the burden, and reduces the costs, of tax
administration because the state may rely on federal audits,
federal case law, and regulations.
Under federal law, members of an LLC that elects to be taxed as
a partnership are treated as self-employed and not as
employees, but state law requires personal income tax
withholding. Excluding a member of an LLC from the definition
of an "employee" under California law would provide conformity
with federal law and would create consistency in tax treatment
of members of those specified LLCs.
REGISTERED SUPPORT / OPPOSITION :
Support
California Society of Enrolled Agents
California Taxpayers Association
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098