September 2002

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Chris Micheli is an attorney and registered lobbyist for the Sacramento governmental relations firm of Carpenter Snodgrass & Associates (916/447-2251) or cmicheli@ carpentersnodgrass.com, where he specializes in tax legislative matters.is a member of the California Assembly, representing parts of Riverside and San Bernardino counties. He wrote this commentary for Cal-Tax Digest.

As part of the 2002-03 California budget agreement, the Senate and Assembly adopted a package of revenue-raising proposals, including several tax law changes in the early morning hours of September 1, 2002. This package was a critical piece of concluding the state budget that was 62 days past due. Governor Davis signed these bills into law on September 5, 2002.

NOL Suspension and Increase

Existing law allows individual and corporate taxpayers to utilize net operating loss (NOL) carryovers for the purpose of offsetting their individual and corporate tax liabilities.

This bill prevents taxpayers from utilizing NOL carryovers in the 2002 and 2003 tax years only. Taxpayers will be able to deduct those suspended NOLs beginning on January 1, 2004. The bill extends the carryover period for the NOL, allowing taxpayers to have the same number of years (10 years carryforward) to utilize the loss, as they would have if the change had not been enacted. Because this bill would result in a change in state taxes for the purpose of increasing state revenues under Constitution Article XIIIA, Section 3, it required a 2/3-majority vote of each house for passage. The bill amends CRTC Sections 17276.3 and 24416.3, and the NOL suspension is applicable for "any taxable year beginning on or after January 1, 2002 and before January 1, 2004."  This provision is contained in AB 2065. Fiscal Impact:  $1.2 billion gain.

In addition, this bill increases the deduction percentage from its current 60% to 100% for net operating losses incurred in taxable years beginning on or after January 1, 2004. Under existing law, the 60% deduction was scheduled to increase to 65% on January 1, 2004.

A similar temporary suspension was enacted the 1991 and 1992 tax years, with businesses allowed to extend the expiration date of their existing NOLs for an additional two years. Note that this suspension does affect NOLs in California’s economic development zones, including EZs, LAMBRAs, and TTAs.

Bank Bad Debt Reserve Accounting Method Modification

Existing law, in partial conformity to federal law, allows a deduction for bad debts, except that the deduction of a savings and loan association, or bank, or financial corporation is determined in accordance with special rules that allow a deduction for a reasonable addition to a reserve for bad debts.

This bill, with respect to banks, savings and loan associations, or financial corporations, modifies that special rule to provide additional conformity to federal income tax law relating to reserves for losses on loans, with certain specified exceptions. It also makes related changes to the alternative minimum tax. The net amount of adjustment shall be determined by “taking into account only 50% of the ‘applicable excess reserves’.”  Thereafter, the amount of reserves shall be reduced to zero and shall not be taken into account. Because this bill would result in a change in state taxes for the purpose of increasing state revenues under Constitution Article XIIIA, Section 3, it required a 2/3-majority vote of each house for passage. The bill amends CRTC Sections 23457, 24348, and 24449. It requires a reasonable addition to a reserve for bad debts "determined in accordance with IRC Section 585 relating to reserves for losses on loans of banks, and would apply only to taxable years beginning on or after January 1, 2002."  This provision is contained in AB 2065.  Fiscal Impact:  $285 million gain

The reserve method of accounting for bad debts allows a taxpayer to take a deduction for debts expected to be worthless in the future. In 1986, the federal government changed its law to not allow large banks (defined as "those with an average adjusted basis of all assets greater than $500 million”) to use the reserve method of accounting for bad debts to determine their bad debt deduction for federal tax purposes. Since 1986, large banks can only deduct the debts that actually become worthless during the taxable year. This language requires the elimination of 50% of bad debt reserves that had been charged off as reasonable, rather than the full amount of reserve against which no bad debts had been charged. Banks would be able to charge off only actual losses, rather than deducting reserves.

Delinquent Accounts

Existing law imposes a tax measured by the income of residents and part-year residents, as well as a sales/use tax on purchases of certain tangible personal property. Any unpaid taxes due and payable under the law are subject to penalties, interest, and any expenses and fees associated with the collection of the taxes owed.

This bill, for the period beginning on October 1, 2002 and ending on June 30, 2003, authorizes the State Board of Equalization (SBE) and the Franchise Tax Board (FTB) to forgive any penalties, interest, or fees on “any unpaid taxes” owed by eligible taxpayers to the extent that the underlying tax liability is reduced by an "eligible amount" (i.e., the outstanding tax liability is paid). This authority granted to the SBE and FTB is limited to unpaid tax liability that has been determined by the tax agency to be a “high-risk collection account.” Because this bill is an urgency statute to take effect immediately, it required a 2/3 vote of each house for passage. It adds and repeals CRTC Sections 7093.8 and 19444, setting forth legislative intent language and definitions of "eligible taxpayer" (basically any individual with an unpaid tax liability that receives notification from the SBE or FTB that the unpaid tax liability of that individual constitutes a high-risk collection account), "eligible amount," "high-risk collection account," and "unpaid tax liability." This provision is contained in AB 2065.  Fiscal Impact: $145 million gain

Under this program, the FTB and SBE will contact delinquent taxpayers with an offer to waive interest and penalties if back taxes are paid. The agencies will determine which taxpayers to contact, in order to ensure that only cases where the full amount could not be collected are eligible for this program.

Land Donation Tax Credit Suspension

Existing law provides the Natural Heritage Preservation Tax Credit of 2000 that provides a personal income or corporate tax credit against the taxes imposed in an amount equal to 55% of the fair market value of any qualified contribution made during the tax year to the state, a local government, or any nonprofit organization designated by a local government. The total amount of tax credits that may be awarded by the Wildlife Conservation Board over the four years of the credit's existence is $100 million.

This bill prevents any tax credits from being awarded from July 1, 2002 through June 30, 2003.  It will be available again beginning on or after July 1, 2003. This bill results in a change in state taxes for the purpose of increasing state revenues under Constitution Article XIIIA, Section 3, and thus required a 2/3-majority vote of each house for passage. It amends Public Resources Code Section 37022. This provision is contained in AB 3009. Fiscal Impact: $3 million gain

Teacher Retention Tax Credit Suspension

Existing law provides a tax credit to a credentialed teacher in an amount of $250, $500, $1,000, or $1,500 based upon the years of service as a credentialed teacher.  Effective January 1, 2002, a credentialed teacher must have at least four years of service to be eligible for the $250 credit. The credit may not exceed 50% of the amount of tax that would be imposed upon the taxpayer’s income attributable to service as a teacher at a qualifying educational institution.

This bill suspends the tax credit for the 2002 tax year only.  It will be available again beginning on or after January 1, 2003. This bill results in a change in state taxes for the purpose of increasing state revenues under Constitution Article XIIIA, Section 3, and thus required a 2/3-majority vote of each house for passage. It amends CRTC Section 17052.2. This provision is contained in AB 2065. Fiscal Impact: $170 million gain

Overpayment Interest Rate Reduced

Existing law provides for the payment of interest at certain specified rates that the State of California pays on unclaimed property claims, as well as corporate and estate tax overpayments.

This bill would provide that the interest rate is the lesser of either the bond equivalent rate of 13-week U.S. Treasury bills (which is currently 1.65%) or five percent. As a result, the interest rate paid by California on estate and corporate tax overpayments, as well as unclaimed property tax overpayments, will be less than the interest rate paid by taxpayers on their underpayments (6%), which is similar to what is done for sales tax overpayments. It amends Code of Civil Procedure Section 1540, and CRTC Sections 13563 and 19521. This provision is contained in AB 1768. Fiscal Impact: $24 million gain

Franchise Tax Board Settlement and Collections Programs Enhanced

Audit program to Step-up Auditing to Target Tax Credits – This proposal uses existing resources to increase auditing activities for tax credits claimed by corporations. Currently, tax credits are audited as part of the normal audit process.  Given the large amount of tax credits available, it is prudent to more closely scrutinize these credits according to the Governor. Fiscal Impact: $60 million gain.

Settlement Workloads Modified to Allow More Cases to be Accepted into the Settlement Process – Currently, when a case is determined to be eligible for the settlement process involving corporate taxpayers, the case is "handed over" from the original attorney to the settlement attorney. This proposal allows the original attorney to follow the case to conclusion through the settlement process, thereby fully utilizing the expertise in the case and ensuring timely and proper settlement. Fiscal Impact: $28 million gain (revenue acceleration).

Prioritize Workload to Maximize Revenues – This proposal ensures that large settlement cases involving corporate taxpayers where tax is due are concluded in a timely manner. Fiscal Impact: $15 million gain (revenue acceleration).

Settlement Program Attorneys – This proposal provides two additional settlement attorneys to work down the backlog of settlement cases. Fiscal Impact: $14 million gain.

Augment Tax Collections Staff for Remaining 5:1 Audits – This proposal provides resources for additional collectors to ensure that all collections above the 5:1 benefit: cost ratio are collected. Fiscal Impact: $11.5 million gain.

Augment Legal Staff for Protest Function – This proposal provides two additional attorneys to ensure timely and proper completion of tax protest cases of $5 million or more. Fiscal Impact: $3 million gain Yr1; $64 million gain Yr2.

These provisions are contained in AB 425.

Increase ERPA Surcharge Cap

Existing law imposes a cap on the surcharge imposed on the consumption of electricity purchased from an electric utility at a rate fixed by the SBE. The surcharge is to fund the Energy Resources Program Account (ERPA) and is based on a rate of two-tenths of a mill per kilowatt-hour for electrical energy purchased from an electric utility on or after January 1, 2003.

This bill increases the "cap" on the surcharge imposed on electricity sales to fund the ERPA from 2 tenths of a mill to 3 tenths of a mill per kilowatt-hour. This bill results in a change in state taxes for the purpose of increasing state revenues under Constitution Article XIIIA, Section 3, and thus required a 2/3-majority vote of each house for passage. It amends CRTC Section 40016. This provision is contained in AB 3009.  Fiscal Impact:  $10 million gain

Commercial Real Estate Sales Withholding

Existing law requires the transferee of real property to withhold 3 1/3% of the purchase price of real property if the property was acquired from a non-resident (i.e., non-Californian) person, or who after the transfer of the real property, will no longer be a resident of California, or from a corporation, if after the transfer that corporation has no permanent place of business in California.

This bill, for tax years beginning on or after January 1, 2003, extends this 3 1/3% withholding requirement to specified transfers of real property acquired from an individual. There are a number of exceptions to this withholding rule, including sales under $100,000, sales of principal residences, and like-kind exchanges under IRC Sections 1031 or 1033. This provision is contained in AB 2065. Fiscal Impact: $225 million gain

Stock Options/Bonus Withholding

Existing law requires the FTB to prepare wage withholding tables to be used by employers for purposes of withholding taxes on wages paid, but allows withholding at a rate of 6% with respect to supplemental wages, including bonuses and stock options, in lieu of the withholding tables.

This bill, effective for payments made on or after January 1, 2002, allows withholding at a rate of 9.3% with respect to stock options and bonus payments, in lieu of the withholding tables or the specified withholding rate with respect to supplemental wages, and makes other related conforming changes. This provision is contained in AB 2065. Fiscal Impact: $400 million gain

Underpayment Penalty Waived

Existing law provides that no addition to tax shall be made for any period before April 15, 2003, with respect to any underpayment of an installment for the 2002 tax year if that underpayment was due to any provision of the omnibus federal tax conformity bill (AB 1122) signed into law on May 8, 2002 (Chapter 35). Generally, the FTB may impose penalties with respect to the underpayment of taxes.

This bill provides that no underpayment penalty may be imposed if any underpayment of an installment for the 2002 tax year was created or increased by “any law enacted or amended by an act chaptered during the 2002 calendar year.” It amends CRTC Section 19136.8. This provision is contained in AB 2065.

2002 BUDGET TAX PACKAGE

© Chris Micheli, 2002.