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Proposition 30:
Retroactive Income Tax Increase With Penalty Relief; No Relief for Government on Sales Tax Hike

Proposition 30, the governor's tax increase measure that was approved by the voters November 6, will affect not only the pocketbooks of "higher income" California taxpayers – by raising the top personal income tax rate to 13.3 percent, starting with the 2012 taxable year – but it also will affect the pocketbooks of every California taxpayer through a quarter-cent increase in the state sales and use tax rate, starting in January.

In addition to the increased statewide SUT rate, some cities and counties have voter-approved district taxes. Taxpayers located in special tax districts also will see their sales and purchases subject to the increased statewide rate of 7.50 percent, plus the applicable district tax rate. This means the SUT rate will be as high as 10 percent in some areas.

Both the PIT and SUT rate increases are temporary under Proposition 30, with the PIT increase lasting seven tax years – 2012 through 2018 – and the SUT rate increase lasting four calendar years – 2013 through 2016. Unfortunately, it is likely that billions of dollars' worth of ongoing spending will be based on these temporary increases in revenue, which will only exacerbate the state's chronic budget problems and increase pressure for additional tax increases as these near their expiration dates.

Underpaid Personal Income Taxes, but Penalty Waived

Proposition 30 imposes a retroactive PIT increase, more than 10 months into affected taxpayers' 2012 taxable year. Because of this, many of the affected taxpayers may be severely underpaid on their 2012 tax liability. The dilemma of underpayments affects taxpayers who are employees subject to withholding, as well as taxpayers subject to estimated tax payments. The table below offers an example of a single taxpayer's increased tax liability under Proposition 30.

Example of a Single-Filer's Tax Liability
Under Proposition 30*

Taxable Income

Current Tax Liability

Tax Liability Under Prop. 30

Net Tax Increase Under Prop. 30

$35,000

$1,114

No Change

No Change

$65,000

$3,648

No Change

No Change

$125,000

$9,228

No Change

No Change

$265,000

$22,248

$22,398

$150

$550,000

$48,753

$54,753

$6,000

$1,500,000**

$142,103

$176,603

$29,500

* Calculations based on the Franchise Tax Board's single-filer rate schedule, as revised for Proposition 30.
**Calculations include the state's 1 percent surcharge for mental health services for taxpayers with taxable income in excess of $1 million.

Increasing Withholding and Estimates

On November 7, the Employment Development Department (EDD) released revised withholding tables both for both 2012 and 2013 to reflect the higher Proposition 30 PIT rates. However, the revised 2012 tables do not contain "catch-up" amounts, instead reflecting the Proposition 30 tax increase over a 12-month period. Affected employees have just the remainder of November and all of December to try to catch up with their increased tax liability via withholding.

Since the revised withholding tables do not reflect "catch-up" amounts, employees may request additional withholding or make one or more estimated tax payments if they want the state tax deduction on their 2012 federal return. Taxpayers who want to defer their state tax deduction to their 2013 federal return may wait until April 15, 2013 (calendar-year taxpayers) to make their payment in full (but see discussion of federal AMT patch below).

Normally, taxpayers who fail to pay at least 90 percent of their current year's tax, or 100 percent of their prior year's tax, are subject to an underpayment penalty under R&TC Section 19136. However, Proposition 30 provides that affected taxpayers who are underpaid will be held harmless from the underpayment penalty (California Constitution, Article XIII, Section 36(f)(2)(C)(i)). To obtain relief, taxpayers must pay any balance due by April 15, 2013 (calendar-year taxpayers), and complete form FTB 5805, "Underpayment of Estimated Tax by Individuals and Fiduciaries." The FTB will not provide automatic penalty relief.

Federal AMT Patch

If Congress fails to fix the computation of alternative minimum tax, taxpayers affected by Proposition 30 likely will be hammered with a federal AMT that they may not have expected or calculated in their 2012 tax projections (taxpayers unaffected by Proposition 30 also may face a significant increase in their federal AMT, absent a patch). Congress historically has patched the AMT every year, first by expanding the AMT exemption amounts, then by allowing taxpayers to use certain personal credits to offset AMT (California has a permanent patch).

Government Gets Hit With SUT Increase, Too

Existing law generally imposes a sales and use tax on the sale or purchase of tangible personal property at a combined base rate of 7.25 percent, which increases to 7.50 percent on January 1 under Proposition 30. State and local governments aren't exempt from the SUT.

Fixed-price contracts or fixed-price taxable lease agreements, other than certain leases of mobile transportation equipment, are not exempt from Proposition 30's SUT rate increase. Consequently, the rate increase will apply to contracts and leases other than leases of mobile transportation equipment.

In the past, SUT rate increases done legislatively generally provided an exemption from future increases (or decreases) in the SUT rate for fixed-price contracts between government entities and contractors. Proposition 30 does not provide such an exemption.

While the tax money paid by government agencies eventually makes its way back to the general fund, there will be administrative costs for both the payer and the collector, and there is no guarantee that the agency that pays the tax will get a larger general fund allocation in the future to cover the cost.

While Proposition 30 does not entitle a contractor to an increase in payment as a result of the SUT increase, contractors have never been prohibited from including a contract provision that allows either party to increase the fixed price, especially resulting from tax increases.

As of August 2011, the Department of Transportation (Caltrans), for example, had $3.3 billion in construction contract expenditures, approximately one-third of which was attributable to materials that would be subject to the sales and use tax. The Department of General Services and the University of California also regularly utilize fixed-price contracts. Without a general exemption, an increase in SUT like that imposed by Proposition 30 may result in multimillion-dollar increases in contract costs in a future fiscal year, according to the Senate Appropriations Committee's 2011 analysis of AB 780 (Calderon), which was held by that committee.

For more information about the impacts of Proposition 30, please see CalTax's Proposition 30 Fact Sheet.

November 16, 2012
2012 California Taxpayers Association. All Rights Reserved.