David R. Doerr, principal contributor
Ronald W. Roach, editor
Entitled "Competitiveness of City Taxes and Fees," the interim report was released last Tuesday. The so-called tax-equity study, commissioned by the city, is being conducted by MIJCF, Arthur Andersen LLP, UT Strategies, Incorporated, and Landmark Partners. The final analysis of tax and fee issues that affect the city's ability to compete in business location decisions is expected by July.
Gary Mendoza, Mayor Richard Riordan's deputy mayor for economic development, said the study "reaffirms what we have been saying for a long time: the tax system is not competitive, it is outdated, and it is complicated. We want these issues to be fully debated by the City Council to see what changes can be made to make the structure more competitive and compatible."
Mr. Mendoza said, "There are opportunities to fix the tax system. We think we can broaden the base, reduce the rates and not blow a hole" in the city's budget.
Among interim conclusions and recommendations:
Complicated Tax System. It is estimated that L.A.'s business taxpayer compliance rate is 60 percent, meaning that 40 percent of those companies doing business in the city are not paying their taxes. The city's audit rate is 3 percent of revenue compared to the Internal Revenue Service-defined optimal rate of 7 percent of revenue.
"The complicated nature of the tax system results in a significant loss of revenue to the city due to the low level of compliance and the low audit rate that the city is able to achieve," the report concluded.
Recommendations: Increase enforcement. Use Franchise Tax Board data to identify companies doing business in the city or those that have established nexus; monitor truck bill of lading to establish nexus, as is done in Denver, New Orleans and Chicago, and use other city data bases, including permits filed with city departments, to assure that all those doing business in the city are registered with the city clerk.
Administrative actions recommended by the study include development of a new tax form and, as part of an overall strategy, a new amnesty program that would follow a campaign to publicize the city's increased enforcement mechanisms.
Uncertain Development Costs. Businesses with a choice of location are discouraged from locating in Los Angeles. Developer fees in other cities are typically fixed at the time of initial application, but Los Angeles development fees often change and increase until the project is completed. Thus, the fee can be substantially higher in Los Angeles.
Recommendations: Minimize uncertainty of fees by assigning a fixed cost on an area-by-area basis. If a citywide formula is used, it could be adjusted to encourage development in certain areas. All development fees should be locked in at the time the permit is issued.
Gross Receipts Tax. Since companies are taxed regardless of their net income, it is especially hard on start-up companies and companies that continue to re-invest in their business.
The business tax is imposed upon most businesses based on gross receipts, regardless of profit or loss. The tax rate can vary from $1.18 to $5.91 per $1,000 of gross receipts, depending upon which of the 52 classifications apply to a particular business. Some businesses fall within multiple classifications. The city has different apportionment methodologies for differing classifications of taxpayer.
Recommendations: Consider replacing this tax with a different form of tax, such as payroll, income or flat tax. Also to be considered in the future, based on the final report, should be a simplification of the code, change in apportionment rate, equalization of rates between categories and shifting of businesses between existing categories.
High Fixed-Rate Utility Tax (without a cap). It is particularly onerous on retail, warehousing and manufacturing operations.
Utility tax rates in Los Angeles are the highest of all 16 competitor cities surveyed. Culver City and Long Beach, two of the cities closest to Los Angeles in heavy utility tax burden, have much lower business taxes.
Competitor cities are Burbank, Culver City, Glendale, Irvine, Las Vegas, Long Beach, Ontario, Phoenix, Salt Lake City, San Francisco, San Jose, Santa Monica, Seattle, Simi Valley, Torrance and Vernon. Here is how Los Angeles compares with average taxes and fees for the competitor cities:
Low-tech industry (gross receipts of $7 million and 82 employees) would pay total taxes and fees in Los Angeles of $25,471. The total non-Los Angeles average: $8,996.
High-tech industry ($33 million in gross receipts and 325 employees) would pay $57,081 in Los Angeles; $20,963 as an average in the 16 competitor cities.
Professional services ($24 million in gross receipts and 400 employees) would pay $160,275 in taxes and fees for Los Angeles, compared to an average of $45,268 elsewhere.
Warehousing ($28 million in gross receipts and 100 employees) would pay $48,198 in Los Angeles; $14,576 elsewhere.
Retail ($15 million in gross receipts and 250 employees) would pay $65,644 in Los Angeles; $21,762 elsewhere.
Taxing tourists. The report recommends access fees on car rentals, such as those charged in Chicago, Orlando and New York. It also recommends a surcharge on taxis and buses originating at the airport, similar to a structure used in Chicago. While taking into account the impact on the tourist industry, the city should consider an increase in the hotel occupancy tax.
The study found that competitor cities tend to shift a greater burden of taxes to non-residents.
When businesses have a choice, the costs of city-imposed fees and taxes is a deterrent in Los Angeles; the economic incentive packages are similar but the process is difficult, and the uncertainty of development costs in Los Angeles is a major deterrent, the study found.
Incentives. The approval process for incentives in Los Angeles is "perceived as significantly longer and generally more political than in other cities."
More than two months have passed since Brad Sherman resigned his State Board of Equalization seat and went to Congress. John Chiang, his chief deputy, is serving as acting board member until Governor Pete Wilson names a successor who is acceptable to most state senators and Assembly members.
Wilson is a Republican. Democrats are majorities in the Senate and Assembly. Congressman Sherman and Mr. Chiang are Democrats, and the BOE's Los Angeles-area District 2 is considered Democrats' turf.
While there has been little public comment on a potential nominee to date (Mr. Wilson told the Cal-Tax annual members' meeting February 7 that he will make a nomination but offered no details), there has been plenty of behind-the-scenes maneuvering. Details of jockeying for the $95,500-a-year post were recently reported by Copley News Service (CNS).
Assembly Speaker Cruz Bustamante declined comment, and his spokesman Ron Gray called it "premature" to discuss Mr. Beverly's "speculative" prospects for the job.
BOE Chair Ernest Dronenburg Jr., a Republican, told CNS he expects Mr. Beverly to be nominated by the governor. "I think Bob could do an outstanding job with his background. He has seen so much tax legislation that he would come ready to do business right away." Mr. Beverly served a stint as chair of the Senate Revenue and Taxation Committee.
Steve Tatum, a Wilson spokesman, said the governor considers nominating a Sherman successor to be a "high priority." He would not say whether Mr. Beverly would get the nod.
The State Board of Equalization wants to have it both ways and the Second District Court of Appeal agrees. Not only is property purchased outside of California for use in California subject to the use tax, but the court held on February 21 that property purchased in California and given away out of state is also subject to a use tax (Yamaha Corporation of America v. State Board of Equalization).
Yamaha purchased musical instruments out of state, placed the instruments in resale inventory, then made promotional gifts to musicians out of state in the original package and made no physical change in the property. The company made out-of-state gifts of promotional literature that it purchased out-of-state and in California with a resale certificate.
Yamaha did not report sales tax because it argued that Revenue and Taxation Code Section 6009.1 unambiguously "excludes from the definition of "storage" and "use," and thus from the requirement of paying a use tax (6201), "the keeping, retaining or exercising any right or power over tangible personal property for the purpose of subsequently transporting it outside the state for use thereafter solely outside the state...." The trial court agreed with Yamaha.
The BOE argued that by delivering the property to common carriers for transportation to out-of-state donees, Yamaha made a gift, and hence, a taxable use in California.
The appeals court said, "The Board's view that the gift takes place in California is not arbitrary or capricious. The view is not one which the Board adopted ad hoc as a litigating position in this case only, but is one which Yamaha concedes the Board has maintained consistently for at least 20 years... The Board correctly argues that, in certain contexts and for certain purposes, a gift is deemed to be made when the subject property is delivered by a third party for the benefit of the donor...Moreover, a plain and good reason exists for deeming the gifts at issue in this case to have been complete upon delivery to the common carrier in California, for if they were not, Yamaha will escape paying any tax on the subject property."
The appeals court disposed of Section 6009.1, exempting property "solely for use outside the state," by saying the gift is subject to tax whether or not a "functional use" is made in California if the gift is made in California.
Governor Pete Wilson announced February 20 that approximately 600,000 California taxpayers are receiving more than $55 million in State Disability Insurance (SDI) refunds. These dollars are unclaimed excess SDI withheld from taxpayers during 1993, 1994, and 1995. The refunds are being made pursuant to SB 1682 (Johnston) signed into law by Governor Wilson last year.
"California taxpayers work hard for their money," Mr. Wilson said. "Putting this legislation into action is enabling them to receive these refunds -- income that is rightfully theirs."
The legislation requires the state Employment Development Department, in collaboration with the Franchise Tax Board, to review taxpayers' accounts to determine if they failed to claim excess SDI contributions on their state income tax forms and are eligible for refunds.
Taxpayers should review their W-2 forms for 1996 before filing their tax returns. If they have paid more than $254 in SDI, they have overpaid and should claim a refund on the California tax form.
A regulation that provides for a deferral of gain from distributions between members of a combined report when the distribution exceeds stock basis is on the drawing boards at the Franchise Tax Board, according to FTB Notice 97-2.
Under federal law, if a nondividend distribution between members of a consolidated return group with respect to stock exceeds the stock's basis, income is deferred by placing it in an excess loss account.
According to the FTB, there is no mechanism in California unitary law which provides for either deferral of such income or its restoration. Thus, the only means to create a deferral mechanism and a binding restoration counterpart is by closing agreement. In order to effect such a deferral for any year open to the statute of limitations, taxpayers may request a closing agreement with the FTB under Section 19441 of the Revenue and Taxation Code.
Requests for closing agreements must be in writing to the FTB's Legal Division and should describe the parties to the transaction, including federal identification numbers, the nature of the distribution, the timing and amounts of the income involved, and any other relevant facts. Requests must be made within one year from the date of this notice or before the due date of the return for the year of the distribution, whichever is later.
The Los Angeles Taxpayers' Association (LATAX) has formed a task force to work on methods of simplifying the city's complex tax structure. The association acted at its meeting last week after a discussion of major findings in an interim city-sponsored report on tax equity (see story on Page 1).
LATAX President Bob Cendejas said the results "are not a major surprise to anyone. The question is, can we all work together to modify this system or adopt a new system? Our goal is to maintain businesses for the good of all. Without businesses and job growth, we are on a downward spiral. We want to work with the city to develop ideas. We all have a vested interest in the future of Los Angeles."
Officers elected by the Board of Directors last week, in addition to Mr. Cendejas of Texaco, were Dino Sifuentes of Fox, first vice president; Chester Graine III of Times-Mirror, executive vice president; Tony Smith of Southern California Edison, treasurer; Jeff Varga of Paul, Hastings, Janofsky & Walker LLP, secretary; Virginia Andrade (ex-officio member) of Western States Petroleum Association, assistant secretary; John Donner of Pacific Telesis, vice president/government communications; David Naney of Arthur Andersen LLP, vice president/government media, and Steve Danowitz of Ernst & Young LLP, vice president/membership.
Deductible pot? The Internal Revenue Service says taxpayers, on their federal returns, cannot deduct the cost of marijuana as a medical expense. How about California, where voters last November legalized medicinal use of pot? In response to a Cal-Tax query, Franchise Tax Board spokesman Jim Shepherd said last Wednesday that, according to FTB lawyers, "If you can get a prescription for it, you can deduct it."
The FTB had yet to issue a formal statement on the question, but Mr. Shepherd said "prescription drugs are deductible." However, he quickly added that California and federal laws are similar, and, "The catch is, we don't think you can get a prescription for it." The medicinal marijuana initiative says it is legal for use if "recommended" by a physician, but recommend and prescribe have different meanings. It remains illegal to prescribe a Schedule I controlled substance, such as marijuana.
In Washington, according to the New York Times, the IRS published, without fanfare on February 14, "another strike by the Clinton Administration against new laws in California and Arizona that legalize marijuana in some circumstances."
Federal law allows deductions for uninsured medical expenses that exceed 7.5 percent of the taxpayers' income. The new IRS ruling, however, is much broader, the newspaper reported. Employee benefit packages called "cafeteria plans" cannot cover marijuana expenses as part of their medical insurance. Benefits that are not tax deductible cannot be offered.
Because the Drug Enforcement Administration lists marijuana as a Schedule I controlled substance, it is illegal in all circumstances and cannot be prescribed for medical application. Therefore, The Times reported, the IRS had no choice but to make marijuana expenses nondeductible, as the law allows deductions only for prescribed drugs and does not allow deductions for illegal purchases.
Ellis Building for sale. The Legislative Analyst's Office, nearly all of the Capitol Press Corps, and a number of lobbyists may have a new landlord in the near future. The "Ellis Building" catercorner from the Capitol at 925 L Street is for sale. The asking price by the owners (a business group from Kuwait): $26 million.
Manufacturers' tax specialist. Carrie-Lee Coke (pronounced Cook), an attorney who most recently was a staffer for the Assembly Insurance Committee, is the new tax specialist for the California Manufacturers Association.
Dunn succeeds White. George Dunn, a deputy chief of staff since 1991, has moved up to succeed Bob White as Governor Pete Wilson's chief of staff. The appointment was announced February 21. Mr. White, saying he is "burned out," is leaving the administration in April. Before joining the Wilson team, Mr. Dunn, 47, was political affairs director for Atlantic Richfield Company in California and other western states. Before that, he assisted the public affairs chairman for Pacific Holding Corporation in Los Angeles. His bachelor's degree in political science is from Claremont McKenna College. He also has a master's degree in government from Claremont Graduate School.
Higher Education--Tax Deferral: AB 13 (Firestone) has been amended to establish a tax deferral system, through a statewide trust, to encourage savings for future higher education costs.
Sports Teams License Plates. AB 296 (Vincent) requires the Department of Motor Vehicles to issue license plates containing the name and logo of a professional sports team that elects to participate in the program. Applicants for the plates must pay $100 for the initial issuance and $80 for each renewal. No team can be included until there are 5,000 applications for its license plate. Revenues generated by the license plate program are allocated to the Professional Sports Arena and Stadium Fund to finance stadiums and arenas (or improvements thereto) for each participating team.
Discharge of Indebtedness. AB 364 (Baca) provides that discharges of student loans made through the California State University's Forgivable Loan Program are discharges of indebtedness.
Bunker Fuel. AB 366 (Havice) extends indefinitely the sales tax exemption for bunker fuel. Bunker fuel is used by a vessel after it reaches its first out-of-state port.
Tax Credit--Computer Donations AB 372 (Battin) allows a tax credit for donation of qualified computers. The computer must be donated to a qualified refurbisher for placement in a school. The credit is as follows:
Joint Strike Fighter Program. AB 390 (Runner) establishes a tax credit of a percentage of California gross sales under a contract awarded under the Joint Strike Fighter Program. The program is a U.S. Government project to develop and produce the next generation of air combat aircraft. The credit is:
Public Safety Sales Tax Allocation. AB 408 (Morrow) revises the "base year" for allocation of the 0.5 percent public safety sales tax to the City of San Clemente (the site of President Richard Nixon's Western White House).
Acupuncturists Partial Sales Tax Exemption. AB 410 (Gallegos) establishes a partial sales tax exemption for vitamins, minerals, dietary supplements, herbs, and drugless supplements furnished by an acupuncturist. The sales tax would be based on the wholesale price.
Spot Bill. AB 417 (Davis) is a spot bill relating to franchise taxes.
Sales Tax Increase. AB 5X (Floyd) increases the sales tax by 0.25 percent from June 1, 1997 to May 31, 1998 to fund disaster relief.
Conformity. SB 455 (Alpert) establishes the date from California's conformity to federal tax law as January 1, 1997; thus, conforming to a great many federal tax law provisions enacted from 1993 through 1996.
Social Security Number. SB 458 (Peace) prohibits state agencies from sending correspondence to individuals that contains on the outside a person's Social Security number. "Our State Franchise Tax Board has repeatedly mailed out tax forms with a person's Social Security number right there on the envelope for the world to see," stated Mr. Peace. The FTB has agreed to support the bill.
Property Tax Allocation. SB 466 (Rainey) increases the negotiation period (from 30 to 90 days) between local agencies for a reallocation of property tax revenue when there is a jurisdictional change.
Minimum Franchise Tax. SB 510 (Monteith) exempts from the $800 minimum corporate franchise tax new businesses with gross receipts under $1,000,000 (less returns and allowances). The exemption is for the first two years of operation.
March 5: SENATE REVENUE AND TAXATION COMMITTEE HEARING
Location: Room 3191, State Capitol, at 1:30 p.m.
Subjects: SB 81 (McPherson), exempting fire district purchases from sales tax; SB
100 (Lewis), allowing a capital loss deduction on sale of a residence; and
SB 218 (Knight), expanding the college property tax exemption.
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