David R. Doerr, principal contributor
Ronald W. Roach, editor

TARGETED TAX CUT MEASURE APPROVED BY LEGISLATURE

Just prior to adjournment, the Legislature last Saturday approved a massive targeted tax cut measure (SB 38, Lockyer) containing many provisions sought by Cal-Tax and other taxpayers. In the aggregate, the bill provides, over a three-year period, approximately $279 million in tax relief, offset by $202 million in additional revenue from conformity with federal law and administrative reforms. It consists of 25 separate targeted tax cuts, including some relief on the taxation of foreign dividends and an increase in the research and development tax credit. (See pages 3 and 4 for SB 38 details.)

Senate President Pro Tem Bill Lockyer said the purposes of the bill were to return a piece of the state's growth in tax revenue to taxpayers and to strengthen California's jobs base. Mr. Lockyer and Assembly Speaker Curt Pringle developed the package through extensive negotiations in August.

At the last minute, Lenny Goldberg, who seeks higher taxes through his proposed November initiative (Proposition 217), tried to scuttle the agreement. He sent a letter urging a "no" vote, stating, "The bill will continue to generate growing revenue losses for California, with little expectation of benefit from tax breaks which, with few exceptions, are effectively giveaways to special interests."

Speaker Pringle said the program is a good compromise that will spur investment in California. Assemblyman Jim Cunneen added the package is "crucial because it sends a message that we care about jobs -- especially manufacturing jobs that create stability."

The cuts follow a reduction of the bank and corporation tax rate of 5 percent (to 8.84 percent ) that was signed by Governor Pete Wilson in July. Mr. Wilson is expected to sign SB 38.

In other action, the Legislature approved and sent to the governor:

• Nonresident Taxation. The Assembly on August 22 approved AB 850 (Morrissey), exempting California source income of nonresidents from state income taxes in conformance with federal law. The 48-5 Assembly vote concurred in Senate amendments that deleted a provision limiting the exemption to qualified retirement income up to $50,000 a year.
• Minimum Tax Cancellation. AB 744 (Kuykendall), canceling minimum taxes for corporations inactive since 1987 under specific conditions, was sent to the governor on a 55-7 Assembly vote August 22 that concurred in Senate amendments.
• Possessory Interest. The Senate concurred in Assembly amendments to SB 1737 (Alquist). The bill allows counties to exempt up to $50,000 in value of a possessory interest in a convention center.
• Local Sales Tax Allocation Appeals. Legislation establishing an appeals procedure for local sales tax allocation disputes (SB 1909, Dills), was approved when the Senate on August 26 unanimously agreed with Assembly amendments. Among primary movers and shakers behind the bill were firms which provide consulting services to cities and ferret out misallocations of sales tax among cities.
• Assessment of Wildlife Habitat. Legislation requiring land restricted by the federal or state government for the benefit of "wildlife," including insects, to be enrolled, on request of the owner, in a wildlife habitat contract and assessed, as "enforceably restricted" land (SB 1804, Monteith) was approved when the Senate concurred in Assembly amendments on August 26.
• Transfer of Base-Year Values. The Senate on August 27 concurred in Assembly amendments to SB 1692, (Petris) allowing disabled persons to transfer their Proposition 13 base-year value to a new dwelling even though they had transferred their base-year value once before. Current law allows eligible persons to transfer their base-year value only once. SB 1692 also contains a provision, sponsored by the Oakland Museum, expanding the property tax welfare exemption to property owned and used by a non-profit organization's auxiliary services to a public museum.
• Floral Vendors. After initially rejecting the measure, the Senate approved AB 2551 (Cannella), imposing an added $500 penalty for unlicensed sidewalk or curbside sellers of flowers.
• Interest on Property Tax Refunds. The Senate concurred in Assembly amendments to SB 2106 (Russell), providing counties do not have to pay interest on property tax refunds where values have been lowered due to a disaster.
• Hotel Tax on Free Meals. AB 3407 (Knowles), prohibiting local government imposing a hotel/motel tax on "free meals" furnished with lodging that are subject to sales tax (very few under a new BOE decision), was approved.
• Record-Keeping Regulation Clean-Up. Legislation allowing taxpayers to appeal FTB actions taken under the controversial record-keeping regulation (SB 715, Killea) was approved.
• Stock Options. AB 3194 (Vasconcellos), establishing a new class of stock options for low and middle income taxpayers with no minimum holding period, was approved.
• Railroad Equipment. A sales tax exemption for railroad parts and equipment purchased out-of-state and used in interstate commerce (AB 3375, Olberg) was approved.
• Multiple Tax Parcels. AB 188 (Machado), requiring local government to treat multiple parcels of agriculture and timber property under common ownership as a single parcel for local parcel tax purposes, was adopted.
• Enterprise Zones. AB 296 (Knight), and SB 2023 (Costa), both designating "program areas" are to be enterprise zones (with better tax benefits), passed the Senate and Assembly on August 31.
• Assessment Administration. Although AB 1055 (Caldera) was sent to the governor, counties suffered a significant defeat as the bill was amended to only state the intent of the Legislature to reimburse counties for costs of property tax administration for schools in a future bill.
• Non-Profit Organizations. The Assembly concurred in Senate amendments to AB 2523 (Cunneen), prohibiting local business license taxes on non-profit organizations.
• Property Tax Allocation. A conference committee report on AB 2797 (Aguiar) was approved, shifting the growth in property tax revenue on part of the schools property tax revenue back to cities and counties. This will be an expensive proposition for the state.
• Thrift Stores. The Assembly concurred in Senate amendments to AB 3187 (Martinez), exempting from sales tax thrift store sales benefitting individuals with AIDS.
• Possessory Interests. The Assembly concurred in Senate amendments to AB 1991 (Granlund), allowing counties to set up a lease-leaseback of publicly owned property without triggering a possessory interest assessment. The bill also expands the church parking lot exemption.

• Computer Donation Tax Credit. The Senate refused to consider Assembly amendments to SB 405 (Haynes), providing an income tax credit for computers donated to schools, and the bill died.

SENATE BILL 38 REVENUE RAISERS (In millions $)	96-97	97-98	98-99
Moving Expenses Conforms with federal restrictions on moving expense deductions, including an expansion from 35 to 50 miles for the threshold within which moving expenses are disallowed.	+$25	+$25	+$25
Corporate-owned Life Insurance Policies Disallows, except for "key" employees, a deduction for interest on loans secured by companies to buy life insurance policies for their employees, in conformity with federal law.	+ 10	+ 15	+ 20
Corporate Estimated Payments Requires 1998 estimated corporate tax payments be based on 98% (rather than 95%) of current year's tax, and requires for 1999 and thereafter the estimated payment to be based on 100% of current year's tax.	0	+ 11	+ 13
Mark-to-Market Accounting Requires security dealers to value their inventory of securities at market values and taxes unrealized gains, in conformity with federal law.	0	+ 10	+ 10
Discharge of Indebtedness Conforms to federal discharge of indebtedness provisions.	minor	+ 4	+ 5
Restriction of Deduction of Interest to Foreign Entities Restricts the deductibility of interest in cases of loan guarantees by a related foreign entity, in conformity with federal law.	+ 3	+ 3	+ 4
Payment to Retired or Deceased Partners Repeals partnership authority to deduct distributions of goodwill or unrealized receivables to retiring partners or the estates of deceased partners, in conformity with federal law.	+ 2	+ 2	+ 3
Corporate Disclosure Extends to Sub S corporations the program allowing out-of-state corporations having nexus in California who have not paid taxes to voluntarily pay taxes and interest to avoid penalties.	0	+ 2.5	+ 2.5
Spousal Travel Allows deduction of spousal travel expenses on a business trip only if spouse is an employee of the company and is traveling for a legitimate business purpose, in conformity with federal law.	+ 1	+ 1	+ 1
Depreciation of Real Property Extends depreciation period for non-residential real property from 31.5 years to 39 years, in conformity with federal law.	0	+ 1	+ 1
Employee Information Allows the Employment Development Department to share new employee information with the FTB.	0	+ 1	+ 1
TOTAL	+$41	+$75.5	+$85.5

(Note: Revenue figures in these tables are "static" estimates from the Franchise Tax Board and State Board of Equalization, and Cal-Tax does not vouch for their accuracy. Some are prorated from federal estimates. There are disagreements on some estimates.)

SENATE BILL 38 TAX CUTS (In millions $)	96-97	97-98	98-98
Research and Development Tax Credits Increases business-based credit from 8% to 11%, and from 12% to 24% for basic university research.	-$ 6	-$22	-$27
Small Business Expensing Increases the amount of personal property small businesses may expense, rather than depreciate, from $10,000 to $12,500 as of 1/1/97, and to $15,000 as of 1/1/98.	- 2	- 11	- 15
Foreign Dividends Excludes 75% of foreign dividends (for water's-edge filers), without a foreign payroll factor adjustment. Reduces the amount of "interest offset" by 25%.	- 7	- 10	- 12
Long-Term Care Deduction Qualifies long-term medical care insurance and expenses as a medical deduction.	- 2	- 9	- 10
Medical Savings Accounts Excludes contributions to Medical Savings Accounts from income for federally qualified taxpayers.	- 4	- 8	- 10
Aircraft Repair Sales Tax Exemption Exempts from sales tax parts purchased after 10/1/96 for commercial aircraft repair.	- 7.3	- 9	- 9
Spousal IRAs Excludes $2,000 for non-working spouse contribution to an Individual Retirement Account.	- 3	- 8	- 9
Educational Assistance Exclusion Limits educational assistance exclusion to undergraduate costs, and makes exclusion permanent.	+ 7	+ 3	- 7
Minimum Franchise Tax Reduces from $800 to $600 the first-year minimum franchise tax for an independent small business.	- 6	- 8	- 5
ESOP Conformity Conforms to federal dividend and contribution deductions on 1/1/96 for Employee Stock Ownership Plans;	- 6	- 4	- 4
Aerospace Clean-Rooms Manufacturers Investment Credit (MIC) Extends MIC to special purpose buildings ("clean rooms") used by manufacturers of space satellites.	- 2	- 2	- 3
Semiconductor Clean-Rooms MIC Extends MIC to special purpose buildings ("clean rooms") used by semiconductor manufacturers.	- 1	- 1	- 1
Aerospace Enterprise Zone Allows aerospace companies in the Long Beach Enterprise Zone to claim the zone hiring credit for wages paid workers of the first 202% of minimum wage (instead of 150%) for up to 1,350 workers per firm.	0	- 2.7	- 2.7
Sales Tax Exemption for Food Animal Medicines Exempts from sales tax medicines given to food animals.	- 1.1	- 2.2	- 2.2
Corporate Charitable Contributions Deduction Increases corporate charitable contributions to the federal limit of from 5% to 10% of net income.	- 3	- 2	- 2
Credit for Enhanced Oil Recovery Establishes a 5% tax credit for costs of "enhanced" oil and gas recovery by certain oil producers.	- 2	- 2	- 2
Alternative Minimum Tax Exempts new businesses with gross income of less than $1 million from alternative minimum tax.	- 2	- 2	- 2
Manufacturer-Lessors in MIC Allows a manufacturer that leases equipment it manufactures to pay sales tax at the start of the lease, enabling its lessee to claim the manufacturers' investment credit.	+ 3	+ 1	- 2
Discharge of Indebtedness Allows a noncorporate debtor to exclude from income a discharge of "qualified real property business indebtedness," in conformity with federal law.	- 3	- 2	- 1
MIC and Net Operating Loss (NOL) Carryforward: Biotech Firms Extends, for biopharmaceutical and biotechnology firms awaiting their first FDA approval, the carryforward of unused manufacturers' investment tax credit from 7 to 9 years, and the carryforward of 100% of NOL carryforwards for 8 years. (Current law, for other than new firms, allows a 50% carryforward for 5 years.)	Future Impact	Future Impact	Future Impact
Tax Credit for Farmworker Housing Establishes a 50% tax credit for donation of farm worker housing. Total credits are limited to $500,000.	- 0.5	- 0.5	- 0.5
Tax Credit for Use of Rice Straw Establishes a tax credit to users of rice straw for uses other than burning at $15 per ton of straw used. The credit is capped at $400,000, with an added $100,000 for costs of administering the credit.	0	- 0.5	- 0.5
Tax Credit for Disabled Compliance Creates a 50% tax credit for the first $250 of costs in complying with the Americans with Disabilities Act.	- 0.3	- 0.3	- 0.3
Non-Profit Insurance Risk Pools Exemption Provides bank and corporation tax exemption for non-profit groups' insurance risk pools.	- 0.3	- 0.2	- 0.2
Credit for Transportation of Donated Food Products Establishes a 50% tax credit for truckers who transport donated food to food banks.	- 0.2	- 0.2	- 0.2
TOTAL	-$48.7	-$102.6	-$127.6

SB 657 SHIFT OF BURDEN OF PROOF APPLIES TO ALL PENDING PROPERTY TAX APPEALS

Legislative Counsel Bion Gregory, in an opinion to Senator Ken Maddy released August 21, has concluded that the shift of the burden of proof in assessment appeals approved in SB 657 (Maddy) of 1995 applies to all assessment appeals pending in 1996. SB 657 shifted the burden of proof to the assessor in appeals of specified escape assessments.

Los Angeles County is arguing before appeals boards that the new law does not apply to pre-1996 disputes.

The legislative counsel, noting that SB 657 does not contain language precluding the application of the bill to pending actions, said, "In the analogous context of court actions, the courts have stated that the amendment of a procedural statute applies to cases pending at the time of its enactment..."

The counsel drew this conclusion, if an assessment appeals board hearing is conducted in 1996 with respect to a timely escape assessment appeal in 1995: "The amendments made to Section 167 by Chapter 498 of the Statutes of 1995, that took effect and became operative on January 1, 1996, do establish a rebuttable presumption affecting the burden of proof in that hearing in favor of the taxpayer."

FTB GETS NEW BUILDING AS EFFORT TO REPEAL MTC MEMBERSHIP FAILS

A bid by foes of the Multistate Tax Commission (MTC) to repeal California's membership in the organization fell short during the final days of the state Legislature's 1995-96 session.

Governor Pete Wilson's administration stepped in and broke a deadlock that had threatened approval by the Legislature of the revenue bond financing plan for the Franchise Tax Board's new administrative building. Critics of the MTC earlier had succeeded in axing more than $400,000 in annual dues to the commission from the FTB and Board of Equalization budgets, but were advised that separate legislation was needed to repeal the state's MTC membership.

In the final week of the session, the FTB-sponsored building bill (SB 1517, Johnston) was amended in the Assembly Appropriations Committee, chaired by MTC foe Charles Poochigian, to also repeal the MTC compact. Senator Patrick Johnston responded by dropping his bill and amending the revenue bond provisions into an Assembly bill (AB 2962, Firestone), which was sent to the governor's desk.

Sources say the governor's office, in brokering legislative approval of the FTB building bill, agreed to discuss the future of the state's relationship with the MTC in the context of the 1997-98 session of the Legislature, which begins in December. However, the governor's office reportedly has made no commitment to support Mr. Poochigian or BOE Member Dean Andal in their continued efforts to sever ties with the MTC.

BOE PARTIALLY ADOPTS ANDAL'S BUDGET-CUTTING PROPOSALS

The State Board of Equalization agreed to $1,756,000 of Member Dean Andal's proposed $7.5 million in cuts to the BOE's 1997-98 budget at the board's administrative meeting August 22. A number of staff-proposed economies also were adopted before Mr. Andal's proposals were debated.

The BOE budget this year is about $297 million. There are about 3,900 employees located in offices throughout California and also in New York, Chicago and Houston. The proposed cuts (identified in the August 26 Caltaxletter) and the board's actions included:

• Technology Savings -- $4,518,577. A contract with American Management Systems, Inc., for the purchase and installation of the Automated Compliance Management System (ACMS) on a "shared risk" basis provided for payment of $8.598 million only if ACMS increases collector productivity by 30 percent and increases marginal collections by $2.35 million per month during a baseline period. Mr. Andal proposed a reduction of 82 of 1,426.5 compliance positions at a savings of $4.5 million. BOE staff opposed the proposal.

Mr. Andal then moved to reduce the budget reduction by 50 percent, leaving its implementation to staff. There was no second to the motion.

• Supervisory Ratio Savings -- $1,570,000. This proposal reflects savings from moving from a ratio of 7.5 staff per supervisor to 8.0 by July 1, 1997. BOE Chair Johan Klehs said he would rather flatten the organization (reduce the number of levels between the top and bottom) than reduce the span of control. BOE staff also proposed to move positions to audit rather than abolish the positions.

This cut was approved 3-2, with Mr. Andal, Ernie Dronenburg and Rex Halverson (representing Controller Kathleen Connell) voting in favor.

• Sinclair Paint Case Reductions -- $700,000. The Andal proposal to eliminate 11.7 positions for administration of the childhood lead tax is based on the Third District Court of Appeal ruling that the tax is unconstitutional because it was not passed by a two-thirds vote in the Legislature. The decision has been appealed to the California Supreme Court. The board, on a 3-2 vote, accepted the staff's timeline, awaiting the state Supreme Court decision.
• Savings from Sale of Excess Vehicles -- $375,000. Mr. Andal's proposal to sell 46 of the 56 BOE vehicles and to eliminate one position was amended and moved by Mr. Dronenburg to 20 vehicles, as recommended by staff. The sale of 20 vehicles was approved unanimously, at a savings of $160,000.
• Savings from Defunding the Multistate Tax Commission -- $212,702. The Legislature eliminated funding for the MTC from the baseline budget, but authorized the use of other budget resources to retain membership. Mr. Andal suggested eliminating MTC funding from the BOE's 1997-98 budget proposal. He has argued the MTC provides services California does not need and is advocating policies directed against California interests.

Member Dronenburg said California is best served by being a member and wielding influence and effecting change. The vote was 2-3 against Mr. Andal's proposal, with Mr. Dronenburg, Mr. Klehs and Member Brad Sherman in the majority.

• Cancel Washington, D.C. Lobbyist Contract and Interagency Agreements -- $110,000. Mr. Andal proposed canceling the $50,000 District of Columbia lobbyist contract and using California's D.C. office to represent the state's interest. BOE Executive Officer Les Sorenson argued that the governor's office may have a different agenda than the BOE's interests. Chair Klehs suggested that the lobbyist contract should be restricted to necessary information and not be used for analyses of campaign proposals. Mr. Andal's motion failed to get a second.
• Limit on Subscriptions -- $36,200. Mr. Andal cited the multiple subscriptions to the Wall Street Journal and the California Journal as examples of duplicates. He also inferred that some subscriptions appeared to be unrelated to the department's functions.

Mr. Dronenburg's motion to limit subscriptions to a 15 percent reduction ($26,000), instead of 25 percent, was approved 3-2.

• Partial Elimination of Documents Translations -- $33,000. California law requires translation of documents into foreign languages only if non-English contacts exceed 5 percent. Mr. Andal proposed eliminating all those less than 5 percent, which would retain only Spanish translations.

Mr. Andal's motion did not receive a second.

• Training Expenses Savings -- $30,000. Unnecessary and unrelated courses were proposed for elimination. Mr. Sorenson argued that courses such as "stress management" were effective in keeping BOE's costs of workers' compensation at a low level. Mr. Andal's motion to remove "stress management" courses failed on a vote of 1-3, with one abstention.

• Rules of Order. Approved 5-0 were amendments allowing exhibits to be entered into evidence for the record; providing that committee meetings should be held in Sacramento whenever possible, and outlining the procedure for committee meetings.
• Consent Items. Approved 5-0 were the Emergency Telephone Users' Surcharge Rate of 0.72 percent; Assessors' Handbook 534 (Rural Building Costs), and Assessor's Handbook 566 (Assessment of Petroleum Properties).

FTB INTERPRETS NOL PROVISIONS

The Franchise Tax Board has issued Legal Ruling 96-5 interpreting which businesses qualify for the 100 percent net operating loss (NOL) carryforward. Legislation enacted in 1993 and 1994 allows small businesses and businesses new to California to carryforward 100 percent, rather than 50 percent of NOLs, for specified periods. A small business is one with $1,000,000 of gross receipts (less returns and allowances) or less in a year.

The FTB states a taxpayer engaged in more than one business may take a 100 percent NOL for each activity that is a small business or is new to California that is properly classified in a separate division of the Standard Industrial Classification (SIC) Manual from the taxpayer's other business activities.

The FTB also advises that, in determining if an activity qualifies as an eligible small business, all activities conducted by the taxpayer and related persons within the same SIC division will be aggregated to determine worldwide (or water's-edge) gross receipts.

In determining if an entity qualifies as a business new to California, a different division of a corporation doing business in California will be eligible for the 100 percent NOL as a "new business" if the division has not wholly or partly conducted business in California within the preceding 36 months.

In Legal Ruling 96-5, the FTB also sets forth a formula to determine if a business new to California satisfies the asset test. The "asset test" generally requires that in any case where any existing California business activity is acquired, either substantial additional assets must be contributed to the post-acquisition business activity or the acquired assets must represent a relatively small percentage of the acquiror's overall same SIC Manual division trade or business activity.

RECORD-KEEPING REGULATION HEARING SCHEDULED

The Franchise Tax Board has scheduled a hearing to get public comments on changes in the controversial record-keeping regulation (Section 19141.6) it adopted last Fall. Primarily, the proposed changes rework provisions rejected by the Office of Administrative Law (OAL).

The proposal provides that the FTB may review determinations made by the staff. Legislation passed last week (SB 715, Killea) to broaden this standard of review. The regulation also contains other minor changes.

The hearing is scheduled for October 8, at 10:00 a.m., at 9645 Butterfield Way. Access to the building is restricted and interested parties will need to get special passes to enter the building.

CONSTITUTION REVISION EFFORTS FALL FLAT

After more than two years of meetings and mounds of paper, efforts of the California Constitution Revision Commission (CCRC) to bring change to state and local government fell flat.

The Legislature adjourned early Sunday morning (September 1) after the Senate had rejected a watered-down proposal, with only nine votes in support of ACA 49 (Isenberg). It needed 27, and there were 17 votes in opposition. The conference committee report was not taken up in the Assembly.

Of the CCRC's 38 recommendations, only five were in the final Senate-Assembly conference committee product, and the plan was to put them on the ballot in 1998, not 1996. They would have required the governor and lieutenant governor to run as a ticket from the same political party; reduced the length of legislative sessions; provided local boards more control over schools, and required adoption of a balanced state budget. Also, the measure would have strengthened home rule taxation powers of charter cities.

The commission's proposals, many of which could not gain consensus support among the commissioners themselves, appeared to be in trouble all along in the Legislature. Opposition also mounted as a result of efforts by the League of Cities to make it harder to challenge non-voted tax increases in charter cities. Cal-Tax urged rejection of the charter cities' provisions, stating they would make it harder to apply Proposition 62's voter-approval requirements to charter cities.

While the two legislative champions of the effort -- Senator Lucy Killea and Assemblyman Phil Isenberg -- are leaving the Legislature later this year because of term limits, and the commission has been disbanded, its former chair, William Hauck, says its ideas are not dead. In an interview with The Los Angeles Times, Mr. Hauck said he is organizing a group, including some former CCRC members, to continue to pursue constitutional reform. "I think we will continue to pursue the ideas ... in the hope that we can get a real package of reform on the ballot in 1998," said Mr. Hauck.

BAY AREA TOLLS NOT GOING UP -- FOR NOW

The compromise plan to raise Bay Area bridge tolls by one dollar (see Caltaxletter of August 19) fell apart in the closing days of the Legislature's session. The question of who will pay the $2 billion tab for earthquake proofing the bridges remains unresolved for now. The $650 million set aside for such repairs in a bond issue approved last March is not enough.

The deal fell apart because the one dollar toll increase was not enough to supplement the bond funds. Assembly Transportation Chair Larry Bowler wanted the one dollar increase extended beyond six years. Senator Quentin Kopp said "no." Senator Kopp said, "I have given up on the negotiations."

There is some speculation that earthquake repair funds might come from existing toll revenues, however, Bay Area legislators vowed to fight such a move in court.

COMING UP

Sept. 9: FRANCHISE TAX BOARD MEETING
Location: Room 121, 450 N Street, Sacramento, at 10:00 a.m.
Subjects: Among subjects on agenda is MTC Nexus Bulletin 95-1.