Another Taxing Tax Levy

JULY 22, 2010


Senator Gloria Romero, D-Los Angeles, is sponsoring a tax bill that the California Chamber of Commerce calls a “Job Killer.” The tax levy bill has already passed the Senate Revenue and Tax Committee as well as the Senate Appropriations Committee, and is headed to the Senate floor for a vote, even as the state’s budget stalemate continues.

SB 1316 seeks to establish a new California tax credit program modeled after the federal New Markets Tax Credit (NMTC). The program goal of the federal tax credit is to revitalize low-income and impoverished minority communities.

But the Cal Chamber says Romero’s bill “Places California out of step with federal law and creates a disincentive for multi-state companies to invest in California by making it the only state to impose a tax liability when a company needs flexibility to exchange a California property with one owned in another state.”

But Romero says SB 1316 would provide $44 million in tax credit investments to high-poverty, low-income and minority communities, as well as to small businesses in distressed areas. In the Senate Appropriations Committee, Romero explained that the goal of SB 1316 is to assist California’s economic recovery by stimulating further investments within the state, providing funding for minority communities and establishing small-business projects in distressed areas that would otherwise be denied financing due to their small size.

“California currently offers a range of tax credits that are of no direct benefit to the state,” said Romero.  “With our economy still faltering, it’s a more prudent use of General Fund dollars to stimulate direct investment in California and not to subsidize private investments outside the state.”

Romero’s website states, “The new program would be funded by phasing out the portion of the 1031 exchange tax credit program awarding credits for out-of-state properties. This amounts to about $44 million annually. The New Markets program would provide for a somewhat smaller amount ($35 – 38 million) in new tax credits, ensuring some General Fund savings. The bill would use General Fund dollars to stimulate direct investment in California, rather than continue to fund tax credits for investments in out-of-state properties – a practice that essentially subsidizes private investment activity outside California.”

Section 1031 (a federal tax rule) has existed since 1921, and permits a taxpayer to sell appreciated investment property and defer the resulting capital gains tax, if the taxpayer acquires like-kind replacement property.

The bill analysis explained that opponents of SB 1316 argue that disqualifying exchanges for out-of-state property will be less likely to invest in California if they know that a subsequent transaction may be treated as taxable. Opponents also assert that the tax benefit leads to additional real estate investment, thereby stimulating the economy.  And Opponents add that taking California out of conformity with federal law will create additional administrative burdens.

The California Taxpayers Association, the primary opponent at the Appropriations hearing, expressed concern that the measure’s restriction on like-kind exchanges is in discriminatory violation of the federal Commerce Clause, with the potential for a constitutional legal challenge.

A coalition of business bankers, building, real estate and land associations, chambers of commerce and taxpayers associations addressed concerns of the bill in a letter to Romero and committee consultants. “Owners of real estate are encouraged by the tax benefits to reinvest in real estate, rather than place their money in other investments,” the coalition wrote. “These tax exemptions serve to stimulate the economy and encourage purchases and sales because tax on the gain can be deferred.  Without the exemptions, many transactions will be put off and real estate values in California will be further eroded. Non-California investors and out of state companies will be less likely to invest in California real estate if they know that the transaction may be taxable when they need to exit that property.”

SB 1316 was amended to deny state income tax deferral for California taxpayers who exchange California real estate for investment property located outside of California. If this bill is enacted as proposed, the limitation on deferral would apply retroactively to all exchanges initiated after Jan. 1, 2010.

The state Department of Finance expressed additional concerns. First, that SB 1316 would take California further out of conformity with federal tax law. Secondly, that it would create an additional burden for multi-state taxpayers doing business in California, which could lead to a higher rate of taxpayer error as well as add additional complexity for Franchise Tax Board auditors.

The Senate is expected to debate and vote on the bill when they reconvene.

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