The Personal Income Tax Law allows various credits against the taxes imposed by that law, including certain credits that are allowed in modified conformity to credits allowed by federal income tax laws.

This bill, for taxable years beginning on or after January 1, 2016, and before January 1, 2023, would allow a credit to a qualified taxpayer, as defined, computed by multiplying the federal earned income credit amount, as defined, by 15%. The bill would provide that the credit amount in excess of the qualified taxpayers liability would be paid to the qualified taxpayer upon appropriation by the Legislature. This bill would require the Franchise Tax Board to submit a report to the Legislature, beginning January 1, 2017, and each January 1 thereafter, until January 1, 2023, regarding the credit, as provided.

This bill would take effect immediately as a tax levy.

The Personal Income Tax Law allows various credits against the taxes imposed by that law, including certain credits that are allowed in modified conformity to credits allowed by federal income tax laws.

This bill, for taxable years beginning on or after January 1, 2016, and before January 1, 2023, would allow a credit to a qualified taxpayer, as defined, computed by multiplying the federal earned income credit amount, as defined, by 15%. The bill would provide that the credit amount in excess of the qualified taxpayers liability would be paid to the qualified taxpayer upon appropriation by the Legislature. This bill would require the Franchise Tax Board to submit a report to the Legislature, beginning January 1, 2017, and each January 1 thereafter, until January 1, 2023, regarding the credit, as provided.

This bill would take effect immediately as a tax levy.

The Personal Income Tax Law imposes taxes on income and provides a definition for the Franchise Tax Board for purposes of that law allows various credits against the taxes imposed by that law, including certain credits that are allowed in modified conformity to credits allowed by federal income tax laws.

This bill would make a technical, nonsubstantive change to that definition bill, for taxable years beginning on or after January 1, 2016, and before January 1, 2023, would allow a credit to a qualified taxpayer, as defined, computed by multiplying the federal earned income credit amount, as defined, by 15%. The bill would provide that the credit amount in excess of the qualified taxpayers liability would be paid to the qualified taxpayer upon appropriation by the Legislature. This bill would require the Franchise Tax Board to submit a report to the Legislature, beginning January 1, 2017, and each January 1 thereafter, until January 1, 2023, regarding the credit, as provided.

The Personal Income Tax Law imposes taxes on income and provides a definition for the Franchise Tax Board for purposes of that law.

This bill would make a technical, nonsubstantive change to that definition.

SENATE COMMITTEE ON APPROPRIATIONS

Senator Ricardo Lara, Chair

2015 - 2016 Regular Session

SB 152 (Vidak) - Personal income taxes: earned income credit

This bill meets the criteria for referral to the Suspense File.

Bill Summary:

SB 152 would create a refundable Earned Income Tax Credit (EITC), upon appropriation of the Legislature, equal to 15 percent of the federal EITC.

Fiscal Impact:

• The fiscal impact depends in large part on future funding decisions by the Legislature. The Franchise Tax Board (FTB) estimates that, if there is no appropriation made by the Legislature, this bill would reduce General Fund revenues by $24 million in 2015-16, $120 million in 2016-17, and $120 million in 2017-18. Conversely, if the Legislature does make a yearly appropriation, FTB estimates that this bill would reduce General Fund revenues by $240 million in 2015-16, $1.2 billion in 2016-17, and $1.2 billion in 2017-18.

• Administration costs to FTB have not yet been identified, but would likely be in the millions of dollars annually (General Fund).

Background:

Tax credits differ from other tax expenditures in that they directly reduce income tax liability, as opposed to indirectly by reducing taxable income. For instance, a one dollar credit reduces tax liability by one dollar, whereas a tax deduction of one dollar will reduce taxable income by one dollar, but reduces tax liability by the marginal tax rate. For example, an additional one dollar of deduction for a taxpayer in the 10 percent tax bracket reduces tax liability by 10 cents, while a taxpayer in the 39.6 percent tax bracket reduces tax liability by 39.6 cents.

The federal EITC was enacted in 1975. It was originally intended to be temporary in nature, to mitigate the impact of (1) the Social Security payroll tax, and (2) rising food and energy prices. Instead, the EITC was made permanent in 1978. The Tax Reform Act of 1986 indexed both the maximum earned income and phase-out income levels to inflation. The EITC differs from most other tax credits in that it is partially or fully refundable. A taxpayer with $100 in tax liability and $200 in a refundable tax credit would receive a tax refund of $100.

The EITC is considered both (1) an anti-poverty program and (2) an alternative to cash-transfer programs because it incentivizes work. The EITC is work-oriented in that the amount of the credit is based on earnings. The amount of the credit (which varies depending on the number of qualifying children in addition to earned income) initially rises as earnings increase, then reaches a plateau, and then falls as earnings increase further. For example, for a couple with two children in 2014, the credit is equal to 40 percent (the credit rate) of the first $13,700 in earnings. The maximum credit of $5,460 is received by taxpayers with earnings between $13,700 and $23,300. The credit phases out at a rate of 21.06 percent (that is, it is reduced by 21.06 cents for every additional dollar of earnings) for earnings over $23,300 and is zero for taxpayers with earnings over $43,950.

The value of the EITC has increased over time. For example, the maximum credit for a worker with three children has increased from $400 in 1978 (roughly $1,465 in 2014 dollars) to $6,143 in 2014.

Current state law provides that individuals with income below specified levels are not required to file a return, as the standard deduction and personal exemption credit eliminate any tax liability. For 2013, these thresholds are $12,838 in adjusted gross income for single filers, and $25,678 for married individuals filing jointly. These thresholds are increased based on the number of dependents claimed and are increased annually for inflation.

Twenty-five states, the District of Columbia, and two local jurisdictions (New York City and Montgomery County, Maryland) currently provide the EITC in varying forms and amounts.

Proposed Law:

This bill would allow a refundable tax credit, upon appropriation of the Legislature, equal to 15 percent of the federal EITC. The credit would be nonrefundable but could be carried over in years when an appropriation is not made by the Legislature.

This bill would require FTB to adjust the phase-out percentages and the maximum investment income amount for inflation, measured by the Department of Industrial Relations as specified. Additionally the bill would require FTB to do the following:

• Administer enforcement activities to address improper payments.

• Collaborate with the Employment Development Department (EDD) to develop criteria for, and a process to verify, taxpayer income information using wage and withholding data.

• Establish criteria for, and a process to identify, high-risk returns that may be subject to increased verification procedures and suspension of payments until the information is verified.

• Submit a yearly report to the Legislature that includes information on the eligibility for the credit, use of the credit, and information regarding improper payments.

SB 152 would take effect immediately as a tax levy and applies to taxable years 2016 through 2023.

Related Legislation:

• SB 38 (Liu, 2015), would create a refundable EITC equal to 30 or 100 percent of the federal EITC. SB 38 will be heard in this Committee on May 18^th 2015.

• AB 43 (Stone, 2015), would create a refundable EITC equal to 15, 35, or 60 percent of the federal EITC, as specified. AB 43 is pending before the Assembly Revenue and Taxation Committee.

• SB 1189 (Liu, 2014), would have provided a nonrefundable EITC equal to 15 percent of the federal EITC. SB 1189 failed to pass out this Committee.

Staff Comments:

The actual revenue loss associated with the bill is difficult to estimate with precision. In order to claim the federal EITC, a qualifying taxpayer must file a federal income tax return. This is the only way to claim the credit, even for those taxpayers who do not earn sufficient income to be required to file. As a result, it has been estimated that in 2009, about 800,000 Californians (about 20 percent of those eligible) failed to claim EITC refunds worth $1.2 billion. The revenue estimate for this bill must incorporate assumptions regarding (1) whether the introduction of the state-level EITC increases the extent to which the federal EITC is claimed, and (2) the future growth of wage income (and by extension the growth of the economy). Greater EITC participation and a stronger wage growth would increase the revenue loss associated with this bill.

FTB notes several implementation considerations, all of which would have a fiscal impact:

• Many taxpayers eligible for the federal EITC have no California income tax return filing requirement. These non-filers would be required to file a California income tax return to claim the proposed state EITC, which could impact the department's programs and costs.

• Typically, refund returns are filed early in the filing season. If taxpayers claiming the California EITC file late in the filing season, after they receive their federal EITC, that behavior could have a major impact on the processing of returns and possibly cause delays in the issuance of refunds. The taxpayer error rate on the federal EITC and the fraud concerns cause the IRS to adjust many returns. Consequently, the correct federal EITC amount may be unknown until after the taxpayer has filed the state return, claimed the proposed California credit, and received a refund. FTB could be required to issue an assessment to retrieve incorrect refunds and incur costs to do so.

• Relying on the EITC under federal law may present implementation problems for Registered Domestic Partners (RDPs). RDPs are required to file California income tax returns using the rules applicable to married individuals. If the author's intent is to allow EITCs for RDPs, a rule should be included in the bill to address the difference between federal and state law.

• Historically, the department has had significant problems with refundable credits and fraud. These problems are aggravated because if a refund is made that is later determined to be fraudulent, the refund commonly cannot be recovered. Striking the refund provision from this credit would substantially reduce the department's concerns regarding fraud.

Finally, the Governor’s 2015-16 May Revision proposes an EITC, which would provide a refundable tax credit for wage income for households with income limits of $6,580 (zero dependents) up to $13,870 (three or more dependents). The credit would match 85 percent of the federal credits up to half of the federal phase-in range; and then, begin to taper off relative to these maximum wage amounts. The credit would be available beginning with tax returns filed for wages earned in 2015. The tax credit is estimated to reduce revenues by $380 million annually beginning in 2015-16, and benefit an estimated 825,000 families. The estimated average household benefit is $460 per year, with a maximum credit of $2,653.

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SENATE COMMITTEE ON GOVERNANCE AND FINANCE

Senator Robert M. Hertzberg, Chair

2015 - 2016 Regular

PERSONAL INCOME TAX: EARNED INCOME CREDIT

Allows a refundable Earned Income Tax Credit (EITC), upon appropriation of the Legislature, equal to 15% of the federal EITC.

Background and Existing Law

Federal law allows eligible individuals a refundable EITC, which allows the taxpayer to obtain a refund for the excess of the credit over the taxpayer’s liability. As the name implies, the credit is based on a percentage of the taxpayer's earned income, and phases out as income increases. The percentage varies depending on whether the taxpayer has qualifying children. Married individuals are eligible for only one credit on their combined earned income and must file a joint return to claim the credit.

Federal law specifies that if the federal EITC is denied, and the Internal Revenue Service (IRS) determined that the taxpayer’s error was due to reckless or intentional disregard of EITC rules, the EITC would be denied for the next two years. If the error was due to fraud, the denial period would be ten years.

State law provides various tax credits designed to provide tax relief for tax-payers who incur certain expenses or to influence behavior, including business practices.

State law allows individuals with income below a certain threshold to not file a return, when the standard deduction and personal exemption credit eliminate any tax liability. For 2014, these thresholds are $16,047 in gross income or $12,838 in adjusted gross income (AGI) for single taxpayers and $33,097 in gross income or $25,678 in AGI for married individuals filing jointly. These thresholds are increased based on the number of dependents claimed, and are increased annually for inflation. State law does not provide an EITC.

Proposed Law

Senate Bill 152 allows a refundable tax credit, upon appropriation of the Legislature, equal to 15% of the federal EITC. In a year when an appropriation is not made by the Legislature, the credit becomes nonrefundable, but can be carried over to succeeding taxable years until exhausted.

SB 152 defines “federal earned income credit amount” to mean the amount determined under Section 32 of the IRC as amended by several public laws, except as provided.

This bill defines a “qualified taxpayer” to mean an individual who:

• is eligible for a credit, for federal income tax purposes;

• is legally working in the state; and

• possesses a valid SSN, legal work authorization, or taxpayer’s identification number (TIN).

The credit allowed may be claimed only on a qualified taxpayer’s timely filed original return, and any amounts refunded would not be included in income. FTB’s determination with respect to the date a return was received could not be reviewed in any administrative or judicial proceeding. Any simple error would be treated as a mathematical error appearing on the return.

This bill requires FTB, from the 2017 taxable year to taxable year 2022, to adjust the phase-out percentages and the maximum investment income amount for inflation. The inflation adjustment would be based on the percentage change in the California Consumer Price Index (CCPI) for all items, on a calendar year June-to June basis, as provided to the FTB by the Department of Industrial Relations.

SB 152 requires the FTB to do all of the following:

• Administer enforcement activities to address improper payments;

• Collaborate with the Employment Development Department (EDD) to develop criteria for, and a process to verify, taxpayer income information using wage and withholding data;

• Establish criteria for, and a process to identify, high-risk returns that may be subject to increased verification procedures and suspension of payments until the information is verified; and

• Submit a yearly report to the Legislature that includes information on the eligibility for the credit, use of the credit, and information regarding improper payments.

SB 152 takes effect immediately as a tax levy and applies to taxable years beginning on or after January 1, 2016 and before January 1, 2023.

State Revenue Impact

FTB estimates that this bill would reduce General Fund revenues by $24 million in fiscal year 2015-16, $120 million in 2016-17, and $120 million in 2017-18 if there is no appropriation made by the Legislature.

If there is a yearly appropriation made by the Legislature, FTB estimates that this bill would reduce General Fund revenues by $240 million in 2015-16, $1.2 billion in 2016-17, and $1.2 billion in 2017-18.

Comments

1. Purpose of the bill. According to the author, “The federal EITC is a refundable tax credit for low and middle class working households that helps reduce poverty and reward work. Researchers cite the federal EITC as among the most effective tool for reducing poverty since it promotes work and provides resources that lift families out of poverty. Nationwide 28 million American tax returns received the federal EITC in tax year 2013. In fact over 3.1 million Californian tax returns received the EITC. These 3.1 million returns resulted in $7.3 billion in refundable tax credits for California families with the average tax credit being $2,373. The Legislative Analyst Office (LAO) estimates that the federal EITC alone helps to keep 750,000 Californians out of poverty every year. Twenty five states and the District of Columbia have already established their own EITC to magnify the impact of the federal EITC, but California has yet to do so. These state EITC’s range from 40% of the federal EITC in the District of Columbia to 3.5% in Louisiana. Some states have credits which fluctuate between 34-37% of EITC in Minnesota and 0-34% in Wisconsin. Studies based on other states EITCs have estimated that each additional dollar received back by a tax filer generates a further $1.50-2.00 in local economic activity. The impact of this increased purchasing power in communities benefited by federal and state EITC dollars can help to support local jobs and small businesses. Senate Bill 152 creates a refundable California Earned Income Tax Credit (CEITC) that would be equal to 15% of the federal EITC. Eligible individuals must meet the federal EITC requirements for the current tax year as well as have either a Social Security Number, legal work authorization, or a taxpayer identification number. This EITC would sunset in 2023. Additionally, the legislation creates a framework for the Franchise Tax Board (FTB) to use to ensure that eligible families are receiving the California EITC.”

2. What is an EITC? The EITC is a federal tax credit for low-to-moderate income individuals and families. Congress originally approved the tax credit legislation in 1975, in part to offset the burden of social security taxes and to provide an incentive to work. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit.

In order for a taxpayer to qualify for the credit, an individual's AGI in the 2014 taxable year must be less than:

• $46,997 ($52,427 filing jointly) with three or more qualifying children.

• $43,756 ($49,186 filing jointly) with two qualifying children.

• $38,511 ($43,941 filing jointly) with one qualifying child.

• $14,590 ($20,020 filing jointly) without a qualifying child.

The 2014 maximum credit for taxpayers is as follows:

• $6,143 with three or more qualifying children.

• $5,460 with two qualifying children.

• $3,305 with one qualifying child.

• $496 with no qualifying children.

Taxpayers cannot claim the federal EITC if their 2014 investment income (from interests and dividends) is more than $3,350. The amount of the federal EITC is reduced by the alternative minimum tax (AMT), if any.

In 2009, 800,000 eligible Californians failed to claim over $1.2 billion worth of federal EITC dollars. According to the New America Foundation study Left on the Table, if these refunds were claimed, they would spur over $1.2 billion in business sales, pay $311 million in wages, and add nearly 7,500 jobs to the California economy, which would result in $88 million in taxes coming back to the state. According to the Internal Revenue Service (IRS), currently, 25 states and the District of Columbia offer state-level EITC for their residents.

3. A Note on Fraud. Although the federal EITC lifts families and individuals out of poverty, the refundable credit is highly susceptible to fraud. The Treasury Inspector General for Tax Administration estimates that improper EITC claims total over $10 billion a year. The payments paid out improperly for 2012 were at least 21-25% of all payments, according to the latest report from the IRS inspector general.

4. Another way? As stated in SB 152’s legislative findings, the federal EITC is a proven antipoverty measure, but there are other programs we can invest in to help working families. The state can invest in increasing TANF grants, restore CalWORKs childcare subsidies that were cut during the recession, and increase funding for food stamps, to name a few.

5. Let’s get clear. SB 152 lays out the framework for a California EITC, but leaves out many critical details needed to implement the credit. For example, the credit is refundable upon appropriation of the legislature, thus if there is no appropriation in the first two years, but an appropriation in the third, can individuals who would have received a refund amend their last two returns? Would individuals who are amending returns be entitled to payment first or would FTB prioritize individuals filing original returns? The simple solution would be to amend the bill to include a continuous appropriation; however this would likely result in the bill requiring a 2/3 vote for passage. The Committee may wish to consider amending the bill to clarify the mechanics of who is eligible for a refund when an appropriation is made by the Legislature.

6. Related legislation. SB 38 (Liu) creates a refundable EITC equal to 15 or 100 percent of the federal EITC. SB 38 is set to be heard on April 22, 2015 in this Committee. AB 43 (Stone) creates a refundable EITC equal to 15 to 60 percent of the federal EITC. AB 43 is set to be heard in the Assembly Revenue and Taxation Committee.

7. FTB's Implementation Concerns. FTB notes the following implementation concerns in its analysis of this bill:

• Many taxpayers eligible for the federal EITC have no California income tax return filing requirement. These non-filers would be required to file a California income tax return to claim the proposed state EITC, which could impact the department's programs and costs.

• Typically, refund returns are filed early in the filing season. If taxpayers claiming the California EITC file late in the filing season, after they receive their federal EITC, that behavior could have a major impact on the processing of returns and possibly cause delays in the issuance of refunds. The taxpayer error rate on the federal EITC and the fraud concerns cause the IRS to adjust many returns. Consequently, the correct federal EITC amount may be unknown until after the taxpayer has filed the state return, claimed the proposed California credit, and received a refund. FTB could be required to issue an assessment to retrieve incorrect refunds and incur costs to do so.

• Relying on the EITC under federal law may present implementation problems for Registered Domestic Partners (RDPs). RDPs are required to file California income tax returns using the rules applicable to married individuals. If the author's intent is to allow EITCs for RDPs, a rule should be included in the bill to address the difference between federal and state law.

• Historically, the department has had significant problems with refundable credits and fraud. These problems are aggravated because if a refund is made that is later determined to be fraudulent, the refund commonly cannot be recovered. Striking the refund provision from this credit would substantially reduce the department's concerns regarding fraud.

8. Let’s get technical. FTB has proposed the following clarifying amendments:

• On page 3, line 10 delete the incorrect cross-reference

• On page 3, line 36, remove “taxpayer‘s” and replace it with “taxpayer”

• On page 3, line 40, insert “the” after “exceeds”

Support and Opposition

(4/16/15)

Support: Fresno Chamber of Commerce; Western Center on Law and Poverty.

Opposition: California Taxpayers Association (CalTax).

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