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. Federal income tax laws allow a refundable earned income tax credit for certain low-income individuals who have earned income and who meet certain other requirements.

This bill, for taxable years beginning on or after January 1, 2016, and before January 1, 2027, would allow a credit based upon earned income that is equal to 30% for eligible individuals with qualifying children and 100% for eligible individuals with no qualifying children, as specified, of the earned income tax credit allowed by federal law. If the amount allowable as a credit exceeds tax liability, the bill would require the excess to be credited against other amounts due, if any, and the balance, if any, to be carried forward, or, upon appropriation by the Legislature, be paid from the General Fund and refunded to the eligible individual. The bill would require the Franchise Tax Board to report to the Legislature regarding the utilization of the tax credit, as provided. 2015, in modified conformity with federal income tax laws, would allow a refundable earned income credit to an eligible individual that is equal to the earned income tax credit allowed by federal law in an amount determined by the earned income tax credit adjustment factor as determined in the annual Budget Act.

(1)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, 2027, would allow a credit based upon earned income that is equal to 30% for eligible individuals with qualifying children and 100% for eligible individuals with no qualifying children, as specified, of the earned income tax credit allowed by federal law. If the amount allowable as a credit exceeds tax liability, the bill would require the excess to be credited against other amounts due, if any, and the balance, if any, to be carried forward, or, upon appropriation by the Legislature, be paid from the General Fund and refunded to the eligible individual. The bill would require the Franchise Tax Board to report to the Legislature regarding the utilization of the tax credit, as provided.

This bill would also require the Franchise Tax Board to establish a pilot program to allow eligible individuals to secure advance payments of the aforementioned credit. The bill would make the pilot program applicable to taxable years beginning on or after January 1, 2017, and before January 1, 2019, where an employer and an eligible individual have agreed to participate in the pilot program. The bill would require the Franchise Tax Board to study and report on the pilot program by a specified date.

(2)Existing law establishes the California Tax Education Council, a nonprofit organization, and requires the council to register and regulate tax preparers. Existing law requires the council to issue a certificate of completion to the tax preparer when the tax preparer demonstrates that he or she has completed basic tax instruction from an approved curriculum provider. Existing law also requires a tax preparer to annually complete continuing education from an approved curriculum provider. Except as provided, a violation of the provisions governing tax preparers is a crime.

This bill, for purposes of basic instruction and continuing education, would require an approved curriculum provider to include instruction for filing preparing taxes for a taxpayer who is an eligible individual and meets the requirements for the state earned income tax credit, as described above. Because a violation of these requirements would constitute a crime, the bill would impose a state-mandated local program.

The California Constitution requires the state to reimburse local agencies and school districts for certain costs mandated by the state. Statutory provisions establish procedures for making that reimbursement.

This bill would provide that no reimbursement is required by this act for a specified reason.

(1)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 would, bill, for taxable years beginning on or after January 1, 2016, and before January 1, 2027, would allow a credit based upon earned income that is equal to 15% 30% for eligible individuals with qualifying children and 100% for eligible individuals with no qualifying children, as specified, of the earned income tax credit allowed by federal law. If the amount allowable as a credit exceeds tax liability, the bill would require the excess to be credited against other amounts due, if any, and the balance, if any, to be carried forward, or, upon appropriation by the Legislature, be paid from the General Fund and refunded to the eligible individual. The bill would require the Franchise Tax Board to report to the Legislature regarding the utilization of the tax credit, as provided.

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 would, for taxable years beginning on or after January 1, 2016, and before January 1, 2027, allow a credit based upon earned income that is equal to 15% of the earned income tax credit allowed by federal law. The bill would require the Franchise Tax Board to report to the Legislature regarding the utilization of the tax credit, as provided.

This bill would take effect immediately as a tax levy.

 THIRD READING  

Bill No: SB 38

Author: Liu (D)

Amended: 6/2/15

Vote: 27

SENATE GOVERNANCE & FIN. COMMITTEE: 6-0, 4/29/15

AYES: Hertzberg, Nguyen, Beall, Hernandez, Lara, Pavley

NO VOTE RECORDED: Moorlach

SENATE APPROPRIATIONS COMMITTEE: 5-2, 5/28/15

AYES: Lara, Beall, Hill, Leyva, Mendoza

NOES: Bates, Nielsen

SUBJECT: Personal income tax: credit: earned income: tax preparer education

SOURCE: Author

DIGEST: This bill creates a refundable Earned Income Tax Credit (EITC).

ANALYSIS:

Existing law:

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

2. Does not require individuals with income below a certain threshold to not file a return, when the standard deduction and personal exemption credit eliminate any tax liability.

This bill:

1. Provides a refundable tax credit, and unless otherwise specified in the annual Budget Act, the credit adjustment factor is zero percent.

2. Applies to taxable years for which resources are authorized in the annual Budget Act for the Franchise Tax Board (FTB) to oversee and audit returns.

3. Provides that the credit and phase out percentages shall be determined as follows:

• 7.65% for individuals with no qualifying children,

• 34% for individuals with one qualifying child,

• 40% for individuals with two or more qualifying children, and

• 45% for individuals with three or more qualifying children.

4. Provides that the earned income and phase out shall be determined as follows:

• $3,290 for individuals with no qualifying children,

• $4,940 for individuals with one qualifying child, and

• $6,935 for individuals with two or more qualifying children.

5. Limits investment income, from interests and dividends, to no more than $3,400.

6. Limits eligibility to wage earners.

7. Applies to taxable years beginning on or after January 1, 2015.

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 $1 credit reduces tax liability by $1, whereas a tax deduction of $1will reduce taxable income by $1, but reduces tax liability by the marginal tax rate. For example, an additional $1 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.

FISCAL EFFECT: Appropriation: Yes Fiscal Com.: Yes Local: No

According to the Senate Appropriations Committee, the Department of Finance estimates that this bill will result in an annual General Fund revenue loss of $380 million beginning in 2015‑16. Administration costs to FTB have not yet been identified, but would likely be in the millions of dollars annually (General Fund).

SUPPORT: (Verified 6/2/15)

Alameda County Board of Supervisors

American Academy of Pediatrics, California

American Association of University Women

California Association of Food Banks

California Catholic Conference of Bishops

California Food Policy Advocates

California Hunger Action Coalition

California Partnership

California Reinvestment Coalition

Children’s Defense Fund – California

Coalition of California Welfare Rights Organization

Community Action Partnership of Kern

Community Action Partnership of Riverside County

Courage Campaign

Friends Committee on Legislation of California

Lutheran Office of Public Policy – California

National Association of Social Workers, California Chapter

Pacoima Beautiful

PolicyLink

Ventura County Board of Supervisors

Western Center on Law and Poverty

OPPOSITION: (Verified 6/2/15)

California Taxpayers Association

ARGUMENTS IN SUPPORT: According to the author, “The state EITC will help thousands of low- and middle-income working Californians and is an excellent complement to the federal tax credit. The federal EITC lifts 6.6 million Americans, including 3.3 million children, out of poverty each year, making it the nation’s largest and most successful anti-poverty program. Research shows that the credit does more than reduce poverty and provide a short-term safety net for low-income working families The EITC, which benefits between 25 and 30 million low- and moderate-income families, stimulates the local economy by increasing their spending power. That is in addition to the income, employment, educational, and health benefits to children that can extend into adulthood. Nearly 70% of families living in poverty in 2013 had at least one working adult. Further, according to the PPIC [Public Policy Institute of California] 61% of all of our state’s impoverished children live in working families. The state Earned Income Tax Credit will help struggling families while increasing the take up rate of the federal EITC, bringing more federal dollars into our state. With the economy improving this is an ideal time to make an investment in those that have yet to recover from the Great Recession. The state EITC is an effective anti-poverty policy and will help working Californians and our state’s children.”

ARGUMENTS IN OPPOSITION: Opponents argue that 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.

Prepared by: Myriam Bouaziz / GOV. & F. / (916) 651-4119

6/2/15 21:49:51

**** END ****

SENATE COMMITTEE ON APPROPRIATIONS

Senator Ricardo Lara, Chair

2015 - 2016 Regular Session

SB 38 (Liu) - Personal income tax: credit: earned income: tax preparer education

SUSPENSE FILE. AS AMENDED.

Bill Summary:

SB 38 would (1) create a refundable Earned Income Tax Credit (EITC), and (2) require the Franchise Tax Board (FTB) to establish an advance payments pilot program.

Fiscal Impact (as approved on May 28, 2015):

• The Department of Finance estimates that this bill would result in an annual General Fund revenue loss of $380 million beginning in 2015‑16.

• 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 30 percent of the federal EITC for eligible individuals (as defined) with qualifying children, and 100 percent for eligible individuals without qualifying children. The credit would be nonrefundable but could be carried over in years when an appropriation is not made by the Legislature.

The bill also would require FTB to (1) establish a pilot program to allow eligible individuals to secure advance payments of the EITC through their employers, and (2) report findings on the program, as specified. The pilot program would apply to taxable years 2017 and 2018.

Additionally, the bill would require providers of basic and continuing education to tax preparers to include instruction for preparing taxes for a taxpayer who is eligible for the state EITC.

The bill would take effect immediately as a tax levy and apply to taxable years 2016 through 2026.

Related Legislation:

• SB 152 (Vidak, 2015), would create a refundable EITC equal to 15 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.

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.

Committee amendments make this bill identical to the EITC proposal contained in the Governor’s 2015-16 May Revision proposal.

-- END --

SENATE COMMITTEE ON APPROPRIATIONS

Senator Ricardo Lara, Chair

2015 - 2016 Regular Session

SB 38 (Liu) - Personal income tax: credit: earned income: tax preparer education

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

Bill Summary:

SB 38 would (1) create a refundable Earned Income Tax Credit (EITC), and (2) require the Franchise Tax Board (FTB) to establish an advance payments pilot program.

Fiscal Impact:

• The fiscal impact depends in large part on future funding decisions by the Legislature. FTB estimates that, if there is no appropriation made by the Legislature, this bill would reduce General Fund revenues by $60 million in 2015-16, $300 million in 2016-17, and $350 million in 2017-18. Conversely, if the Legislature does make a yearly appropriation, FTB estimates that this bill would reduce General Fund revenues by $600 million in 2015-16, $2.9 billion in 2016-17, and $3 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 30 percent of the federal EITC for eligible individuals (as defined) with qualifying children, and 100 percent for eligible individuals without qualifying children. The credit would be nonrefundable but could be carried over in years when an appropriation is not made by the Legislature.

The bill also would require FTB to (1) establish a pilot program to allow eligible individuals to secure advance payments of the EITC through their employers, and (2) report findings on the program, as specified. The pilot program would apply to taxable years 2017 and 2018.

Additionally, the bill would require providers of basic and continuing education to tax preparers to include instruction for preparing taxes for a taxpayer who is eligible for the state EITC.

The bill would take effect immediately as a tax levy and apply to taxable years 2016 through 2026.

Related Legislation:

• SB 152 (Vidak, 2015), would create a refundable EITC equal to 15 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.

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.

-- END --

SENATE COMMITTEE ON GOVERNANCE AND FINANCE

Senator Robert M. Hertzberg, Chair

2015 - 2016 Regular

PERSONAL INCOME; CREDIT: EARNED INCOME: TAX PREPARER EDUCATION

Allows a refundable Earned Income Tax Credit (EITC), upon appropriation of the Legislature, equal to 30% or 100% 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 38 allows a refundable tax credit, upon appropriation by the Legislature, equal to 30% of the federal EITC for eligible individuals with qualifying children or 100% for individuals with no qualifying children. 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.

An “eligible individual” would have the same meaning as in Section 32(c)(1) of the Internal Revenue Code (IRC), except that an individual without a qualifying child would qualify for the credit at age 21 instead of 25. Any amounts refunded to a taxpayer under SB 38 would not be included in income.

For an individual who is a nonresident or is a part-year resident of this state, the amount of the credit or refund allowed under this bill would be determined based on the part of the earned income credit that is attributable to California.

SB 38 also requires FTB to establish a pilot program to allow eligible individuals to secure advance payments of the EITC through their employers and requires FTB to report findings on the program. The pilot program applies to taxable years beginning on or after January 1, 2017 and before January 1, 2019.

SB 38 requires FTB to report to the legislature information on the effectiveness of the credit. Additionally, the bill requires providers of basic and continuing education to tax preparers to include instruction for preparing taxes for a taxpayer who is eligible for the state earned income tax credit

SB 38 takes effect immediately as a tax levy and applies to taxable years beginning on or after January 1, 2016 and before January 1, 2027.

State Revenue Impact

FTB estimates that this bill would reduce General Fund revenues by $60 million in fiscal year 2015-16, $300 million in 2016-17, and $350 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 $600 million in 2015-16, $2.9 billion in 2016-17, and $3 billion in 2017-18

Comments

1. Purpose of the bill. According to the author, “SB 38 will create a refundable state Earned Income Tax Credit (EITC) equal to 30% of the federal EITC for eligible individuals with qualifying dependents and 100% of the federal rate for eligible individuals with no qualifying dependents. Further, it calls upon the Franchise Tax Board (FTB) to establish a pilot advance pay program for the credit. The state EITC will help thousands of low- and middle-income working Californians and is an excellent complement to the federal tax credit. The federal EITC lifts 6.6 million Americans, including 3.3 million children, out of poverty each year, making it the nation’s largest and most successful anti-poverty program. Research shows that the credit does more than reduce poverty and provide a short-term safety net for low-income working families The EITC, which benefits between 25 and 30 million low- and moderate-income families, stimulates the local economy by increasing their spending power. That is in addition to the income, employment, educational, and health benefits to children that can extend into adulthood. Nearly 70% of families living in poverty in 2013 had at least one working adult. Further, according to the PPIC 61% of all of our state’s impoverished children live in working families. The state Earned Income Tax Credit will help struggling families while increasing the take up rate of the federal EITC, bringing more federal dollars into our state. With the economy improving this is an ideal time to make an investment in those that have yet to recover from the Great Recession. The state EITC is an effective anti-poverty policy and will help working Californians and our state’s children.”

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 38’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 38 lays out the framework for a California EITC, and a pilot program to secure advance payment of an EITC, but leaves out many critical details needed to implement both components of the bill. 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. Additionally, the pilot program does not specify an application process for participating or an entity that would process applications and determine eligibility. Also the pilot program does not contain a funding mechanism so employers can make advance payments. The Committee may wish to consider amending the bill to provide the infrastructure needed to implement the pilot program and to clarify the mechanics of who is eligible for a refund when an appropriation is made by the Legislature.

6. Related legislation. SB 152 (Vidak) creates a refundable EITC equal to 15 percent of the federal EITC. SB 152 is set to be heard on April 29, 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 amendment:

• On page 6, line 19, after 17052.1, add “for taxable years beginning”

• On page 6, line 19, after “on or after” strike out “taxable years” and add “January 1, 2017”

Support and Opposition

(4/23/15)

Support: Alameda County Board of Supervisors; American Academy of Pediatrics, California; American Association of University Women (AAUW); California Association of Food Banks; California Catholic Conference of Bishops; California Food Policy Advocates (CFPA); California Hunger Action Coalition (CHAC); California Partnership; California Reinvestment Coalition; Children’s Defense Fund – California (CDF-CA); Coalition of California Welfare Rights Organization; Community Action Partnership of Kern (CAPK); Community Action Partnership of Riverside County (CAP); Courage Campaign; Friends Committee on Legislation of California; Lutheran Office of Public Policy – California; National Association of Social Workers, California Chapter (NASW-CA); Pacoima Beautiful; PolicyLink; Ventura County Board of Supervisors; Western Center on Law and Poverty.

Opposition: California Taxpayers Association (CalTax)

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