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 from specified sources and who meet certain other requirements.

The Personal Income Tax Law, for taxable years beginning on or after January 1, 2015, in modified conformity with federal income tax laws, allows an earned income credit against personal income tax, and a payment from the Tax Relief and Refund Account for an allowable credit in excess of tax liability, to an eligible individual in an amount determined in accordance with federal law as applicable for federal income tax purposes for the taxable year, multiplied by the earned income tax credit adjustment factor, as specified. Existing law creates the Tax Relief and Refund Account, which is continuously appropriated, and provides that required payments to be made to taxpayers or other persons from the Personal Income Tax Fund are to be paid from that account, including amounts allowable as an earned income credit in excess of any tax liability. The Personal Income Tax Law provides that the amount of the credit is calculated as a percentage of the eligible individuals earned income and is phased out above a specified amount as income increases.

This bill, for specified taxable years beginning on and after January 1, 2017, would increase the earned income threshold for which the phaseout begins, thereby increasing the amount of eligible taxpayers and the credit percentage for those eligible individuals for those taxable years beginning on and after January 1, 2017. The bill would suspend this increase under specified circumstances.

By increasing the allowable credit amount, this bill would authorize new payments from the Tax Relief and Refund Account for additional amounts in excess of personal income tax liabilities, thereby making an appropriation.

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 from specified sources and who meet certain other requirements.

The Personal Income Tax Law, for taxable years beginning on or after January 1, 2015, in modified conformity with federal income tax laws, allows an earned income credit against personal income tax, and a payment from the Tax Relief and Refund Account for an allowable credit in excess of tax liability, to an eligible individual in an amount determined in accordance with federal law as applicable for federal income tax purposes for the taxable year, multiplied by the earned income tax credit adjustment factor, as specified. Existing law creates the Tax Relief and Refund Account, which is continuously appropriated, and provides that required payments to be made to taxpayers or other persons from the Personal Income Tax Fund are to be paid from that account, including amounts allowable as an earned income credit in excess of any tax liability. The Personal Income Tax Law provides that the amount of the credit is calculated as a percentage of the eligible individuals earned income and is phased out above a specified amount as income increases. Under existing law, a credit is not allowed where a taxpayers aggregate amount of investment income, which includes interest or dividends, exceeds a specified amount.

This bill, for specified taxable years beginning on and after January 1, 2017, would increase the earned income threshold for which the phase out begins and would increase the amount of investment income that is allowed per taxable year before the credit is denied, phaseout begins, thereby increasing the amount of eligible taxpayers and the credit percentage for those eligible individuals for those taxable years beginning on and after January 1, 2017.

By increasing the allowable credit amount, this bill would authorize new payments from the Tax Relief and Refund Account for additional amounts in excess of personal income tax liabilities, thereby making an appropriation.

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 from specified sources and who meet certain other requirements.

The Personal Income Tax Law, for taxable years beginning on or after January 1, 2015, in modified conformity with federal income tax laws, allows an earned income credit against personal income tax, and a payment from the Tax Relief and Refund Account for an allowable credit in excess of tax liability, to an eligible individual in an amount determined in accordance with federal law as applicable for federal income tax purposes for the taxable year, multiplied by the earned income tax credit adjustment factor, as specified. Existing law creates the Tax Relief and Refund Account, which is continuously appropriated, and provides that required payments to be made to taxpayers or other persons from the Personal Income Tax Fund are to be paid from that account, including amounts allowable as an earned income credit in excess of any tax liability. The Personal Income Tax Law provides that the amount of the credit is calculated as a percentage of the eligible individuals earned income and is phased out above a specified amount as income increases. Under existing law, a credit is not allowed where a taxpayers aggregate amount of investment income, which includes interest or dividends, exceeds a specified amount.

This bill, for taxable years beginning on and after January 1, 2017, would increase the earned income threshold for which the phase out begins and would increase the amount of investment income that is allowed per taxable year before the credit is denied, thereby increasing the amount of eligible taxpayers and the credit percentage for those eligible individuals for taxable years beginning on and after January 1, 2017.

By increasing the allowable credit amount, this bill would authorize new payments from the Tax Relief and Refund Account for additional amounts in excess of personal income tax liabilities, thereby making an appropriation.

Date of Hearing: April 5, 2017

ASSEMBLY COMMITTEE ON APPROPRIATIONS

Lorena Gonzalez Fletcher, Chair

ABPCA Bill Id:AB 225

Author:(Caballero) – As Amended Ver:March 20, 2017

Urgency: No State Mandated Local Program: No Reimbursable: No

SUMMARY:

This bill increases the earned income thresholds at which the California Earned Income Tax Credit (CalEITC) begins to phase out. Specifically, this bill:

1. Increases the earned income thresholds annually for taxable years beginning on or after January 1, 2017, and before January 1, 2023, as specified.
2. Provides that the earned income thresholds specified for taxable years beginning on or after January 1, 2023 shall be annually adjusted for inflation.
3. Suspends the scheduled increase in earned income thresholds in years when the scheduled California’s minimum wage increase is also suspended.

FISCAL EFFECT:

1. General Fund (GF) cost pressures of $400 million in 2017-18, $440 million 2018-19, and $500 million in 2019-20. (See Comment #4).
2. Unknown GF cost pressures for FTB’s administration of the expanded CalEITC. These costs only materialize if FTB receives a budget appropriation to administer the credit, as required by current law.

COMMENTS:

1. Purpose. According to supporters, AB 225 strengthens the CalEITC program by ensuring that more low-income families receive the credit. Supporters note that under current state law, a full-time minimum wage worker with two children cannot claim the credit because that worker’s earnings are too high. This bill expands CalEITC eligibility so that these workers can claim the credit even as the statewide minimum wage gradually increases to $15 per hour.
2. CalEITC. The CalEITC is a state refundable income tax credit that is modeled after the federal EITC. Similar to the federal credit, the state credit amount is based on a percentage of the taxpayer’s earned income, and that percentage is determined by income levels and the size of the household. The state credit phases in at low levels of income until it reaches its maximum size at a specified income threshold, after which it phases out gradually until it reaches zero. The credit phases in so as to reward work: The more someone earns, the bigger the tax credit. The credit phases out so as to not discourage work by immediately taking away the credit when earned income reaches a certain threshold.

While the CalEITC is based on the federal program, the two programs have some key differences that shape who is eligible and the size of the tax refund available. One important difference is that the CalEITC reaches far fewer households because eligibility is restricted to households with very low incomes. For example, in 2016 the maximum income allowed in order for a single person with two children to receive a state credit was $14,161. In comparison, the maximum income for the federal program for a similar taxpayer was $44,648. Currently, these income thresholds for both the federal EITC and CalEITC are adjusted for inflation each year.

1. How AB 225 works. This bill increases the earned income thresholds at which the CalEITC begins to phase out. For example, in 2016, a single taxpayer with two children could receive the maximum state credit at an income level of $7,080, after which the credit phases out until it reaches zero. AB 225 increases the threshold for this type of household to $10,950 in 2017, a much larger increase than what the inflation adjustment will generate. Then, AB 225 increases these thresholds each year to keep up with the scheduled increases in the statewide minimum wage.

AB 225’s threshold increases are simple modifications that result in far-reaching changes to the CalEITC program. Because this bill does not change the rate at which the state credit phases in or out, both eligibility and the size of the credit are significantly expanded. For instance, the household described above would still receive a state credit in 2017 until their income reaches $21,840, instead of $14,161, adjusted for inflation, under current law. Moreover, maximum credit amount will increase since it is based on a percentage of income, and the income level at which the credit reaches its maximum size would be higher under this bill.

1. Cost pressures. Another key difference between the CalEITC and the federal EITC is that the CalEITC is not guaranteed to be provided each year. This is because under current law, the state credit is available when the Franchise Tax Board (FTB) receives an appropriation to administer the credit. Moreover, the size of the credit is subject to an “adjustment factor,” which sets the size of the state credit as a percentage of the federal EITC. The default adjustment factor is 0%, and a budget measure must set the adjustment factor each year. Recent practice has been to set the adjustment factor to 85%.

The fiscal cost estimates cited in this analysis make a number of assumptions about how the program will look in future years. These estimates assume that the 85% adjustment factor will persist in future years and that the FTB will receive an appropriation to administer the state credit. These estimates are considered cost pressures because they are contingent upon a budget measure putting in place certain conditions.

1. Related legislation. Other bills introduced in 2017 that expand the CalEITC program include:
   1. AB 75 (Steinorth), currently pending in policy committee, expands the definition of earned income for the purposes of calculating CalEITC eligibility to include self-employment net earnings. AB 75 also permanently sets the CalEITC adjustment factor at 85%.
   2. AB 1010 (Ting), currently pending in policy committee, expands the definition of earned income for the purposes of calculating CalEITC eligibility to include self-employment net earnings. AB 1010 also changes the percentages at which the state credit phases out to conform to the federal EITC.

Analysis Prepared by: Luke Reidenbach / APPR. / (916) 319-2081

Date of Hearing: March 13, 2017

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Sebastian Ridley-Thomas, Chair

ABPCA Bill Id:AB 225 (

Author:Caballero) – As Amended Ver:March 6, 2017

2/3 vote. Fiscal committee.

SUBJECT: Personal income taxes: earned income credit: earned income amount: disqualified income

SUMMARY: Increases the earned income threshold at which phase out of the California Earned Income Tax Credit (CalEITC) begins, thereby increasing the amount of earned income a taxpayer may earn while still remaining eligible for the CalEITC. Specifically, this bill:

1. Increases the earned income threshold at which phase out of the CalEITC begins, as follows:
   1. For taxable years beginning on or after January 1, 2017, and before January 1, 2018:
2. $5,181 for eligible individuals with no qualifying children (allowing earnings up to $10,362 to claim the credit);
   • • 1. $7,779 for eligible individuals with one qualifying child (allowing earnings up to $15,558 to claim the credit); or,
       2. $10,920 for eligible individuals with two or more qualifying children (allowing earnings up to $21,840 to claim the credit).
   1. For taxable years beginning on or after January 1, 2018, and before January 1, 2019:
      • 1. $5,427 for eligible individuals with no qualifying children (allowing earnings up to $10,854 to claim the credit);
        2. $8,149 for eligible individuals with one qualifying child (allowing earnings up to $16,298 to claim the credit); or,
        3. $11,440 for eligible individuals with two or more qualifying children (allowing earnings up to $22,880 to claim the credit).
   2. For taxable years beginning on or after January 1, 2019, and before January 1, 2020:
      • 1. $5,921 for eligible individuals with no qualifying children (allowing earnings up to $11,842 to claim the credit);
        2. $8,890 for eligible individuals with one qualifying child (allowing earnings up to $17,780 to claim the credit); or,
        3. $12,480 for eligible individuals with two or more qualifying children (allowing earnings up to $24,960 to claim the credit).
   3. For taxable years beginning on or after January 1, 2020, and before January 1, 2021:
      • 1. $6,414 for eligible individuals with no qualifying children (allowing earnings up to $12,828 to claim the credit);
        2. $9,631 for eligible individuals with one qualifying child (allowing earnings up to $19,262 to claim the credit); or,
        3. $13,520 for eligible individuals with two or more qualifying children (allowing earnings up to $27,040 to claim the credit).
   4. For taxable years beginning on or after January 1, 2021, and before January 1, 2022:
      • 1. $6,907 for eligible individuals with no qualifying children (allowing earnings up to $13,814 to claim the credit);
        2. $10,372 for eligible individuals with one qualifying child (allowing earnings up to $20,744 to claim the credit); or,
        3. $14,560 for eligible individuals with two or more qualifying children (allowing earnings up to $29,120 to claim the credit).
   5. For taxable years beginning on or after January 1, 2022:
      • 1. $7,401 for eligible individuals with no qualifying children (allowing earnings up to $14,802 to claim the credit);
        2. $11,112 for eligible individuals with one qualifying child (allowing earnings up to $22,224 to claim the credit); or,
        3. $15,600 for eligible individuals with two or more qualifying children (allowing earnings up to $31,200 to claim the credit).
3. Provides that the earned income thresholds specified for taxable years beginning on or after January 1, 2022 shall be annually adjusted, as specified.
4. Makes an appropriation by authorizing new payments from the continuously appropriated Tax Relief and Refund Account as more taxpayers become eligible for the CalEITC and are allowed a credit in excess of any tax liabilities.

EXISTING FEDERAL LAW:

1. Allows a refundable EITC to certain eligible individuals. A refundable credit allows for the excess of the credit over the taxpayer's tax liability to be refunded to the taxpayer. The federal EITC amount is based on a percentage of the taxpayer's earned income and is phased out as income increases. The percentage varies depending on whether the taxpayer has qualifying children. Married individuals must file a joint return to claim the credit.
2. Includes the following as earned income:
   1. Wages, salaries, tips, and other employee compensation; and,
   2. Net earnings from self-employment. (Internal Revenue Code (IRC) Section 32(c)(2)(A).)
3. Requires paid preparers of federal income tax returns or claims for refund involving the EITC to meet due diligence requirements in determining the taxpayer's eligibility for, and the amount of, the EITC.

EXISTING STATE LAW:

1. Allows, in modified conformity with the federal EITC, a refundable state EITC under the Personal Income Tax (PIT) Law for the lowest income Californians for taxable years beginning on or after January 1, 2015.
2. Modifies, for purposes of the CalEITC, the meaning of "earned income" set forth in IRC Section 32 to specify that:
   1. Earned income is only such amounts subject to withholding by the Employment Development Department; and,
   2. Earned income does not include net earnings from self-employment.
3. Provides that the CalEITC is only operative for taxable years for which resources are authorized in the annual Budget Act for the Franchise Tax Board (FTB) to oversee and audit returns associated with the credit.
4. Requires the Legislature to establish the CalEITC adjustment factor for each taxable year, or otherwise provides that the adjustment factor is zero percent.
5. Creates a schedule for a phased increase in the minimum wage from $10 per hour to $15 per hour over seven years, depending on the size of the employer and general economic conditions, and links the minimum wage to the U.S. Consumer Price Index (CPI) once the minimum wage reaches $15 per hour.

FISCAL EFFECT: The FTB estimate of General Fund revenue losses associated with this bill is pending.

COMMENTS:

1. Author's Statement: The author has provided the following statement in support of this bill:

AB 225 will provide more working families the ability to qualify for the California Earned Income Tax Credit (Cal EITC). There are far too many families across all of California who, given the Cal EITC salary cutoff, would not qualify for this tax credit. This bill raises the income threshold, closes the gap, and empowers more families to have access to this financial benefit.

1. Committee Staff Comments:
   1. Arguments in Support: The sponsor of this bill states that "the income qualification for the CalEITC is so low; workers making the state minimum wage currently do not qualify" and that the "issue of low-income earners being priced out of this tax credit will only be compounded as California's minimum wage continues to increase to $15/hour through 2022." This bill would "expand the current maximum an individual can make and qualify for the CalEITC to include these full-time minimum wage workers, offering them much needed financial relief."
   2. Federal EITC Overview: The federal EITC is a refundable income 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. To qualify for the EITC, an individual must be employed. When the EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. The EITC is a percentage of the taxpayer's earned income with the amount of the credit first growing with earnings over a phase-in range, flattening out at the maximum credit amount until earnings reach the phase-out point, and then declining over a phase-out range as earnings increase until the credit reaches zero. The credit phase-in rate ranges from 7.65% to 45% and the phase-out rate ranges from 7.65% to 21.06%, depending on the number of qualifying children claimed by the taxpayer.

In order for a taxpayer to qualify for the federal EITC in tax year 2016, an individual's earned income must be less than the following amounts:

1. $14,880 ($20,430 if married filing jointly) with no qualifying children, for a maximum credit amount of $506;
2. $39,296 ($44,846 if married filing jointly) with one qualifying child, for a maximum credit amount of $3,373;
3. $44,648 ($50,198 if married filing jointly) with two qualifying children, for a maximum credit amount of $5,572; or,
4. $47,955 ($53,505 if married filing jointly) with three or more qualifying children, for a maximum credit amount of $6,269.
   1. CalEITC Overview: The CalEITC was established through the FY 2015-16 state budget. Similar to the federal EITC, the CalEITC is established as a refundable credit under the PIT Law and is based on a percentage of the taxpayer's earned income with the amount of the credit first growing over a phase-in range from 7.65% to 45%. Unlike the federal EITC, however, the credit immediately begins to phase out at the same rate that it phased in once the maximum credit amount is reached, with no flat range in between.

The CalEITC earned income eligibility ceilings are also lower than those set forth in the federal EITC and do not increase to account for married taxpayers filing jointly. As such, the CalEITC only reaches a portion of workers who are eligible for the federal EITC. The CalEITC also provides for an "adjustment factor" in calculating the amount of state credit that taxpayers would receive. The adjustment factor is a matching percentage of the credit amount allowed under the federal EITC and is currently set at 85%. For a taxpayer to qualify for the CalEITC in tax year 2016, an individual's earned income must be less than the following amounts:

• • • 1. $6,717 with no qualifying children, for a maximum credit amount of $217;
      2. $10,087 with one qualifying child, for a maximum credit amount of $1,452;
      3. $14,161 with two qualifying children, for a maximum credit amount of $2,406; or,
      4. $14,161 with three or more qualifying children, for a maximum credit amount of $2,706.

The CalEITC further differs from the federal EITC by not including self-employment income in calculations of "earned income." The CalEITC requires all income used to calculate the credit amount to be subject to withholding and specifically excludes self-employment income. In the 2015 tax year, more than 385,000 taxpayers received almost $200 million under the CalEITC, resulting in an average credit of $519 per taxpayer.

• 1. Increasing Awareness of the CalEITC: Because the CalEITC is limited to the lowest-income households, encouraging taxpayers to take advantage of the credit can be challenging. Some low-income workers are not required to file a tax return and must be encouraged to do so to claim the credit, and those who do file returns yearly may not be aware of the credit.

When the CalEITC was first enacted, $380 million in credits was expected to be claimed. However, the FY 2016-17 budget only estimated a $255 million reduction in PIT revenue from the credit, recognizing that many individuals eligible for the credit may not claim it. In response, the FY 2016-17 budget also included $2 million for the FTB to expand awareness of the credit amongst eligible individuals and increase the amount of credits claimed.

Recent figures from the FTB show that as of February 25, 2017, the state has issued $132.9 million worth of credits, a 50% increase compared to the same time last year. The state has also seen the number of claims increase to 212,000, an increase of 42% compared to the same time last year.

• 1. Indexing the CalEITC to the Minimum Wage: The CalEITC was structured to focus the benefits of the credit on working families with very low earnings, allowing this smaller population to receive a more substantial benefit to supplement the benefit provided by the federal EITC. However, this structure provides that many taxpayers earning the minimum wage in California are ineligible for the state credit. For example, an individual with two or more qualifying children had to earn less than $13,870 in the 2015 tax year to qualify for the CalEITC, equivalent to the annual earnings one would earn working just less than 30 hours a week at minimum wage. As noted by the Legislative Analyst's Office in its review of the CalEITC^[1], the "state credit magnifies incentives to move from no work to part-time work. However, because the state credit has a relatively low earnings ceiling for eligibility, it would not increase incentives to move to full-time work – a full-time worker in a minimum wage job would earn too much over a full year to qualify."

Effective January 1, 2017, the minimum wage for all industries is $10 per hour for employers with 25 or fewer employees and $10.50 per hour for employers with 26 or more employees, and will be increased annually as follows^[2]:

This bill would set the maximum amount of earned income a taxpayer may earn while still remaining eligible for the CalEITC to be equal to the amount of annual wages an individual would earn if he or she worked full-time (40 hours a week for 52 weeks) at minimum wage for an employer with 26 employees or more. For example, an individual earning $10.50 per hour in 2017 would make $21,840 for the year, the maximum amount a taxpayer with two or more qualifying children could make while still remaining eligible for the credit. As such, it is important to note that a taxpayer with one qualifying child or no qualifying children would not be able to remain eligible for the CalEITC (although a taxpayer with one qualifying child would remain eligible for the federal EITC) if he or she worked full-time at minimum wage, as those taxpayers would become ineligible for the state credit with earned income over $15,558 and $10,362, respectively.

In addition to creating a schedule for a phased increase in the minimum wage, existing law provides that the Governor may suspend the annual minimum wage increase if specified economic conditions are met or the Department of Finance finds that a minimum wage increase would push the state budget into deficit. The Committee may wish to consider whether the earned income threshold increases proposed by this bill should occur in years when the minimum wage increase is suspended.

• 1. Related Legislation: AB 75 (Steinorth) expands the definition of earned income for the CalEITC to include specified net earnings from self-employment and sets the CalEITC adjustment factor at 85%. AB 75 is scheduled to be heard by this Committee today.

REGISTERED SUPPORT / OPPOSITION:

Support

Fiona Ma, State Board of Equalization Member, Second District (Sponsor)

Alameda County Community Food Bank

California Association of Food Banks

California Catholic Conference

California Tax Reform Association

Children's Defense Fund – California

Friends Committee on Legislation of California

Golden State Opportunity

United Ways of California

Opposition

None on file

Analysis Prepared by: Irene Ho / REV. & TAX. / (916) 319-2098

1. Ryan Woolsey and Justin Garosi, May Revision: Earned Income Tax Credit Proposal, Legislative Analyst's Office, May 17, 2015. ↑

2. "Minimum Wage," Labor Commissioner's Office, California Department of Industrial Relations, December 2016. <https://www.dir.ca.gov/dlse/faq_minimumwage.htm> ↑