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 wages, salaries, tips, and other employee compensation plus net earnings from self-employment 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, which is only for earned income from wages, salaries, tips, and other employee compensation, and a payment in excess of that credit amount, to an eligible individual that is equal to that portion of the earned income tax credit allowed by federal law as determined by the earned income tax credit adjustment factor as set forth in the annual Budget Act which, unless otherwise specified in that act, is 0%.

This bill would, bill, for taxable years beginning on and after January 1, 2016, 2017, would expand the earned income credit allowed by the Personal Income Tax Law by providing additional conformity with federal income tax law to include specified net earnings from self-employment in earned income, thus allowing an earned income credit for taxpayers for those earnings. This bill would additionally set the earned income tax credit adjustment factor as 85%.

Existing law establishes the continuously appropriated Tax Relief and Refund Account and provides that payments required to be made to taxpayers or other persons from the Personal Income Tax Fund are to be paid from that account, including any amount allowable as an earned income credit in excess of any tax liabilities.

By authorizing new payments from that account for additional amounts in excess of personal income tax liabilities, this bill would make an appropriation.

This bill would declare that it is to take effect immediately as an urgency statute.

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 wages, salaries, tips, and other employee compensation plus net earnings from self-employment 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, which is only for earned income from wages, salaries, tips, and other employee compensation, and a payment in excess of that credit amount, to an eligible individual that is equal to that portion of the earned income tax credit allowed by federal law as determined by the earned income tax credit adjustment factor as set forth in the annual Budget Act which, unless otherwise specified in that act, is 0%.

This bill would, for taxable years beginning on and after January 1, 2016, expand the earned income credit allowed by the Personal Income Tax Law by providing additional conformity with federal income tax law to include specified net earnings from self-employment in earned income, thus allowing an earned income credit for taxpayers for those earnings. This bill would additionally set the earned income tax credit adjustment factor as 85%.

Existing law establishes the continuously appropriated Tax Relief and Refund Account and provides that payments required to be made to taxpayers or other persons from the Personal Income Tax Fund are to be paid from that account, including any amount allowable as an earned income credit in excess of any tax liabilities.

By authorizing new payments from that account for additional amounts in excess of personal income tax liabilities, this bill would make an appropriation.

This bill would declare that it is to take effect immediately as an urgency statute.

Date of Hearing: March 27, 2017

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Sebastian Ridley-Thomas, Chair

ABPCA Bill Id:AB 75 (

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

FOR TESTIMONY ONLY

2/3 vote. Urgency. Fiscal committee.

SUBJECT: Personal income taxes: earned income credit

SUMMARY: Expands the definition of “earned income” for the California Earned Income Tax Credit (CalEITC) to include specified earnings from self-employment, and sets the CalEITC adjustment factor at 85%. Specifically, this bill:

1. Modifies, for taxable years beginning on or after January 1, 2017, the definition of "earned income" to include the amount of the taxpayer's reportable gross income from self-employment for the taxable year.
2. Defines "reportable gross income from self-employment" as gross income derived by an individual from any trade or business carried on by such individual that is properly reported to the Secretary of Treasury on an information return for the taxable year and reported on a written statement furnished to that individual, as specified.
3. Provides that the CalEITC adjustment factor for taxable years beginning on or after
   January 1, 2017, is 85% (instead of 0%).
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.
5. Takes immediate effect as an urgency statute.

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.
4. Requires a trade or business that makes payments of $600 or more to another person during the course of the trade or business to file an information return (Internal Revenue Service (IRS) Form 1099-MISC Miscellaneous Income) with the Secretary of Treasury.

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.

FISCAL EFFECT: The FTB estimates General Fund revenue losses of $12 million in fiscal year (FY) 2017-18, $13 million in FY 2018-19, and $13 million in FY 2019-20.

COMMENTS:

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

AB 75 addresses the unnecessary exclusion of self-employed individuals from eligibility for the CalEITC tax credit. Working families supported by self-employment and "sharing economy" jobs do not have access to the benefits of CalEITC tax credit, which has the potential to lift them out of poverty. AB 75 moves to resolve this exclusion of self-employed individuals by allowing IRS Form 1099 to be used to qualify workers for the credit provided through CalEITC. Expanding the CalEITC to self-employed individuals assists working, low-income households by returning more money back to their families for everyday expenses.

1. Committee Staff Comments:
   1. Arguments in Support: Supporters of this bill state that limiting the CalEITC to income reported on an IRS Form W-2 denies some low-income taxpayers the credit simply due to the nature of their work. They state that with "self-employment and the growing number of 'sharing economy' jobs being commonly utilized by low-income workers, the current CalEITC program excludes the most vulnerable individuals from this tax credit."
   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;
   • 1. $39,296 ($44,846 if married filing jointly) with one qualifying child, for a maximum credit amount of $3,373;
     2. $44,648 ($50,198 if married filing jointly) with two qualifying children, for a maximum credit amount of $5,572; or,
     3. $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. 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.

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. California has also seen the number of claims increase to 212,000, an increase of 42% compared to the same time last year.

• 1. Expanding the CalEITC to Include Self-Employment Income: Another significant way in which the CalEITC differs from the federal EITC is that the CalEITC does not include 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. This bill would include "reportable gross income from self-employment" income as "earned income" in calculating the CalEITC if the income is property reported on a Form 1099-MISC. While inclusion of self-employment income would increase the pool of individuals eligible to claim the credit and increase the credit amount for some taxpayers with a mix of income sources, it would also decrease or eliminate the credit amount for other taxpayers if their recalculated income exceeds existing limits.

As part of the Supplemental Report of the 2015-16 Budget Package, the FTB released a report exploring methods that could be considered to allow self-employment income to be included as earned income while protecting against improper claims. Inclusion of self-employment income in the federal EITC has historically contributed to income misreporting that resulted in improper claims of the credit. The IRS has found that improper EITC claims range from 29% to 39%, that income misreporting is the second biggest contributor to improper claims, and that the value of improper claims from misreporting self-employment income is approximately four times greater than that from misreporting wage income. To help increase compliance and avoid reporting errors, the IRS requires paid tax preparers to complete a form identifying the taxpayer-provided documents the preparer relied upon to calculate self-employment income. The IRS also provides specific correspondence to taxpayers to ensure accuracy of self-employment income and imposes restrictions on non-compliant taxpayers from claiming the EITC. Despite these efforts, a 2014 report by the Treasury Inspector General found that the estimated EITC improper payment rate had remained "relatively unchanged."

According to the FTB report:

Based on IRS experience with the federal EITC, expansion of the California EITC from a wage-based credit that enables verification against reliable employer-reported data to a credit that also includes [self-employment] income is likely to increase the amount of improper payments. Although Form 1099 or Form 1099-MISC Miscellaneous Income (Information Return) would be an indication of authentic business activity, historical return data indicates that only 34 percent of returns at the [adjusted gross income] levels applicable for the California EITC received a Form 1099 or Form 1099-MISC. Based on review of other state' review processes, the most reliable method to minimize improper payments would require significant manual review of EITC claims during return processing prior to issuance of the refund. Thus, expanding the California EITC to include [self-employment] income would be challenging to administer, and the department anticipates the costs to effectively administer the program would be significant.

The FTB report concludes by summarizing a number of methods that could be utilized to protect against improper payments if the CalEITC was expanded to include self-employment income, such as expanding documentation requirements, return analysis, and education and outreach efforts. This bill incorporates a method explored by the FTB to allow self-employment income in the CalEITC while protecting against improper payments by only allowing income from self-employment that is reported on a Form 1099. This bill further requires includable self-employment income to be gross income. Under the federal EITC, "earned income" includes net earnings from self-employment beyond that reported on a Form 1099. Because self-employed individuals only receive a Form 1099 when performing services for a trade or business (not an individual) and net income represents gross income less expenses, this method would only allow a fraction of self-employed individuals eligible for the federal EITC to become eligible for the CalEITC.

• 1. Setting a Permanent Adjustment Factor: The CalEITC 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. Existing law provides that the adjustment factor is 0% unless reestablished for each taxable year at a different rate, meaning that the amount of credit can change from year to year. The Governor's proposed FY 2017-18 budget sets the adjustment factor at 85% for tax year 2017, the same rate that has been established for all tax years since the program's inception.

This bill would set the adjustment factor in perpetuity at 85% instead of relying on annual action by the Legislature and Governor. Setting a fixed adjustment factor may result in more financial certainty for CalEITC beneficiaries, especially during economic downturns, but may also limit the state's ability to adjust revenue losses associated with the credit in times when fiscal flexibility is most needed.

• 1. Related Legislation: AB 225 (Caballero) increases the CalEITC earned income threshold at which the credit's phase out begins, thereby increasing the amount of earned income a taxpayer may earn while still remaining eligible for the CalEITC. AB 225 is scheduled to be heard by this Committee today.
  2. Prior Legislation: AB 2807 (Steinorth), of the 2015-16 Legislative Session, would have modified the meaning of "earned income" to include self-employment income. AB 2807 was never heard by this Committee and returned to the Chief Clerk without further action.

REGISTERED SUPPORT / OPPOSITION:

Support

California Alternative Payment Program Association

California Association of Food Banks

California Association for Micro Enterprise Opportunity

California Catholic Conference, Inc.

Children's Defense Fund – California

Common Sense Kids Action

County Welfare Directors Association of California

Friends Committee on Legislation of California

Golden State Opportunity

Small Business California

One individual

Opposition

None on file

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

Date of Hearing: March 13, 2017

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Sebastian Ridley-Thomas, Chair

ABPCA Bill Id:AB 75 (

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

2/3 vote. Urgency. Fiscal committee.

SUBJECT: Personal income taxes: earned income credit

SUMMARY: Expands the definition of “earned income” for the California Earned Income Tax Credit (CalEITC) to include specified net earnings from self-employment, in conformity with federal law, and sets the CalEITC adjustment factor at 85%. Specifically, this bill:

1. Modifies, for taxable years beginning on or after January 1, 2017, the definition of "earned income" to include the amount of the taxpayer's reportable gross income from self-employment for the taxable year.
2. Defines "reportable gross income from self-employment" as gross income derived by an individual from any trade or business carried on by such individual that is properly reported to the Secretary of Treasury on an information return for the taxable year and reported on a written statement furnished to that individual, as specified.
3. Provides that the CalEITC adjustment factor for taxable years beginning on or after
   January 1, 2017, is 85% (instead of 0%).
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.
5. Takes immediate effect as an urgency statute.

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.
4. Requires a trade or business that makes payments of $600 or more to another person during the course of the trade or business to file an information return (Internal Revenue Service (IRS) Form 1099-MISC Miscellaneous Income) with the Secretary of Treasury.

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.

FISCAL EFFECT: The FTB estimates General Fund revenue losses of $12 million in fiscal year (FY) 2017-18, $13 million in FY 2018-19, and $13 million in FY 2019-20.

COMMENTS:

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

AB 75 addresses the unnecessary exclusion of self-employed individuals from eligibility for the CalEITC tax credit. Working families supported by self-employment and "sharing economy" jobs do not have access to the benefits of CalEITC tax credit, which has the potential to lift them out of poverty. AB 75 moves to resolve this exclusion of self-employed individuals by allowing IRS Form 1099 to be used to qualify workers for the credit provided through CalEITC. Expanding the CalEITC to self-employed individuals assists working, low-income households by returning more money back to their families for everyday expenses.

1. Committee Staff Comments:
   1. Arguments in Support: Supporters of this bill state that limiting the CalEITC to income reported on an IRS Form W-2 denies some low-income taxpayers the credit simply due to the nature of their work. They state that with "self-employment and the growing number of 'sharing economy' jobs being commonly utilized by low-income workers, the current CalEITC program excludes the most vulnerable individuals from this tax credit."
   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;
   • 1. $39,296 ($44,846 if married filing jointly) with one qualifying child, for a maximum credit amount of $3,373;
     2. $44,648 ($50,198 if married filing jointly) with two qualifying children, for a maximum credit amount of $5,572; or,
     3. $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. 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.

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. California has also seen the number of claims increase to 212,000, an increase of 42% compared to the same time last year.

• 1. Expanding the CalEITC to Include Self-Employment Income: Another significant way in which the CalEITC differs from the federal EITC is that the CalEITC does not include 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. This bill would include "reportable gross income from self-employment" income as "earned income" in calculating the CalEITC if the income is property reported on a Form 1099-MISC. While inclusion of self-employment income would increase the pool of individuals eligible to claim the credit and increase the credit amount for some taxpayers with a mix of income sources, it would also decrease or eliminate the credit amount for other taxpayers if their recalculated income exceeds existing limits.

As part of the Supplemental Report of the 2015-16 Budget Package, the FTB released a report exploring methods that could be considered to allow self-employment income to be included as earned income while protecting against improper claims. Inclusion of self-employment income in the federal EITC has historically contributed to income misreporting that resulted in improper claims of the credit. The IRS has found that improper EITC claims range from 29% to 39%, that income misreporting is the second biggest contributor to improper claims, and that the value of improper claims from misreporting self-employment income is approximately four times greater than that from misreporting wage income. To help increase compliance and avoid reporting errors, the IRS requires paid tax preparers to complete a form identifying the taxpayer-provided documents the preparer relied upon to calculate self-employment income. The IRS also provides specific correspondence to taxpayers to ensure accuracy of self-employment income and imposes restrictions on non-compliant taxpayers from claiming the EITC. Despite these efforts, a 2014 report by the Treasury Inspector General found that the estimated EITC improper payment rate had remained "relatively unchanged."

According to the FTB report:

Based on IRS experience with the federal EITC, expansion of the California EITC from a wage-based credit that enables verification against reliable employer-reported data to a credit that also includes [self-employment] income is likely to increase the amount of improper payments. Although Form 1099 or Form 1099-MISC Miscellaneous Income (Information Return) would be an indication of authentic business activity, historical return data indicates that only 34 percent of returns at the [adjusted gross income] levels applicable for the California EITC received a Form 1099 or Form 1099-MISC. Based on review of other state' review processes, the most reliable method to minimize improper payments would require significant manual review of EITC claims during return processing prior to issuance of the refund. Thus, expanding the California EITC to include [self-employment] income would be challenging to administer, and the department anticipates the costs to effectively administer the program would be significant.

The FTB report concludes by summarizing a number of methods that could be utilized to protect against improper payments if the CalEITC was expanded to include self-employment income, such as expanding documentation requirements, return analysis, and education and outreach efforts. This bill incorporates a method explored by the FTB to allow self-employment income in the CalEITC while protecting against improper payments by only allowing income from self-employment that is reported on a Form 1099. This bill further requires includable self-employment income to be gross income. Under the federal EITC, "earned income" includes net earnings from self-employment beyond that reported on a Form 1099. Because self-employed individuals only receive a Form 1099 when performing services for a trade or business (not an individual) and net income represents gross income less expenses, this method would only allow a fraction of self-employed individuals eligible for the federal EITC to become eligible for the CalEITC.

• 1. Setting a Permanent Adjustment Factor: The CalEITC 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. Existing law provides that the adjustment factor is 0% unless reestablished for each taxable year at a different rate, meaning that the amount of credit can change from year to year. The Governor's proposed FY 2017-18 budget sets the adjustment factor at 85% for tax year 2017, the same rate that has been established for all tax years since the program's inception.

This bill would set the adjustment factor in perpetuity at 85% instead of relying on annual action by the Legislature and Governor. Setting a fixed adjustment factor may result in more financial certainty for CalEITC beneficiaries, especially during economic downturns, but may also limit the state's ability to adjust revenue losses associated with the credit in times when fiscal flexibility is most needed.

• 1. Related Legislation: AB 225 (Caballero) increases the CalEITC earned income threshold at which the credit's phase out begins, thereby increasing the amount of earned income a taxpayer may earn while still remaining eligible for the CalEITC. AB 225 is scheduled to be heard by this Committee today.
  2. Prior Legislation: AB 2807 (Steinorth), of the 2015-16 Legislative Session, would have modified the meaning of "earned income" to include self-employment income. AB 2807 was never heard by this Committee and returned to the Chief Clerk without further action.

REGISTERED SUPPORT / OPPOSITION:

Support

California Association of Food Banks

California Association for Micro Enterprise Opportunity

California Catholic Conference, Inc.

Children's Defense Fund – California

Common Sense Kids Action

Friends Committee on Legislation of California

Opposition

None on file

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