California's
Tax Expenditure Programs

Income Tax Programs--Part 4

Contents

• Dependent Exemption
• Blind Exemption
• Senior Exemption
• Renters' Credit
• Senior Head of Household
• Prison Inmate Labor Costs
• Activities in Enterprise Zones and
• Other Economically Depressed Areas
• Increased Research and Development Expenses
• Employer-Provided Child Care Expenses
• Low-Income Rental Housing Expenses
• Joint Custody Head of Household
• Salmon and Steelhead Trout
• Habitat Restoration
• Manufacturers' Investment Tax Credit
• Enhanced Recovery Costs
• Farmworker Housing Costs
• Rice Straw
• Disabled Access Expenditures
• Transportation of Donated
• Agricultural Products
• Child Adoption Expenses
• Subchapter S Corporations
• Head-of-Household and Surviving Spouse

Credit (Person Specific):

Dependent Exemption

Description

This program allows all taxpayers to claim a tax credit for each of their dependents. For 1997, the credit amount was $68 per dependent. Under California's 1997 tax relief package, this amount was to be increased to $120 in 1998 and $222 in 1999. However, these amounts were changed as part of the 1998-99 budget agreement, in Chapter 322, Statutes of 1998 (AB 2797, Cardoza). The amount for 1998 was increased to $253 and the amount for 1999 will be $227. In addition, the exemption amount will be indexed annually based on the California Consumer Price Index, beginning in 2000.

The phase-out provisions with respect to the credit for high-income taxpayers and requirements for nonresident taxpayers are the same as those listed under the immediately preceding tax credit program "Personal Exemption." In addition, California's dependent exemption credits can be reduced or eliminated altogether under the state's alternative minimum tax (AMT).

Rationale

This program provides tax relief to taxpayers who are financially responsible for the support of dependents, such as children or the aged. The rationale for this program is that such financial responsibilities reduce the ability of individuals to pay taxes.

Distribution of Benefits

The accompanying table shows the distribution of benefits from this program, based on income class. The program is one which largely benefits taxpayers in the lower- and moderate-income categories. Roughly two thirds of all returns receiving some benefit from the program involve taxpayers earning $60,000 or less on an annual basis. Over one-half of the total benefits from the program also go to this group of taxpayers. Average benefits are very similar over most income classes. They are smaller only for the two highest and two lowest income categories, due to the effect of income limits and the nonrefundable nature of the credit, respectively.

Dependent Exemption Credit
1998 Tax Year
Adjusted Gross Income ($000)	Percent of		Average Amount Claimed
	Total Taxpayers Benefitting	Total Amount Claimed
$0-20	13.9%	2.3%	$55
20-40	31.0	21.3	231
40-60	20.4	27.5	453
60-80	13.7	19.9	486
80-100	8.4	11.8	472
100-150	8.5	12.0	474
150-200	2.4	3.3	449
200-250	1.1	1.5	435
250-500	0.7	0.4	207
Over 500	--	--	--

Comments

Federal law allows a dependent exemption in the form of a deduction from adjusted gross income, as opposed to providing a tax credit, as under this program. The federal exemption amount for 1998 was $2,700 for each dependent. In general, California allows a dependent credit for everyone for whom a federal dependent exemption is allowed.

Credit (Person Specific):

Blind Exemption

Description

This program allows a taxpayer who is blind to claim an additional personal exemption tax credit. The amount of this credit (which is indexed annually for inflation based on the California Consumer Price Index) is $70 for 1998.

Rationale

This program provides tax relief to those who are blind, based on the rationale that individuals with certain types of diminished physical abilities have increased expenses and/or decreased earnings potential.

Comments

Instead of a tax credit, federal law (Internal Revenue Code Section 63 [f]) provides an additional deduction from adjusted gross income (AGI) for blind taxpayers who do not itemize their deductions. In 1998, the amount of this deduction is $850 for married taxpayers (whether filing separately or jointly) and surviving spouses, and $1,050 for single taxpayers.

Credit (Person Specific):

Senior Exemption

Description

This program allows taxpayers over the age of 65 to claim an additional personal exemption tax credit. The amount of this credit (which is indexed annually for inflation) is $70 in 1998. In the case of a husband and wife filing a joint return, if both are over the age of 65, the amount of the credit is $140 in 1998.

Rationale

This program provides tax relief to those over the age of 65 under the rationale that such persons are more vulnerable to high medical or personal care expenses as a result of illness or infirmity.

Comments

Federal law allows an additional deduction from adjusted gross income for taxpayers age 65 or over. For 1998 the amount of this deduction is $850 for married individuals (whether filing separately or jointly) and surviving spouses, and $1,050 for single individuals.

Credit (Person Specific):

Renters' Credit

Description

The renters' credit allows taxpayers to deduct a specified amount from their tax liabilities, providing that they rent their principal place of residence. For the years 1993 through 1997, the credit was suspended for reasons largely related to state budget problems. As part of the 1998-99 budget plan, (Chapter 322, Statutes of 1998 [AB 2797, Cardoza]), the credit was restored and modified. Beginning in the 1998 tax year, the credit will be $60 for single filers and $120 for joint filers, and will be available only on a nonrefundable basis. In addition, the credit is income-limited, with the single-return and joint-filer annual income limits set at $25,000 and $50,000, respectively. At various times, this program has allowed qualified renters to claim a refundable tax credit and was not income limited.

Rationale

The renters' credit provides tax relief to renters, and is intended to offset the property taxes that renters indirectly pay through their rental payments. Although landlords actually pay the property taxes on rental properties and are allowed to deduct them as a business expense, it is generally acknowledged that at least a portion of such payments are "passed-on" to tenants in the form of higher rental payments. Thus, proponents argue that in the absence of this program, renters would be treated inequitably relative to homeowners who receive the homeowners' exemption as a form of tax relief. As such, the credit is sometimes viewed as the renters' equivalent of the homeowners' exemption.

Another rationale often offered for the program is that it provides tax relief to renters, many of whom have low incomes. With its current structure of income limits, the credit will now only be received by renters with lower incomes.

Distribution of Benefits

As indicated above, the renters' credit program is limited to those taxpayers with lower and moderate incomes. The accompanying table indicates the distribution of its benefits by income class both in terms of the numbers of returns and share of total benefits received. These distributional estimates are based on the past use of the program prior to its suspension, and adjusted for the effect of subsequent income limits.

Renters' Credit
1998 Tax Year
Adjusted Gross Income ($000)	Percent of
	Total Taxpayers Benefitting	Total Amount Claimed
$0-20	2.7%	0.1%
20-40	46.0	36.8
40-60	21.3	16.5
60-80	17.2	26.3
80-100	12.9	20.3
Over 100	--	--

Comments

The renters' credit was established in 1972 with amounts ranging from $25 to $45, depending on the taxpayer's adjusted gross income. Program changes in 1976 resulted in a fixed dollar amount for the credit of $37. This amount was increased to $60 (for single taxpayers) and $137 (for joint and head-of- household filers) in 1979. In 1982, legislation established a separate credit amount of $99 for joint-custody, head-of-household taxpayers. This separate amount for joint-custody, head-of-household taxpayers was eliminated in 1987. The current credit amounts represent a reduction from $137 to $120 for married couples filing joint returns, heads of households, and surviving spouses. The $60 credit for single taxpayers has remained the same since 1979.

Originally, this program was funded through an annual General Fund appropriation because of requirements related to the discontinued Federal Revenue Sharing program. Under that program, the amount of federal funds available to the state depended partially on its level of "tax effort" relative to other states, which was computed by taking into account the state's level of revenue collections. Thus, by funding the renters' credit through an appropriation instead of a revenue reduction, the state was able to show a greater "tax effort" and thereby increase its revenue-sharing allocation. The program is currently classified as a revenue program.

Credit (Person Specific):

Senior Head of Household

Description

This program allows elderly taxpayers who qualify as head of household to claim a personal income tax credit in an amount equal to 2 percent of their taxable income, not to exceed $860 in 1998. This credit is only available to taxpayers with adjusted gross income of less than $45,675.

Rationale

This program provides tax relief to elderly taxpayers 65 years or older who have low or moderate incomes. The rationale for this is that the ability of such individuals to pay taxes often is limited, given their income constraints and their need to provide for special retirement expenses, such as health care.

Comments

This program was established by Chapter 1154, Statutes of 1990 (SB 389, Seymour) and applies to tax years beginning on January 1, 1990 and thereafter. The maximum credit amount is indexed annually for inflation, and the credit is not refundable.

Credit (Activity Based):

Prison Inmate Labor Costs

Description

This program allows employers a tax credit equal to 10 percent of the wages they pay to each state prison inmate employed in a joint-venture program for the purpose of producing goods or services. For purposes of this program, a joint-venture employer is any public entity, nonprofit or for-profit entity, organization, or business which contracts with the California Department of Corrections for the purpose of employing inmate labor. These work programs are to be patterned after business operations found outside of prison, and priority consideration is given to inmate employment which will retain or reclaim jobs in California, support emerging California industries, or create jobs to fill a void in the labor market.

Rationale

This program provides an incentive for California businesses to use state prison inmate labor. The rationale for the program is that it will provide meaningful work to prison inmates that will enhance their prospects for employment once they are released from prison, and also will benefit the California economy. In addition, the wages earned by inmates are subject to deductions for taxes, prison room and board, restitution to crime victims, and support of the inmate's family.

Comments

The revenue losses associated with this program are speculative due to uncertainties regarding the number of qualifying joint-venture programs and the annual compensation of those employed. This program was enacted by Proposition 139 in the statewide general election in November 1990.

Credit (Activity Based):

Activities in Enterprise Zones and

Other Economically Depressed Areas

Description

These programs allow qualified taxpayers to claim tax credits for certain expenditures or income earned in economically depressed areas of the state, including those that have been designated as Enterprise Zones, Local Agency Military Base Recovery Areas (LAMBRA), the Los Angeles Revitalization Zone (LARZ) or, for specified types of activities, within Targeted Tax Areas and Manufacturing Enhancement Areas. There are three types of income tax credits available.

Wages Paid to Disadvantaged Persons. Employers can receive a credit equal to a portion of the wages paid to qualified "disadvantaged individuals." Generally, qualified individuals are those who were unemployed or economically disadvantaged prior to the date of hiring. For employers in Enterprise Zones, LAMBRA, LARZ, Targeted Tax Areas and Manufacturing Enhancement Areas, the available tax credit is 50 percent of the wages paid during the first year, 40 percent for the second year, 30 percent for the third year, 20 percent for the fourth year, and 10 percent for the fifth year. In addition, a credit of 50 percent of wages paid to area residents who were hired to do construction work within the zone was available to LARZ employers through 1997. A credit claimed under this program, together with the sales and use income tax credit (see below), is limited to the tax attributable to income from the designated area.

Credits are generally recaptured if employees are terminated prior to a prescribed time period (generally one year). Unused credits may be carried over and applied to offset taxes on income from the area in succeeding tax years. Generally, the available credit is reduced to the extent other credits are granted to the same employer for area activities. The eligibility for employers in LARZ expired January 1, 1998. Eligibility for employers in a LAMBRA expires January 1, 2003.

Taxes Paid by Enterprise Zone Employees. Enterprise Zone employees can receive an income tax credit of 5 percent of their "qualified wages," up to a maximum of $525. The credit is reduced by 9 cents for each $1 in wages in excess of "qualified wages," as defined in the federal Internal Revenue Code, Section 3306(b). The credit is nonrefundable, and unused portions may not be carried forward.

Sales Tax on Machinery. An employer can receive an income tax credit for the amount of sales and use taxes paid on the purchase of machinery or parts used for specific purposes in Enterprise Zones, LAMBRA, LARZ, and for certain activities, within Targeted Tax Areas. The credit, together with amounts claimed under the wages credit (discussed above), is limited to the amount of income tax attributable to the incentive area. The credit is nonrefundable, but unused portions may be carried forward into succeeding tax years.

Rationale

These programs are intended to provide incentives for stimulating employment and business activity in economically depressed areas of the state. These areas typically either have higher costs associated with conducting economic activity or are perceived as being high-cost, low-productivity areas. The credits represent an attempt to reduce costs and make the areas more attractive for undertaking investments and conducting economic activity.

Comments

These programs were initially established in 1984 by the state's Enterprise Zone Act and Employment and Economic Incentive Act, and amended in 1985. The Employment and Economic Incentives Act was repealed and essentially replaced by the Enterprise Zone Act of 1996. The LARZ, LAMBRA, Targeted Tax Areas, and Manufacturing Enhancement Areas were added later as qualifying for certain tax credits under these programs.

Pursuant to Chapter 323, Statutes of 1998 (AB 2798, Machado), the credits available under these programs were expanded and enhanced. For additional related information, see comments regarding the effectiveness of tax incentives for Enterprise Zones and related areas discussed under the program "Income From Investments in Economically Depressed Areas."

Credit (Activity Based):

Increased Research and Development Expenses

Description

This program allows taxpayers to claim a tax credit for a portion of certain additional increments to their research and development (R&D) expenses. The credit may be applied to "qualified" research conducted either "in- house" or by contract. Qualified research is defined as research that is: (1) technological in nature; (2) intended to be useful in the development of a new or improved product, service, computer software, technique, formula, or invention of the taxpayer; (3) held for sale, lease, or license, or used by the taxpayer in a trade or business; and (4) performed in California.

Beginning in 1997, the R&D credit is equal to 11 percent of the taxpayer's additional qualified research expenses for the tax year, over a specified percentage of the taxpayer's average annual gross receipts for the four preceding taxable years. For BCT taxpayers, an additional credit equal to 24 percent of the taxpayer's basic (defined as university) research is availaable. To the extent that the credit exceeds the taxpayer's net tax liability in the taxable year, the excess may be carried forward and used to reduce tax liabilities in subsequent years.

Under certain conditions, a specified formula may be used to calculate an alternative incremental credit. This alternative incremental credit was increased pursuant to Chapter 323, Statutes of 1998 (SB 2798, Machado).

Rationale

This program provides an incentive for taxpayers to invest in R&D activities by reducing the after-tax cost of making such investments. The underlying rationale is that if such incentives were not available, industry would "underinvest" in R&D activities from a social point of view.

Distribution of Benefits

The accompanying table (see next page) shows the distribution of benefits from the program by industry, based on number of returns and the amount of tax benefits received. Almost 60 percent of the returns claiming the credit are from electronics firms and other manufacturing enterprises. The dollar amount of tax benefits are even more heavily weighted towards these types of industries, with over two-thirds of the total benefits going to these two industry groups. Electric and electronic equipment industries alone claimed almost one-half of the credits.

Increased Research and Development Expenses Tax Credit
1998 Income Year
Industry Type	Percent of
	Total Taxpayers Benefitting	Total Amount Claimed
Electrical and Electronics Equipment	26.8%	46.6%
Chemicals and Allied Products	3.9	10.0
Food and Kindred Products	0.9	0.3
Other Manufacturing	29.2	20.9
Other	39.2	22.3

Comments

According to the Research Institute of America, over one-third of all states offer a tax credit to businesses for R&D conducted within their state. The amount of the tax credit a business can claim varies from state to state largely due to the differences in the base period used and the percent of expenses applicable. The federal government also provides a tax credit for R&D expenditures, which differs in several respects from the California credit.

Supporters of R&D credits argue that the subsidy they provide is needed to encourage increased investment by private industry in emerging areas of technological change and development--investment which would not occur in the absence of the credit. A number of economists support this view.

Some opponents of the credit, however, argue that it does little to spur additional investment, and that its costs far outweigh the benefits to society. Other critics of R&D credits argue that while underinvestment in R&D would occur in the absence of intervention programs, tax credits are an inappropriate mechanism through which to address the problem. Some, for example, put forth a direct R&D subsidy as an alternative approach.

Evidence regarding the effectiveness of the R&D credit remains ambiguous. Although there do not appear to be any studies that have analyzed the effectiveness of California's R&D tax credit, numerous analyses of the federal credit have been conducted. The U.S. General Accounting Office (GAO), for example, reports that some additional research spending was stimulated by the tax credit, with most of the benefits going to large manufacturing corporations. However, GAO also reported that in 1992, 79 percent of corporations earning R&D credits had accumulated more general business tax credits than could be used. Thus, the marginal incentive provided by additional R&D tax credits was reduced (see U.S. GAO, Tax Policy: Additional Information on the Research Tax Credit, 1995). Some studies regarding the effectiveness of the credit found it to have a relatively minor impact on R&D spending by U.S. corporations (see, for example, Eisner, Albert and Sullivan, The New Incremental Tax Credit for R&D: Incentive or Disincentive?, National Tax Journal, V. 37, 1984; and Karier, Closing the R&D Gap: Evaluating the Sources of R&D Spending, Jerome Levy Economics Institute, Working Paper #22, 1995).

The GAO's recent review of eight separate studies regarding the R&D credit indicates that the effectiveness of the credit is still open to debate. While four of the reviewed studies linked the R&D credit to additional research spending that exceeded the cost of the credit, the remaining four did not support this claim or were inconclusive. The GAO determined that, due to data limitations and methodological issues, available studies are inadequate to the task measuring the effectiveness of the credit (see U.S. GAO, Tax Policy and Administration: Review of the Effectiveness of the Research Tax Credit, 1996).

Credit (Activity Based):

Employer-Provided Child Care Expenses

Description

The PIT and BCT provide employers several tax credits for child care assistance programs. These tax credit programs allow employers to deduct the costs of certain contributions toward employee child care expenses incurred between January 1, 1988 and January 1, 2003. Specifically, employers may deduct:

• Thirty percent of the startup costs of establishing a child care program, the costs of constructing a child care facility, and/or the costs of child care referral services, up to $50,000 per tax year.



• Thirty percent of the cost of contributions to a qualified child care plan. A qualified care plan may include onsite or offsite child care centers, in-home care, and specialized centers which provide care for children with short-term illnesses. Qualifying contributions may not exceed $360 per qualified dependent per tax year.

In order to qualify for the tax credit, these costs must be associated with programs primarily used by children of the taxpayer's employees who are under the age of 15. To the extent that the credit amounts exceed a taxpayer's net tax liability in the year the expenses are incurred, they may be carried forward and used to offset the taxpayer's liability in future years, but not by more than $50,000 in any one tax year.

Rationale

This program is intended to give employers a financial incentive to provide for the child care needs of their employees. It does this by reducing the after-tax cost of making these provisions.

Comments

Employers must reduce their basis cost (which is used for purposes of determining capital gains and losses when property eventually is sold) in child care facilities on which a tax credit is claimed, by the amount of the credit claimed for those facilities. A taxpayer can elect to take depreciation in lieu of claiming the credit. Pursuant to Chapter 323, Statutes of 1998 (AB 2798, Machado), this program was extended from January 1, 1998 to January 1, 2003.

Credit (Activity Based):

Low-Income Rental Housing Expenses

Description

This program provides a tax credit for investors for a portion of the costs of investing in low-income rental housing projects. The amount of the credit depends on the amount needed by the investor in order to make the project economically feasible. This amount is determined by the California Tax Credit Allocation Committee, which reviews program applications and allocates credits based on certain previously established legislative priorities.

Generally, the percentage of costs for which credits may be claimed is based on federal guidelines. The maximum amount the committee may award to a project is designed so that the present value of four annual credit payments generally equals 30 percent of an investor's qualified basis in the low-income housing units. "Qualified basis" is roughly equal to the acquisition, construction, and/or rehabilitation costs of the units. In exchange for the tax credits, the investor must commit to renting a specified percentage of units to low-income individuals based on one of the following options:

• Renting 20 percent of the units to individuals whose income is no more than 50 percent of area median income.
• Renting 40 percent of the units to individuals whose income is no more than 60 percent of area median income.

The rent on these program units based on either option may not exceed 30 percent of these specified income limits.

Rationale

This tax credit program is intended to increase the number of affordable rental housing units available to low-income households in California, by reducing the after-tax costs to developers and investors who produce and invest in such units.

Comments

This program complements a federal tax credit program which also works to promote the development of low-income housing. The maximum federal tax credit that can be awarded is generally equal to 70 percent (on a present-value basis) of a taxpayer's qualified basis in the project, spread over a ten-year period. A project that receives the maximum in both state and federal credits receives 100 percent of the taxpayer's qualified basis over a 10-year period. Both the state and federal programs are administered by the California Tax Credit Allocation Committee. The state program is authorized as long as the federal program continues in existence. California requires that the compliance period over which the program requirements noted earlier must be adhered to extend for 30 consecutive years, rather than the 15-year federal period.

Chapter 1222, Statutes of 1993 (AB 1438, Caldera), expanded this credit to allow insurance companies to qualify. Specifically, insurance companies are allowed a share of the annual credit allocated for investments in low-income housing and can use the credit to offset their gross premiums tax.

Credit (Activity Based):

Joint Custody Head of Household

Description

This program allows a tax credit for divorced or separated individuals who  do bear significant costs in order to maintain a home for a dependent for part of the year, but do not provide the principal residence for a dependent (and, therefore, do not qualify for the more-advantageous "head-of-household" filing status).

Specifically, the program allows a tax credit equal to the lesser of (1) 30 percent of a taxpayer's net tax or (2) a maximum amount determined annually ($281 in 1998). The program is available to divorced or separated taxpayers who (1) live apart from a spouse for at least six months prior to the end of the tax year, and (2) provide for at least one-half of the cost of maintaining the principal residence of a dependent for at least 146 days but not more than 219 days of the tax year. (A taxpayer who maintains the principal residence of a dependent for more than 219 days of the tax year qualifies for the more-advantageous head-of-household filing status.)

Rationale

This program is intended to provide tax relief to taxpayers who are single, or married and living apart, and who care for dependents such as children for a significant portion of the tax year. The program's rationale reflects the view that, in the case of taxpayers who have to maintain households in order to care for dependents, their economic burdens are greater than those of individuals with no such responsibilities.

Comments

Federal law defining "head of household" was incorporated into California law by reference for post-1986 tax years. In order for the head-of-household filing status to be claimed, the household must be the principal residence of the qualifying dependent for more than 219 days of the year. Chapter 1537, Statutes of 1982 (AB 2520, Sher) created a special "joint custody" head-of-household filing status with its own personal exemption credits and tax rates. This separate filing status was replaced with this tax credit by Chapter 1138, Statutes of 1987 (AB 53, Klehs).

Credit (Activity Based):

Salmon and Steelhead Trout

Habitat Restoration

Description

This program, which sunsets on December 1, 2000, provides a tax credit equal to the lesser of (1) 10 percent of the qualified costs paid or incurred for salmon or steelhead trout habitat restoration, up to $50,000 per taxpayer, or (2) the amount certified by the California Department of Fish and Game (DFG). The credit may be used to offset tax liabilities during years in which the expenses are incurred, and any unused credit may be used to offset tax liabilities in future years.

To be able to claim the credit, the taxpayer must apply to the DFG. The department is responsible for certifying that the taxpayer's project has met specified criteria and for authorizing the actual amount of credit that the taxpayer may claim. The project must meet the following criteria: (1) meet the objectives of the Salmon, Steelhead Trout, and Anadromous Fisheries Program Act and contribute to the increase in production of salmon and trout by improving certain habitat conditions; (2) provide employment to unemployed fishing or forestry industry persons in counties with a higher-than-average annual rate of unemployment as specified by the Employment Development Department; and (3) undertake work that does not include construction of office, storage facilities, garages, maintenance buildings, hatchery facilities, permanent surface roadways, bridges, wells, or pumping equipment. The amount of credit allowable must be reduced by the amount of any grant or cost-sharing payment for the project made by a public entity.

Rationale

This program provides an incentive for taxpayers to undertake projects to restore the habitats of salmon and steelhead trout. It does this by offsetting a portion of the costs incurred through a credit that is applied towards the taxpayer's tax liability.

Credit (Activity Based):

Manufacturers' Investment Tax Credit

Description

This program provides a tax credit intended to encourage manufacturing activity and investment in the state. It provides qualified taxpayers an income tax credit equal to 6 percent of the qualified costs incurred for construction, acquisition, or lease of qualified property that is placed in service in California.

• "Qualified taxpayers" are persons engaged in specified businesses as described in the Standard Industrial Classification (SIC) Manual.



• "Qualified costs" include (1) amounts on which the taxpayer paid sales and use tax and that are considered capital acquisitions, and (2) the value of any capitalized labor costs that are directly related to the construction or modification of qualified property.



• "Qualified property" means tangible personal property that is depreciable or computer software used primarily in manufacturing, research, pollution control, recycling, or in maintaining, repairing, measuring, or testing property used in such activities. It also includes, for certain activities, special purpose buildings and foundations that are primarily used in connection with manufacturing, refining, processing, fabricating, or research and storage.

If the property is removed from California, the credit is "recaptured" by adding the credit amount received back on to the appropriate year's net tax liability of the taxpayer. In general, unused credits may be carried forward for up to eight years to offset tax liabilities. In the case of qualified small businesses, the carryforward period is ten years.

Rationale

This program provides an incentive for qualified taxpayers to expand their investments in manufacturing and research property in California. It does this by offsetting a portion of the costs incurred through a credit that is applied towards their tax liabilities.

Distribution of Benefits

The accompanying table (see next page) shows the distribution of benefits of the program for various industries, based on number of returns and by total amount of tax benefits involved. Over one-half of the total dollar amount of benefits of the program goes to electronics and petroleum refining firms. Another one-quarter accrues to other types of manufacturing enterprises.

Manufacturers' Investment Tax Credit
1998 Income Year
Industry Type	Percent of
	Total Taxpayers Benefitting	Total Amount Claimed
Electrical and Electronics Equipment	13.2%	26.9%
Petroleum Refining	0.7	25.1
Chemicals and Allied Products	4.5	5.6
Food and Kindred Products	7.6	7.4
Other Manufacturing	56.5	27.4
Other	17.6	7.4

Comments

A sales and use tax exemption of 5 percent is available for new businesses that first commence activity in California after 1993 and have not been in existence for more than three years. However, if a taxpayer claims this program's income tax credit, then the taxpayer cannot claim the sales and use tax exemption.

This credit essentially reduces the cost of capital acquisitions, and consequently could result in a relative shift away from labor and towards capital. This could be coupled with increased labor demand as a result of overall reduced manufacturing costs, and an increase in production.

Pursuant to Chapter 323, Statutes of 1998 (AB 2798, Machado), the credit was expanded to include taxpayers engaged in software development, computer programming, and computer integrated systems design.

Credit (Activity Based):

Enhanced Recovery Costs

Description

This program provides a tax credit for 5 percent of the qualified costs associated with "enhanced recovery" of oil and gas (such as pumping heated liquids or gasses into a well to enhance the flow of these materials). This credit applies only to nonvertically integrated producers for projects located within California. Unused credits may be used to offset tax liabilities in the future, for up to 15 years. If the taxpayer's costs qualify for another credit, the taxpayer must make an election between credits. No tax deduction is allowed for costs for which the credit is allowed.

Rationale

This program provides an incentive for businesses to use more efficient oil and gas recovery technologies by partially offsetting the associated costs.

Comments

This program conforms with a federally enhanced oil recovery tax credit program. The federal program provides a tax credit for 15 percent of the qualified costs incurred.

Credit (Activity Based):

Farmworker Housing Costs

Description

This program provides a tax credit in the amount of the lesser of: (1) 50 percent of the costs associated with building, repairing, or donating farmworker housing; or (2) the amount certified by the California Tax Credit Allocation Committee. To claim the credit, the taxpayer must enter into an agreement with the committee to build or donate housing meeting specified criteria, with the credit available only during the year when the housing is completed and occupied.

A tax credit is also available to lenders who provide low-interest loans for farmworker housing. It is equal to half of the difference between market interest rates and the rates actually charged. California requires a compliance period of 30 years to be eligible for the credit.

Rationale

This program provides a tax incentive for taxpayers to provide suitable housing for farmworkers. The rationale is that the incentive to farm owners and others will stimulate the provision and construction of suitable housing for farmworkers.

Credit (Activity Based):

Rice Straw

Description

Upon certification by the California Department of Food and Agriculture, this program provides a tax credit in the amount of $15 per ton of rice straw that is grown in California and purchased by the taxpayer. The taxpayer must be an "end user" of rice straw; that is, the taxpayer must use the rice straw for processing, generation of energy, manufacturing, export, prevention of erosion, or for any other purpose exclusive of open burning.

Under the program, the department issues taxpayers a certificate specifying the amount of any tax credit allocated. Up to $400,000 per year in total tax credits may be allocated on a first-come, first-served basis. Any claimed but unused credits may be carried forward by taxpayers to offset their tax liabilities in future years, for up to ten years.

Rationale

The program is aimed at reducing the open burning of rice straw by farmers, thereby reducing the air pollution impacts of such burning. It does so by providing an incentive for taxpayers to purchase rice straw for other purposes. The rationale is that rice straw can be put to more productive uses than simply open burning; however, it often is more costly for the user to choose such other options. This program is intended to partially offset the costs of purchasing the rice straw so that taxpayers will be encouraged to use rice straw in a more efficient manner.

Credit (Activity Based):

Disabled Access Expenditures

Description

Description

This program provides a tax credit for 50 percent of up to $250 of qualified expenditures to eligible small businesses that provide access to disabled individuals. Thus, this program allows a California credit up to a maximum of $125. To qualify for the credit, the business must (1) have earned less than $1 million in gross receipts in the previous year, and (2) employ not more than 30 full-time employees.

Qualified expenditures include those costs associated with complying with the Americans With Disabilities Act of 1990. This includes removing physical barriers that block entrance to a business and acquiring equipment to aid in servicing individuals with specified disabilities, such as hearing and vision impairments. Any unused credit may be carried forward to offset tax liabilities in future years.

Rationale

This program complements an already-established federal tax credit. It also provides an incentive to qualified businesses to make certain "minor" improvements that may not exceed the threshold to qualify for the federal credit.

Comments

The federal government provides a tax credit for 50 percent of qualified expenditures exceeding $250 and up to $10,250. This program covers the initial $250 of qualified expenditures.

Credit (Activity Based):

Transportation of Donated

Agricultural Products

Description

This program provides a tax credit for 50 percent of transportation costs paid or incurred by a taxpayer that are related to the transportation of donated agricultural products to a nonprofit, charitable organization. Upon receipt, the charitable organization furnishes the donor with a certificate specifying the transportation of donated agricultural products, including the type and amount of products donated and the distance transported. Any unused tax credit may be carried forward to offset tax liabilities in future years.

Rationale

This program provides an incentive for taxpayers to donate or incur the costs for transporting agricultural products to charitable organizations. The underlying rationale is that charitable organizations are providing a socially beneficial service by distributing agricultural products to needy individuals, and that this service is worthy of indirect state support. By partially offsetting the costs of transporting the agricultural products, the program encourages more taxpayers to donate or incur the costs of transporting these products. Thus, more agricultural products may reach charitable organizations than otherwise would without the incentive.

Credit (Activity Based):

Child Adoption Expenses

Description

This program provides a tax credit equal to 50 percent of the qualified costs of an adoption of a minor child who is a legal resident or citizen of the United States and was in the custody of a public adoption agency of this state. Qualified costs include fees for required services, travel and related expenses for the adoptive family that are directly related to the adoption process, and medical fees and expenses not reimbursed by insurance that are directly related to the adoption. The tax credit may offset tax liabilities up to $2,500 per child in the year that the adoption papers are ordered. Any unused credit may be carried forward to offset tax liabilities in future years.

Rationale

This program provides tax relief to families choosing to adopt a child. The underlying rationale is that adoption provides a socially beneficial service which is worthy of public financial support.

Special Filing Status:

Subchapter S Corporations

Description

This program allows eligible small business corporations to elect Subchapter S corporation status for purposes of determining their tax liability. The so-called "S" corporations pay taxes on corporate income at a reduced rate of 1.5 percent, except for financial institutions, which are subject to a 3.5 percent rate. The S corporations are not subject to the Alternative Minimum Tax (AMT) but are subject to the applicable corporate minimum tax. Individual shareholders of an S corporation pay personal income taxes on their pro rata share of corporate income.

In contrast to S corporations, a regular "C" corporation pays taxes on its corporate income at a rate of 8.84 percent (or 10.84 percent for financial institutions), for income earned beginning on or after January 1, 1996. Corporate shareholders in C corporations pay taxes on corporate earnings only to the extent that such earnings are paid out of dividends.

In order to be eligible to elect S corporation status, a corporation must have (1) a valid federal S election in effect, (2) fewer than 75 shareholders, and (3) only one class of stock. Those corporations which meet these criteria and make a federal S election are deemed to have made an S election for state purposes as well. However, a corporation may make a separate state election to be treated as a C corporation for state tax purposes, even if a federal S election has been made.

Rationale

This program is intended to provide tax relief to small corporations while still allowing them to take advantage of the limited liability aspect of corporate status. Generally, businesses that make an S election pay less in taxes than they would as C corporations.

Distribution of Benefits

The benefits of the Subchapter S special filing status accrue largely to small-to-mid-sized companies, as shown in Figure 1. Almost three-quarters of the corporate taxpayers benefitting from the program are enterprises with receipts of less than $1 million per year. In terms of total benefits received, over two-thirds of benefits go to enterprises with receipts of $50 million or less. Figure 2 indicates the distribution of benefits of Subchapter S filing status by type of enterprise. The industry sector that benefits the most in dollar terms from the Subchapter S filing status is manufacturing, which accounts for 36 percent of the total benefits. (The distribution of benefits is based only on the effects of the program on BCT revenues and does not include any offset due to increases in PIT revenues.)

Figure 1
Subchapter S Corporations Tax Benefits by Receipt
1998 Income Year
Total Receipts (In Millions)	Percent of
	Total Taxpayers Benefitting	Total Amount Claimed
Under $1	74.0%	7.3%
1-10	20.7	32.7
10-50	4.6	28.6
50-100	0.4	10.5
100-500	0.3	9.7
500-1,000	0.1	10.4
Over 1,000	0.1	0.8

Comments

The revenue increases for PIT result from two factors: (1) unlike C corporation income, all operating income from S corporation earnings is passed through to shareholders and taxed as personal income; and (2) nonresident shareholders must pay California personal income taxes on earnings. These revenue increases may be partially offset by the pass- through of losses to shareholders, which can be deducted from income.

Under federal law, an election of S corporation status completely eliminates any tax liability of the corporation itself. All income and expenses are passed through to shareholders, and there is no entity-level tax imposed. Net income is taxed on a pro rata basis as if it were received as individual income.

According to data from the Franchise Tax Board, there were 118,514 S corporations in California in 1996, with a reported net income of $12.5 billion and tax liabilities of $282 million.

Federal conformity legislation in the form of Chapter 612, Statutes of 1997 (SB 1233, Lockyer), and Chapter 610, Statutes of 1997 (SB 5, Lockyer) contained several provisions affecting S corporations. In particular, scheduled increases in the tax rate were eliminated and the 1.5 percent entity-level tax rate was retained. In addition, the number of allowable shareholders was expanded from 35 to 75. The legislation also liberalized shareholder eligibility, allowed various financial institutions to be S corporations, and permitted S corporations to have wholly owned subsidiaries.

Special Filing Status:

Head-of-Household and Surviving Spouse

Description

This program allows taxpayers who care for dependents to qualify for lower tax rates than are available to single persons or to married persons filing separate returns. This program is intended to provide tax relief to heads-of-households who are single, or married but living apart, and surviving spouses. Surviving spouses qualify for a larger personal exemption in addition to the lower tax rates.

Rationale

The program's rationale reflects the view that taxpayers who have to maintain households in order to care for dependents have greater economic burdens than do individuals with no such responsibilities. In addition, the program reflects the view that tax relief may be needed by many surviving spouses in order to be able to maintain their economic status.

Comments

Federal law definitions for the head-of- household and surviving-spouse filing statuses were incorporated into California law by reference for post-1986 tax years. In order to claim the head-of-household filing status, a taxpayer must provide the principal home of the qualifying dependent for over one-half of the year. In addition, the taxpayer must pay more than one-half of the cost of maintaining that household. A surviving spouse is a taxpayer whose spouse died within two years prior to the taxable year involved, who cares for a dependent child, and has not remarried.

Chapter 846, Statutes of 1990 (AB 3086, Klehs), provides that taxpayers with a nondependent relative living in the home qualify for head-of-household filing status. For example, if a single custodial parent has moved into the home of her widowed father, the father would qualify as a head-of-household. Although the child is the custodial parent's dependent, the grandfather qualifies to claim the head-of-household filing status because he provides more than one-half of the cost of maintaining the home.

Return to California's Tax Expenditure Programs, Income Taxes, Table of Contents
Return to California's Tax Expenditure Programs, Full Table of Contents
Return to Legislative Analyst's Office Home Page