"An Unbelievable Compromise:" California's Proposed New Tax Structure
by Ashley Glazebrook & Jules Walker

In light of the California budget crisis, Governor Arnold Schwarzenegger has embraced a reformed tax plan that he is calling "an unbelievable compromise between Democrats and Republicans." It’s also a proposal that has businesses and labor groups outraged.

In 2009, the Governor set up the bipartisan Commission on the 21st Century Economy to evaluate and modernize California's out-of-date revenue laws that are the main driver of the wide fluctuations in state budget deficits and surpluses.  The Commission, made up of 14 members (seven appointed by the Governor, and seven appointed by the legislature) developed a plan addressing the following goals:

• Establish 21st century tax structure
• Stabilize state revenues
• Promote long term prosperity
• Improve competitiveness
• Reflect principles of sound tax policy
• Ensure fairness and equality

The process, phased in over five years, will be monitored by a technical panel to ensure revenue neutrality and the integrity of the prescribed goals.

The six main components of the plan are as follows:            

• The plan proposes that we compress the state's income tax by reducing the number of brackets from six to two, and limit the top rate at 6.5% (down from 9.3%).  Income over $1 million dollars will still be hit with a supplementary 1% rate for mental healthcare programs.       
• The implementation of a new form of tax called the "Business Net Receipts Tax" ("BNRT"). The BNRT would exclude local, state and federal governments, non-profits, insurance companies and small businesses with less than $500,000 in gross receipts.
  • Net receipts for non-financial entities is defined as:  Aggregate ‘gross receipts’ less ‘purchases’ from all other firms.
  • The initial rate would be 1.6% and would top out at around 4% when fully phased in.
  • The BNRT would be phased-in over a 5-year period beginning in 2012.  
  • Companies would not be able to exempt wages and benefits for employees, but could exempt payments for independent contractors. This would apply to all individual proprietorships, pass-through units (general partnerships, LLPs, S-Corps) and C-Corps.
  • Existing credits and net operating losses could be carried forward for up to 20 years and used to offset the BNRT, not to exceed 5% of the BNRT per year.
  •  Assets acquired prior to 2012 would continue to be depreciated, amortized or depleted and only the gain realized upon disposition would be a “gross receipt.”
• The elimination of the state’s 5% portion of the sales tax that goes toward the general fund would take place. This would occur over a 5 year transition period.
• The state corporate tax would be eliminated in 2012.
• An independent tax body to resolve tax disputes between the state and taxpayers would be established.
• The bill proposes that voters institute a new rainy-day reserve fund representing 12.5% of revenue (up from 5% currently).

So what does this mean for your business?

Like every tax reform plan that has crossed the transom over the years this solution has formidable opposition.  Business groups are claiming that the plan could have substantial consequences, especially on companies who rely mostly on labor rather than materials. Labor groups are saying that because businesses cannot subtract employee benefits and wages, workers will be the ones most adversely affected.  

It is clear that California's tax structure is in desperate need of review and reformation, but is there a plan possible that will not adversely affect someone?  The age old question once again is at the center of the discussion: Is it better to sacrifice a minority for the good of the majority?