What Is a “Loophole” in the Tax Laws?

Chris Micheli
Chris Micheli is a Principal with the Sacramento governmental relations firm of Aprea & Micheli, Inc.

For years around the State Capitol, as well as during ballot wars such as this year’s Proposition 15 to create a split property tax roll, we have heard the claim of tax increase proponents that their bill in the Legislature or their initiative on the ballot is simply “closing a tax loophole.” So, what exactly is a “loophole” in the tax laws?

According to a dictionary definition: 

loop·hole

/ˈlopˌ(h)ōl/

noun

an ambiguity or inadequacy in the law or a set of rules.

Similarly, according to Wikipedia, “A loophole is an ambiguity or inadequacy in a system, such as a law or security, which can be used to circumvent or otherwise avoid the purpose, implied or explicitly stated, of the system.” Other observers have defined a loophole as “basically a technicality that allows one to escape violating the law through some activity.”

My takeaway from these definitions, as well as my own sense after working in tax law for more than twenty years in California, is that a tax loophole is when a taxpayer, whether an individual or a corporation, utilizes the tax law for something that was clearly not intended by the law’s provisions. Unfortunately, those who want to change California’s tax laws that adversely impact individual and corporate taxpayers often loosely throw out the “tax loophole” claim when advocating their position.

However, when a tax law is being used exactly how it was intended and in compliance with what the law provides, then the definition of loophole” is simply not met. In other words, it is wrong for critics to claim there is a “loophole” when companies claim a tax credit or exemption when these companies clearly qualify for the tax incentive. 

For example, last June when the Legislature was debating and ultimately approved the Governor’s proposal to suspend net operating losses and limit the use of tax credits, we heard proponents claiming the research and development tax credit is a “tax loophole” for tech companies to avoid paying their “fair share” of taxes to the state. What nonsense! 

The R&D tax credit has very strict provisions for who qualifies, what qualifies, and other restrictions on its use as set forth in California’s Revenue and Taxation Code Section 23609. In addition, the Franchise Tax Board has for years been aggressively auditing California companies claiming the R&D credit to ensure proper compliance with the law. Nonetheless, last summer’s budget debate actually necessitated a rebuttal of how claiming this credit by tech and biotech companies, among others, is not a loophole, but what the law actually intends.

California’s voters are faced with similar claims in the debate over Proposition 15 on Tuesday’s statewide ballot. Proponents claim that amending Proposition 13 from 1978 requires a split property tax roll be created so that commercial and industrial properties are no longer afforded Prop. 13’s protections so that the state can “close a tax loophole” that, they erroneously argue, has helped California businesses “avoid paying their fair share of property taxes.” Again, what nonsense! 

If we simply look at the language of this ballot measure. Prop. 15 proposes to add a new section to Prop. 13’s provisions in the state constitution. Specifically, Prop. 15, in Section 6 of the measure, would add Section 2.5 to Article 13A of the California Constitution (which was originally added in 1978 by Prop. 13). And, the first clause of new Section 2.5 states, “Notwithstanding Section 2 of this article….” What is Section 2? It is Prop. 13 and how real property is assessed in this state.

Because Prop. 13 applies to all real property on the property tax roll for each county (i.e., our current constitution provides no distinction between residential and commercial or industrial property), Prop. 15 creates an entirely new section and provides, despite what the constitution currently specifies, that we are going to change the law and provide a separate (i.e., “split”) property tax roll going forward. 

So, just like proponents did during this past summer’s debate on the lawful use of business tax credits, the proponents of Prop. 15 are erroneously claiming they are closing a tax loophole. However, Prop. 15 obviously does not close an ambiguity that has been used to circumvent or avoid the purpose of existing law. The simply reason is that Prop. 13 and Article 13A of the California Constitution clearly apply protections to all forms of real property in this state.

While it is appropriate for proponents of limiting the use of business tax credits, or proponents of creating a new split roll property tax system, to want to change the law, the least they can do is not misrepresent the current state of the tax laws and misleadingly claim that the lawful conduct of California businesses is a loophole.

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