Sacramento Report
By Ron Kingston

"If the legislature waits until April 1, 2010, the state is expected to run out of money…"

The California state budget crisis continues to worsen, not improve. Legislators scramble to either increase taxes or reduce spending in an effort to address a $20 billion hole.

One of the unfortunate solutions that is proposed is another budget gimmick, which is to impose a three percent independent contractor withholding mandate on businesses and public agencies.

This proposal directly affects our businesses because according to the proposal, which the Senate Democrats are pushing for, a business or public agency that is hiring an independent contractor (anyone that receives a 1099-MISC) will have to reduce every payment by three percent and is responsible for remitting that money to the state Franchise Tax Board (FTB), the state tax collection agency.

Most every company and government agency, including non-profits, will be required to withhold three percent of the payment.

Almost anyone who receives a 1099-MISC will be withheld upon, including attorneys, real estate agents and property managers.

The proposal will require three percent be withheld even if the business owes no income taxes for the year due to losses or small profit margins.

The state will use the money that we, and almost every other business, will pay to the state interest free until the following year when tax returns are filed with FTB.

Implementation will be costly and very complex should business and local government agencies be forced to comply. And if that was not enough, the mandate will be ongoing and permanent upon businesses and government agencies.

Now here is the kicker. If that was not enough, last year’s state budget agreement between the Legislature and the Governor imposed a new state mandate which requires independent contractors to pay 70 percent of their tax by June each year for the next two years.

The net result of the withholding tax is that it focuses on all businesses that fully comply with paying taxes and requires complex and costly staff computer system changes. Interestingly, State Controller Chiang has stated that the state computer system changes to accommodate pay cuts would cost $177 million, a cost that taxpayers will also pay for. Of course the state will not even consider the unrecoverable cost burdens that we will face.

Lawmakers have until the first part of March before financial gridlock actually starts costing the state. Every day afterward the budget hole widens by millions of dollars. If the legislature waits until April 1, 2010, the state is expected to run out of money and it will “overdraw on its checking account”.

The Governor’s office warns that if the budget adjustments and tax changes are made so late, that it could cost the state an additional $2.4 billion, mostly because making cuts to social programs and starting up new initiatives such as the plan to require independent contractor withholding takes time to implement.

The spokesman for the state Department of Finance warns, “The longer it takes to confront this problem, the bigger the problem is going to be.” This is lost in most budget discussions because the longer the delay in balancing the state budget:

• The larger the budget deficit becomes because the state is spending more money than it is taking in.
• The time it takes to implement changes becomes more complex.

Ron may be reached at: Ron@CALPCG.com
or you can call him at (916) 447-7229.