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California conforms to selected TCJA provisions

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On July 1, 2019, California Gov. Gavin Newsom signed legislation, A.B. 91, which selectively conforms to various provisions of the Tax Cuts and Jobs Act of 2017 (TCJA).1 The legislation only conforms to specific sections of the TCJA, while the state’s overall conformity date to the Internal Revenue Code (IRC) remains Jan. 1, 2015, for provisions not included in A.B. 91. Thus, California does not conform to key provisions of the TCJA such as deemed repatriation, the new tax treatment of foreign income, the net business interest limitation and 100% bonus depreciation. The enactment of A.B. 91 is the first time California has conformed to federal income tax changes since 2015. Unless otherwise noted, the legislation is effective July 1, 2019, and applies to tax years beginning on or after Jan. 1, 2019.

Disparity between federal and California tax law California generally conforms to the IRC in effect on Jan. 1, 2015.2 Because California has a fixed IRC conformity date, legislation must be enacted to advance the conformity date or selectively adopt IRC amendments enacted after the conformity date. The enactment of the TCJA3 in December 2017 created a disparity between federal and state tax regimes. Prior to the recent enactment of A.B. 91, the California Revenue and Taxation Code wholly excluded the IRC sections amended or added by the TCJA. Through the enactment of A.B. 91, California tax law gains parity with certain business and personal income tax provisions enacted by the TCJA.

California conformity to IRC A.B. 91 provides selective conformity to IRC provisions relating to individuals and businesses in addition to a few California specific updates. The items impacting business and individual taxpayers are summarized below:

Business taxpayers
  • Disallowance of Federal Deposit Insurance Corporation (FDIC) premiums for income tax purposes4
  • Elimination of net operating loss (NOL) carrybacks with indefinite carryforward5
  • Elimination of separate IRC Sec. 338 elections6
  • Expansion of the limit on “excessive employee remuneration” to include performance-based compensation and commission payments7
  • Limitation on excess business losses for taxpayers other than corporations8
  • Repeal of technical termination of partnerships9
  • Small business accounting method “reform and simplification”10

Individual taxpayers
  • Elimination of NOL carrybacks with indefinite carryforward11
  • Limitation of like-kind exchanges12
  • Exclusion for student loan debt discharged due to death or disability13
  • Expansion of the earned income tax credit;14
  • Provision of the young child tax credit;15 and
  • Increase of contributions to Achieving a Better Live Experience (ABLE) Act accounts and rollover of IRC Sec. 529 accounts to ABLE accounts.16

California nonconformity Despite California’s conformity to certain IRC provisions by A.B. 91, California law does not conform to other provisions added or amended by the TCJA, including the most significant corporate tax provisions. A.B. 91 does not conform the California tax code to the following domestic tax provisions: the net business interest limitation under IRC Sec. 163(j); 100% bonus depreciation;17 the 80% limitation on NOLs;18 and the dividends received deduction (DRD).19 In addition, A.B. 91 does not conform the California tax code to the following international tax provisions: the base erosion payments of taxpayers with substantial gross receipts (BEAT) regime;20 foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI);21 and the deemed repatriation of deferred foreign income (transition tax).22

Commentary California’s selective conformity under A.B. 91 presents additional complications to taxpayers from a complexity standpoint, paired with an uncertain impact from a tax liability perspective. Prior to this legislation, California taxpayers were tasked with understanding and complying with two parallel tax regimes: (i) the provisions of the TCJA for federal purposes; and (ii) California’s Revenue and Taxation Code, essentially the IRC as it existed prior to tax-reform taking effect with certain modifications.

A.B. 91 presents California taxpayers with the challenge of moving forward in a post-TCJA world with state tax law that does not reflect many aspects of the TCJA. As a result, taxpayers will need to evaluate and revise their current state tax reporting methods that will take effect for the 2019 tax year, and consider the broader impact of this legislation on their business operations as a whole. At the same time, taxpayers should not ignore the fact that A.B. 91 will, at least for the time being, preserve some beneficial aspects of the pre-TCJA law, such as less restrictive interest deduction limitations. Furthermore, some of the changes made by A.B. 91 will allow for flexibility in business operations such as repealing the technical termination of partnerships. Ultimately, A.B. 91 is likely to be the first of several steps that California takes to address the TCJA, since subsequent legislation will be required to affirmatively conform or decouple from the more prominent TCJA provisions. The potential still remains for prospective, or even retroactive, application of some of the more prominent TCJA provisions if California so chooses.


 
1 Ch. 39 (A.B. 91), Laws 2019.
2 CAL. REV. & TAX. CODE §§ 17024.5; 17201; 23051.5; 24271.
3 P.L. 115-97. For a discussion of this Act, see GT Alert: Tax Reform Law Transforming Business and Tax Planning.
4 CAL. REV. & TAX. CODE §§ 17201.2; 24343.1. Adopts addition of IRC § 162(r) made by the TCJA.
5 CAL. REV. & TAX. CODE §§ 24416; 24416.21; 24416.22.
6 CAL. REV. & TAX. CODE § 24451.1. If an election has been made by the taxpayer under IRC § 338, relating to certain stock purchases treated as asset acquisitions, or where a taxpayer has not been deemed to have made an election under IRC § 338(e), relating to a deemed election where the purchasing corporation acquires assets of the target corporation, for federal income tax purposes, a separate California election is not allowed and the federal election is binding.
7 CAL. REV. & TAX. CODE § 17271. Generally adopts amendments to IRC § 162(m) made by the TCJA.
8 CAL. REV. & TAX. CODE § 17560.5(b). Generally adopts amendments to IRC § 461(l) made by the TCJA, but the limitation applies in California for tax years beginning after Dec. 31, 2018.
9 CAL. REV. & TAX. CODE § 17859.
10 CAL. REV. & TAX. CODE § 24654. Generally adopts amendments made by the TCJA to IRC § 448, relating to limitations on the use of cash method accounting. Under the TCJA, a small business with average annual gross receipts not exceeding $25 million is exempt from the provisions requiring taxpayers to take inventories to clearly determine their income. Also, the TCJA exempts long-term construction contracts entered into by taxpayers with annual gross receipts not exceeding $25 million from the requirement that the taxable income from the contract be determined by the percentage of completion method.
11 CAL. REV. & TAX. CODE §§ 17276; 17276.21; 17276.22.
12 CAL. REV. & TAX. CODE § 18031.5. Generally adopts amendments to IRC § 1031, relating to exchanges of real property held for productive use or investment, which were made by the TCJA. For joint return filers, only applies to taxpayers with adjusted gross income of at least $500,000 ($250,000 for single filers) for the taxable year in which the exchange begins. This provision applies to exchanges completed after Jan. 10, 2019.
13 CAL. REV. & TAX. CODE § 17144.8. Adopts addition of IRC § 108(f)(5) made by the TCJA.
14 CAL. REV. & TAX. CODE § 17052(o).
15 CAL. REV. & TAX. CODE § 17052.1. This new credit is available for tax years beginning on or after Jan. 1, 2019.
16 CAL. REV. & TAX. CODE §§ 17140.3; 17140.4. California generally adopts IRC §§ 529 and 529A, including amendments made by the TCJA, with certain adjustments. These provisions also are adopted for corporate income tax purposes. CAL. REV. & TAX. CODE §§ 23711; 23711.4.
17 IRC § 168(k). California historically has required an addition modification for bonus depreciation deducted at the federal level. CAL. REV. & TAX. CODE § 24349.
18 IRC § 172. California does not conform to the federal limitations of IRC § 172, though as discussed above, A.B. 91 has updated California’s NOL provisions to eliminate carrybacks and provide for an indefinite carryforward of NOLs.
19 IRC § 243. California does not conform to the federal DRD limitations, but provides a California-specific DRD to eliminate intercompany dividends and for dividends paid to a corporation by an insurance company. CAL. REV. & TAX. CODE §§ 24410; 25106.
20 IRC § 59A.
21 IRC §§ 250(a)(1)(A), (B); 951A.
22 IRC § 965; Also see California Guidance – Taxable Year 2017 IRC Section 965 Reporting, California Franchise Tax Board, May 2018; Summary of Federal Income Tax Changes – 2017, California Franchise Tax Board, May 16, 2018; Preliminary Report on Specific Provisions of the Federal Tax Cuts and Jobs Act, California Franchise Tax Board, March 20, 2018.



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