TAX SEASON TOOLKIT: Insight for California Businesses and Individuals.

• Author: Saechao, San

California Conformity

As of December 2019, the 'Tax Cuts and Jobs Act turned 2 years old. As noted in the 2018 toolkit in the December 2018 issue of California CPA, California didn't conform to most federal tax law changes introduced in the TCJA. This added complexity for taxpayers who needed to calculate the correct amount of tax owed to the state.

Although California enacted a bill that realigns the state's tax code and adopts certain elements of the TCJA, there are still many areas of the TCJA with which California doesn't conform or only selectively conforms.

Doesn't Fully Conform

In the 2018 tax season guide, we addressed tax law changes that California taxpayers should watch out for. California still doesn't conform with many of those federal tax laws, including the following:

(1.) Qualified Business Income Deduction. California doesn't conform to Internal Revenue Code (IRC) Sec. 199A, which allows certain owners of sole proprietorships, partnerships, trusts and S corps to deduct 20 percent of qualified business income.

(2.) Full-Expensing Deduction. California hasn't and still doesn't conform to IRC Sec. 168(k), which allows the additional first-year depreciation deduction for the cost of certain tangible business-use personal property assets.

(3.) State and Local Tax Deduction. For federal tax purposes, an individual's deduction for the aggregate amount of stale and local taxes (SALT) paid during a calendar year is limited to $10,000--or $5,000 in the case of a married individual filing separately. California doesn't conform to the federal limitation and doesn't allow a deduction for SALT paid in the calculation of income.

Now Conforms

To reduce taxpayer compliance burdens, California Gov. Gavin Newsom signed Assembly Bill 91 on July 1, 2019, which selectively aligned parts of California tax law to the TCJA.

A few important conformity changes are highlighted below. Unless otherwise noted, the legislation is effective July 1, 2019, and applies to tax years beginning on or after Jan. 1,2019.

Accounting Methods for Small Businesses

The TCJA increased the average annual gross receipts thresholds, allowing more taxpayers to use simplified methods of accounting. AB 91 conforms to these changes. Specifically, AB 91 follows the TCJA in increasing the following average annual gross receipts:

(1.) The cash method of accounting. The average annual gross receipts threshold increased from $5 million to $25 million for taxpayers that are permitted to use the cash method of accounting.

(2.) The accrual method of accounting. The average annual gross receipts threshold increased from $5 million to $25 million for farming corporations that are exempt from using the accrual method of accounting.

(3.) Uniform capitalization (UNICAP) provisions. The average annual gross receipts threshold increased from $10 million to $25 million for resellers and zero to $25 million for producers to be exempt from UNICAP provisions.

In addition, California now conforms to TCJA changes that exempt businesses with average annual gross receipts of $25 million or less from rules that require taxpayers to maintain inventories.

Instead, these taxpayers can account for items that are either:

* Nonincidental materials and supplies; or

* In accordance with a taxpayer's method for financial accounting.

California now exempts certain taxpayers' construction contracts from the required use of the percentage-of-completion method. To qualify, the taxpayer must have average annual gross receipts that don't exceed $25 million. These changes apply to personal income taxpayers and corporate taxpayers.

All of these accounting-method changes are effective for tax years beginning on or after Jan. 1, 2019. Taxpayers can make an election to have these provisions apply to tax years beginning on or after Jan. 1, 2018. These elections must be manually filed on paper.

Net Operating Loss Carryback

California will follow the federal changes that disallow net operating loss (NOL) carrybacks for losses sustained in tax years beginning on or after Jan. 1, 2019.

The state retains a 20-year carryforward period under this legislation.

These changes apply to both personal and corporate taxpayers.

Like-Kind Exchanges

California will follow the federal treatment of IRC Sec. 1031, like-kind exchanges, enacted by the TCJA. Like-kind exchanges of tangible personal property no longer qualify for tax deferred treatment in California, except for individual taxpayers with less than $250,000 of federal adjusted gross income or $500,000 for head-of-household and joint filers.

This change is effective for exchanges completed after Jan. 10, 2019, and the change applies to both personal and corporate taxpayers.

Limitation on Excess Business Losses

In general, California conforms to IRC Sec. 461(1), disallowing deductions of excess business losses that are more than:

* $250,000 for a single filer

* $500,000 for a joint filer

The federal change expires in 2026 and provides a net operating loss carryforward for the amount greater than the limit.

However, California decouples from the federal expiration and NOL carryforward. Instead of being treated as an NOL, the disallowed excess business loss is treated as a carryover excess business loss that should be included in the following year's excess business loss computation.

Additional Changes

AB 91 introduces several additional filing changes, including:

* Technical Termination of a Partnership. AB 91 adopts the TCJA's repeal of the federal technical termination of partnership provisions.

* IRC Sec. 338 Election. For qualified stock purchased on or after July 1, 2019, a federal election made under IRC Sec. 338 will be the same for California purposes. This election treats qualified stock purchases of target corporations as asset purchases. In other words, a separate California IRC Sec. 338 won't be allowed.

* Achieving a Better Life Experience (ABLE) Accounts. AB 91 eliminates the differences in federal and California ABLE qualification criteria and increases the contribution limits up to the federal poverty level. The bill allows taxpayers to roll over a IRC Sec. 529 -college savings - plan to an ABLE account.

* Federal Deposit Insurance Corporation Premiums.

In general, California conforms to IRC Sec. 162(r), which relates to the disallowance of Federal Deposit Insurance Corporation premiums.

* Excess Employee Compensation. In general, AB 91 conforms to the TCJA by revising the definitions of covered employee mid publicly held corporation. This limits the amount these taxpayers may deduct for ordinary and necessary expenses. AB 91 also disallows the performance-based compensation and commission exceptions with respect to the limits for deductions relating to covered employees.

Student Loan Debt. Generally, AB 91 confirms to IRC Sec. 108(f)(5) relating to the income exclusion of student loan indebtedness discharged on or after Dec. 31, 2017.

Income Tax Credit

Earned Income Tax Credit

In 2018, the California Earned Income Tax Credit was extended to help low-income taxpayers. AB 91 raises the maximum earned income to $30,000. The bill also added a refundable young child tax credit of up to $ 1,000 per qualified taxpayer, per taxable year.

The FEB webpagc details credit amounts, income limits, qualifications and additional information.

California Competes Tax Credit

The California Competes Tax Credit (CCTC) program has been around since 2014 and is an economic-development incentive intended to attract or retain businesses considering a significant new investment in California. It does this by providing successful applicants with a nonrefundable tax credit that reduces taxpayers' personal income tax or corporation tax.

In the CCTC program's 2019-20 fiscal year, the California Governor's Office of Business and Economic Development is authorized to negotiate up to $237.8 million in tax credits over three application periods.

Application Periods

The first application period ended on Aug. 19, 2019. The next two CCTC application periods for the program's 2019-20 fiscal year are shown in Figure 1.

Disaster Loss Deductions

California taxpayers may be able to claim a disaster loss deduction for any loss sustained in the state during an event proclaimed to be a state of emergency by the California governor. California hasn't conformed to the TCJA in this regard, instead generally following the former federal law regarding the treatment of losses incurred due to casualty or disaster.

Extended Deadlines

The FEB automatically follows the IRS extended deadlines to file or pay taxes until the date indicated for the specific disaster.

Taxpayers are advised to write the disaster name in dark ink at the top of their tax return to alert the FEB of the disaster to which the return is related.

Tropical Storm Imelda

The FTB has announced that the federal postponement period for Tropical Storm Imelda will be recognized as shown in Figure 2.

Additional Designated Areas

The IRS disaster relief webpage lists additional designated areas eligible for a postponement period. If a taxpayer qualifies for the postponement period, any interest, late-filing or late-payment penalties that would otherwise apply will be cancelled. The FEB will also follow these stipulations.

Other 2019 Disasters

Taxpayers may deduct a disaster loss for any loss sustained in a California city or county where the governor declares a state of emergency. Figure 3 (next page) shows a list of California Qualified Disasters, published on the FTB as of Oct. 31, 2019. For more information on California disaster losses, see the FTB website and Publication 1034, Disaster Loss How to Claim a State Deduction.

Additional Changes

The Dynamex Decision

On Sept. 18, 2019, the governor signed AB 5 into law. The bill served to codify the 2018 California Supreme Court decision in Dynamex Operations West. Inc. v. Superior Court of IJOS Angeles (Dynamex). As mentioned in last year's tax season guide, the...