UPDATED JULY 18, 2019: At Last…Partial Conformity…
In December 2017, Congress passed the Tax Cuts and Jobs Act (TCJA) which was the most significant tax reform legislation enacted since the 1980s. In July 2019, 18 months later, the California legislature acted and the governor signed Assembly Bill 91 that contained a select number of conformity provisions. These provisions will simplify tax compliance for California taxpayers as differing federal and California tax reporting for certain transactions will no longer be required. Unfortunately, California has yet to conform to most of the changes enacted by the TCJA.
The conformity changes included in AB 91 are highlighted below.
However, in an act of “reverse conformity,” the legislature passed Senate Bill 78. Originally, the federal Affordable Care Act imposed a “penalty tax” on taxpayers who did not have qualifying health insurance coverage. Congress repealed this “tax” effective January 1, 2019. But due to an act of reverse conformity, a “penalty tax” will once again be imposed on California taxpayers that do not have qualifying health insurance, effective January 1, 2020.
Taxpayers are beginning to work on their 2018 business entity income tax returns and are discovering the impacts and opportunities created by the Tax Cuts and Jobs Act (TCJA), as most of the Act’s provisions are first effective in 2018 (here’s a summary: Tax Reform Has Wide Ranging Impact). Since California is a rather independent state it should not be surprising to know that California has conformed to essentially none of the federal tax law changes created by TCJA. This will create many tax preparation and planning challenges. Currently, conformity is not a major issue to our governor or state legislature so nonconformity will likely be with us for a while.
Significant items of nonconformity are discussed below:
|Corporate Tax Rates||Reduction in top rate from 35% to 21%||Tax rate unchanged at 8.84%|
|Accounting methods||Taxpayers with three year average annual gross receipts under $25 million may switch to the cash method of reporting income and expenses. Contractors can use completed contract method.||UPDATED 7/18/19: Conformity effective for tax years beginning on or after January 1, 2019 but taxpayers can elect to have conformity apply to tax years beginning after January 1, 2018.|
|Inventory accounting and capitalization of indirect costs (UNICAP)||Taxpayers with three year average annual gross receipts under $25 million may account for inventories as non-incidental materials and supplies.|
UNICAP not required if taxpayer is under the $25 million gross receipts ceiling.
|UPDATED 7/18/19: Conformity effective for tax years beginning on or after January 1, 2019, but taxpayers can elect to have conformity apply to tax years beginning after January 1, 2018.|
|Bonus depreciation||Bonus depreciation increased to 100% and applies to both new and used property.||No bonus depreciation.|
|Section 179 first year expensing||Limit increased to $1 million||Limit retained at $25,000|
|Meals and entertainment||Meals remain 50% deductible. Entertainment no longer deductible|
Meals furnished for employer convenience now 50% deductible.
|Both meals and entertainment remain 50% deductible.
Meals for employer convenience still 100% deductible.
|Like kind exchanges||Only real property is eligible for a tax deferred like kind exchange.|
Buildings with personal property (possibly from a cost segregation study) will have taxable gain or loss in a tax deferred exchange as the personal property is not eligible for exchange treatment.
|UPDATED 7/18/19: For exchanges completed after January 10, 2019 California conforms to federal treatment with one exception. For individual taxpayers with adjusted gross income under certain limits ($250K single or $500K joint) the existing rules continue to apply.|
|Interest expense deduction||Interest expense deduction may be limited for entities with gross receipts over $25 million.||No limitation on interest deduction.|
|Net operating losses||Carrybacks no longer allowed. Carryforwards limited to offset 80% of taxable income.||UPDATED 7/18/19: For tax years beginning on or after January 1, 2019 carrybacks are no longer allowed. Carryforwards may offset 100% of taxable income.|
|Corporate Alternative Minimum Tax||Repealed||No change from pre-2018 law|
|Income from pass through entities||Individual taxpayers are allowed a deduction equal to 20% of the qualified business income from S-Corps and Partnerships.||Individuals continue to be taxed on 100% of their pass-through income|
|Losses from pass through entities||Deduction for business losses limited to $250K for single taxpayers and $500K for joint returns. Provision expires in 2025. Unallowed losses are carried forward as part of net operating losses.||UPDATED 7/18/19: For tax years beginning after Dec 31, 2018 California conforms to the loss deduction limits with exceptions. Unallowed deductions are carried forward and treated as business losses subject to limits in future years. This provision is permanent and does not expire in 2025.|
|Partnership technical terminations||Repealed||UPDATED 7/18/19: Repealed for tax years beginning on or after Jan. 1, 2019 but partnership can elect to apply conformity to tax years beginning after December 31, 2017.|
|Transition Tax||IRC sec. 965 imposes a one-time mandatory tax at a reduced rate on all US shareholders on accumulated earnings of controlled foreign corporations or foreign corporations which have 10% US shareholders via a one-time deemed repatriation of those earnings.||Existing California water’s edge provisions do not confirm to transition tax.|
|Dividends received deduction||Dividends from 10% or more owned foreign subsidiaries will not be taxed in the US by means of dividends received deduction.||Existing California water’s edge provisions do not conform to dividends received deduction.|
|Global Intangible Low-Taxed Income (GILTI)||U.S. shareholder of a controlled foreign corporation must include on a current basis certain types of high-return “GILTI” income. C corporations get a 50 percent deduction resulting in an effective tax rate of 10.5 percent on GILTI.||GILTI inclusion amount is
not considered in the computation of California taxable income, nor is it considered in the inclusion ratio for a water's-edge return.
|Foreign Derived Intangible Income (FDII)||A domestic C corporation may deduct 37.5 percent of income generated from sales of property to a non US person for foreign use and or services provided to any person or with respect to any property outside of the United States resulting in an effective tax rate of 13.125 percent on such income.||California does not confirm|