California recently enacted a bill as part of the budget package for the fiscal year 2020. Called the “Loophole Closure and Small Business and Working Families Tax Relief Act of 2019,” the bill affects both California personal income tax and corporate tax. The bill selectively conforms to certain federal provisions from the 2017 tax reform known as the Tax Cuts and Jobs Act (TCJA). However, the bill does not conform to, or decouple from, several of the more significant federal tax reform provisions impacting business and individual taxpayers.
California selectively conforms to specific provisions of the Internal Revenue Code (IRC) that the state has adopted as of a fixed date, currently the IRC as enacted on January 1, 2015. Because the TCJA was enacted on December 22, 2017, and most of its changes were effective for tax years beginning after December 31, 2017, previously California had yet to conform or decouple from any federal provision enacted or amended by the TCJA. With the enactment of the recent bill, California finally responded to select sections of the TCJA, as summarized below.
Notwithstanding the recently-enacted bill, California will continue to conform to all other IRC sections that it has previously adopted, but that are not addressed in the bill, as enacted on January 1, 2015. Further, California’s limited IRC conformity addressed in the bill is only effective for tax years beginning on January 1, 2019.
Section 338 Election
Provides that when an election is made under IRC Section 338 for federal tax purposes to treat a qualified stock purchase of a target corporation as an asset purchase, the federal Section 338 election will be binding for California tax purposes. Likewise, if no federal IRC Section 338 election is made, then a separate California Section 338 election is not allowed.
The new California IRC Section 338 election rules apply to a qualified stock purchase made on or after July 1, 2019, but do not apply to a qualified stock purchase that is subject to a binding contract entered into before the aforementioned date and that remains binding at all times after that date.
Previously, if the target corporation in a qualified stock purchase governed by a federal IRC Section 338 election was not an S corporation, a separate California Section 338 election was allowed if it was not made for federal purposes, or an election out of a federal election was allowed for California bank and corporation tax purposes.
Like-Kind Exchange Rules
Conforms to the TCJA changes made to IRC Section 1031 that limit the like-kind exchange rules, but the California conformity applies starting with exchanges completed after January 10, 2019. The bill eliminates like-kind exchange treatment for exchanges of personal property by limiting like-kind exchange treatment only to real property, except for individual taxpayers with adjusted gross income of less than $250,000 for a single filer and $500,000 for a joint filer.
Net Operating Loss (NOL) Carrybacks
Before this new bill, California allowed NOLs to be carried back two years for tax years beginning in 2013. This bill repeals the ability for taxpayers to carryback NOLs to previous taxable years.
Non-Corporate Business Loss Limits
For tax years beginning after December 31, 2018, the bill conforms to the TCJA provisions found in IRC Section 461(l). The bill disallows deductions under the Personal Income Tax law for excess business losses over $250,000 for a single filer and $500,000 for joint filers.
It establishes these limits in perpetuity, whereas the federal change expires in 2026, and provides that losses cannot be carried forward as a NOL at an amount greater than the limits listed above. The California law differs from the federal law in that the TCJA allows any disallowed excess business losses to be carried forward as NOLs.
Small Business Accounting
Conforms to federal reform and simplification of small business accounting that increases the thresholds for small businesses that may use certain account methods. This conformity is for tax years beginning on or after January 1, 2019, and allows taxpayers to elect to have these changes apply to tax years beginning on or after January 1, 2018, and before January 1, 2019.
Student Loan Debt
Excludes from an individual’s gross income the amount of student loan indebtedness discharged on or after December 31, 2017, due to death or disability of the student, as provided, by conforming to IRC Section 108(f)(5).
The recently bill does not address several important federal tax reform provisions enacted or amended by the TCJA, including the Global Intangible Low Tax Income and Foreign-Derived Intangible Income, (commonly referred to as GILTI and FDII) provisions, the business interest expense limitation of IRC Section 163(j), federal 100-percent bonus depreciation, IRC Section 199A, the limitation on meals and entertainment, and other federal international, corporate, partnership, and personal income tax changes enacted by federal tax reform.
The recent bill is, at best, a limited IRC conformity measure enacted by California. It is also effective only for tax years beginning on and after January 1, 2019, so it does not address California taxpayers 2018 returns. California business and individual taxpayers will still be confronted by a host of federal-California differences that will complicate California taxpayers’ compliance, planning, and transactions for prior and future tax years.