On July 1, 2019, California Gov. Gavin Newsom signed Assembly Bill 91 as part of the state’s fiscal 2020 budget. The bill cited as the Loophole Closure and Small Business and Working Families Tax Relief Act of 2019, addresses the state’s conformity to Public Law 115-97, commonly known as the Tax Cuts and Jobs Act (TCJA).
Assembly Bill 91
California conforms to the IRC on a fixed-date basis as of Jan. 1, 2015. Almost 18 months after the TCJA, signed on Dec. 22, 2017, California becomes one of the last states to address conformity to the extensive federal tax reform legislation. However, Assembly Bill 91 does not change the general fixed-date conformity to the IRC and addresses conformity only to selective provisions of the TCJA as described below. The following is a high-level summary of Assembly Bill 91.
Net operating loss carrybacks
California allowed a net operating loss (NOL) attributable to a taxable year beginning on or after Jan. 1, 2013, to carry back to each of the two taxable years preceding the taxable year of loss. Assembly Bill 91 eliminates the carryback provisions for tax years after Dec. 31, 2018. California has not conformed to any of the NOL provisions addressed in the TCJA.
Excess business losses
Effective for tax years beginning after Dec. 31, 2018, California conforms to new section 461(l) relating to the limitation on excess business losses on non-corporate taxpayers. Under the TCJA, business losses in excess of the taxpayer’s aggregate income and deductions, plus a threshold of $500,000 for taxpayers filing jointly, or $250,000 for single filers, are disallowed.
For California purposes, any disallowed loss is treated as a carryover excess business loss for the following taxable year, and not as an NOL carryover under section 172 as provided by the TCJA. California adopts the federal definition of “excess business loss” and allows any prior year carryover excess business losses to be included in that calculation.
The TCJA provided that like-kind exchanges under section 1031 are limited to real property that is not held primarily for sale. Personal property no longer qualifies for tax-deferred treatment. Assembly Bill 91 generally conforms the state to section 1031.
However, the new exchange restrictions do not apply to California individual taxpayers below certain income thresholds. For the taxable year in which the exchange begins, taxpayers filing a joint return with incomes under $500,000, and individuals with incomes under $250,000 may apply the former rules. Therefore, a qualifying taxpayer entering an exchange involving personal property may be able to defer state tax, but could still be subject to federal tax.
California’s section 1031 conformity provisions do not apply to an exchange where the property to be disposed of by the taxpayer in the exchange is disposed of by that taxpayer on or before Jan. 10, 2019, or where the property to be received by the taxpayer in the exchange is received by that taxpayer on or before Jan. 10, 2019
“Small business” accounting method reform and simplification
The TCJA increased the number of taxpayers that qualify as small businesses under section 448 by raising the cap on gross receipts to $25 million averaged over the prior three years. Qualifying as a small business under the gross receipts test of section 448(c) allows taxpayers to use several simplified methods of accounting, including the cash method of accounting.
Effective for tax years on or after Jan. 1, 2019, California conforms to the small business accounting method reform and simplification provisions of the TCJA. These provisions include the following:
- Use of the cash method of accounting
- Exemption from using the accrual method for certain corporations engaged in farming under section 447
- Exemption from the requirement to capitalize inventory costs under section 263A (UNICAP)
- Exemption from the requirement to account for inventories under section 471
Note that the TCJA provision applying the simplification beginning after Dec. 31, 2017, is not applicable, but a taxpayer may elect to apply the provisions to taxable years beginning on or after Jan. 1, 2018.
Technical terminations of partnerships
The TCJA eliminated the "technical termination" provisions of section 708(b)(1)(B), for partnership tax years beginning after Dec. 31, 2017. The prior law provided that a technical termination occurred when 50% or more of the total interest in partnership capital and profits is sold or exchanged. A technical termination would also require the partnership to file two short-year tax returns and make re-elections – neither required under the amended provisions.
Not all states immediately conformed to the technical termination provisions, including California, and states may have required two short period tax returns following the "termination" or pro forma federal returns.
Assembly Bill 91 conforms California to the federal provisions, no longer triggering a technical termination when a partnership undergoing a sale or ownership change greater than 50% occurs within a 12-month period. The state will also allow partnerships to elect to apply the new rules for partnership tax years after Dec. 31, 2017.
Assembly Bill 91 also addresses conformity to other TJCA provisions and amends various California tax law provisions as follows:
- Conforms to section 162(m) excessive employee compensation provisions providing limitations for the business deductions related to excessive employee remuneration in excess of $1 million and disallows the performance-based compensation and commission exemptions relating to covered employees
- Conforms to various changes related to Achieving a Better Life Experience (ABLE) accounts and 529 accounts
- Conforms to provisions excluding from gross income qualified student loan indebtedness that is discharged due to the student’s death or disability after Dec. 31, 2018
- Conforms to limitations on FDIC premium deductions by large financial institutions
- Expands the state’s Earned Income Tax Credit (EITC) and creates a new young child tax credit for taxpayers allowed the EITC and have at least one qualifying child
- Prohibits a separate state election if an election, or deemed election, has been made by a taxpayer under section 338 (relating to certain stock purchases treated as asset acquisitions)
Assembly Bill 91 provides sweeping changes to the California tax landscape but preserves the state’s general conformity to the IRC as of Jan 1, 2015. Noticeably absent from the selective conformity are any of the TCJA provisions related to international tax reform, including section 965 repatriation and the provisions related to global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII).
Individuals and companies conducting business in California will likely be affected by the new provisions and should anticipate increased due diligence in unpacking all of the changes. Taxpayers should also recognize that the conforming provisions may also be impacted by selected California-specific amendments. In addition, effective dates range widely from the TCJA. Taxpayers with questions on how the changes will affect their business should contact their state and local tax adviser.