California Enacts A.B. 91 to Selectively Conform with Several Provisions from the TCJA

August 2019

California recently changed the mailing address for Small Business Accounting election submissions from Rancho Cordova to Sacramento. This alert has been updated to reflect that change. The information in BDO alerts is dependent on tax policies at the time they are published. The subject matter of this alert has since been updated. To find the latest information on this topic, read California FTB Issues Formal Notices on Elections for Small Business Methods of Accounting and for Technical Termination of Partnerships.

The California Franchise Board has issued Elections under AB 91: update to procedures, which now requires dark colored ink (e.g., blue or black) be used when making required statements on returns. Returns that have already been filed as of 8/22/2019 do not need to be re-filed or amended, they will still be processed. The use of dark colored ink replaces the original requirement to use red ink. The information in this alert has been updated to reflect this change.


Summary

On July 1, 2019, California enacted Assembly Bill No. 91 (A.B. 91) 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,” A.B. 91 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, A.B. 91 does not conform to, or decouple from, several of the more significant federal tax reform provisions impacting business and individual taxpayers.
 

Details

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 A.B. 91, California finally responded to select sections of the TCJA, as summarized below.
 
Notwithstanding A.B. 91, California will continue to conform to all other IRC sections that it has previously adopted, but that are not addressed in A.B. 91, as enacted on January 1, 2015.  Further, California’s limited IRC conformity addressed in A.B. 91 is only effective for tax years beginning on January 1, 2019.
 
Technical Termination of a Partnership
Adopts the TCJA amendments to IRC Section 708, which provide that a sale or exchange of 50 percent or more of the interests in a partnership in a 12-month period no longer is a termination of the partnership.  This adoption by A.B. 91 is important for California partnerships.  However, because A.B. 91 became effective on January 1, 2019, California partnerships were still exposed to termination treatment with respect to transactions occurring after December 31, 2017, the effective date of the TCJA’s amendment of IRC Section 708.  A.B. 91 also provides an election to apply the IRC Section 708 amendment for California tax purposes prior to January 1, 2019. 
 
The Franchise Tax Board will provide the election forms, but until the form is available, the board has advised taxpayers to make the election by providing the following information:
 
  • Include a statement on an original or amended California tax return, for the appropriate tax year, stating the taxpayers’ intent to make an election under Section 16(d)(1) of AB 91.
  • On the top of each page of the original or amended tax return, write “AB 91 – Section 16 Election” in dark colored ink (e.g, blue or black).
  • Mail all “AB 91 – Section 16 Election” returns to:
 
Franchise Tax Board
P.O. Box 1570
Rancho Cordova, CA 95741-1570
 
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, A.B. 91 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.
 
Federal Deposit Insurance Corporation, or FDIC, Premiums
Starting with tax years beginning on or after January 1, 2019, the bill limits the amount banks may deduct for FDIC premiums paid by disallowing deductions entirely for depository banks with assets above $50 billion and limiting them for banks with assets between $10 and $50 billion by conforming to IRC Section 162(r).
 
Excess Employee Compensation
With respect to compensation in excess of $1 million, the bill revises the definitions of “covered employee” and “publicly held corporation” to limit the amount that may be deducted for ordinary and necessary expenses.  Additionally, the bill disallows the performance-based compensation and commission exceptions with respect to the deduction limitation relating to covered employees.  This part of A.B. 91 conforms to the TCJA provisions found in IRC Section 162(m).
 
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.
 
The Franchise Tax Board will provide the election forms, but until the form is available, the board has advised taxpayers to make the election by providing the following information:
 
  • Include a statement on an original or amended California tax return, for the appropriate tax year, stating the taxpayers’ intent to make a Small Business Accounting Election and which election(s) they are making.
  • On the top of each page of the original or amended tax return, write “AB 91 – Small Business Accounting Election” in blue ink.
  • Mail all “AB 91 – Small Business Accounting Election” returns to:
 
Franchise Tax Board
P.O. Box 942857
Sacramento, CA 95741-1570

Earned Income Tax Credit and Young Child Tax Credit
For tax years beginning after 2018, the bill raises the maximum income to $30,000.  It also raises the annual income re-computation floor for the consumer price index from 3.1 percent to 3.5 percent and revises the calculation factors to increase the credit amount for certain taxpayers.  Finally, it provides a refundable young child tax credit not to exceed $1,000 per each qualified taxpayer per taxable year.
 
Achieving a Better Life Experience, or ABLE, Accounts
Eliminates differences in qualification criteria for ABLE accounts between federal and California tax law to increase contribution limits to up to the federal poverty level and allow taxpayers to roll-over Section 529 plans to ABLE accounts.  The changes apply to taxable years beginning on or after December 31, 2017, and before December 31, 2026.
 
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).
 

BDO Insights

A.B. 91 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.

A.B. 91 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. 
 

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