State & Local Tax Update: California Selectively Conforms to Federal Tax Reform

California Gov. Gavin Newsom recently signed Assembly Bill 91 into law, selectively conforming to provisions of the federal Tax Cuts and Jobs Act, also known as tax reform. As part of this response to tax reform, California left its static conformity date as Jan. 1, 2015, but the state identified specific sections to follow for California purposes. In some instances, an election can be made impacting the 2018 tax year.

Business Loss Limitation (IRC § 461)

• California will follow the federal limitation for excess business losses for taxable years beginning after Dec. 31, 2018. Unlike the federal limitation, the California limitation does not expire at the end of the 2026 tax year.
• Any disallowed excess business loss does not become a California net operating loss (NOL) carryover but is a carryover excess business loss to future years.
• Individuals will have to separately track 461 losses and carryovers for California purposes.
• California did not address how long the carryover excess business loss can be carried forward.

Net Operating Loss (IRC § 172)

• Losses incurred in taxable years beginning after Dec. 31, 2018, cannot be carried back. The losses can be carried forward for 20 years.
• Presumably, California will not follow the federal 80% limitation since the state NOL is not calculated off the federal.

Accounting Methods

• For taxable years beginning after Dec. 31, 2018, California follows the changes in federal rules regarding accounting methods related to farming corporations, suspense accounts, cash method of accounting, capitalization and inclusion of inventory cost of certain expenses under 263A, and inventories.
• California will follow the change to who is exempt from using the percentage complete accounting method for long-term contracts.
• California will follow any federal election to change accounting methods for tax years beginning on or after Dec. 31, 2018.
• A.B. 91 also allows taxpayers to elect to have these changes apply to tax years beginning on or after Jan. 1, 2018, and before Jan. 1, 2019. The Franchise Tax Board (FTB) will provide the election forms, but until formal procedures have been adopted and communicated, taxpayers may make the election by providing all of the following information to the FTB:
  • Include a statement with their original or amended California tax return, for the appropriate tax year, stating the taxpayer’s intent to make a small business accounting election and which election(s) they are making.
  • On the top of the first 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
    PO Box 942857
    Sacramento, CA 94257-0500

Technical Terminations (IRC § 708)

• For taxable years beginning after Dec. 31, 2018, California will follow the federal repeal of technical terminations when there is a change in ownership of greater than 50%.
• A.B. 91 provides an election to apply the Internal Revenue Code Section 708 amendment for California tax purposes prior to Jan. 1, 2019.  The FTB will provide the election forms, but until formal procedures have been adopted and communicated, taxpayers may make the election by providing all of the following information to the FTB:
  • Include a statement with their original or amended California tax return, for the appropriate tax year, stating the taxpayer’s intent to make an election under Section16(d)(1) of AB 91.
  • On the top of each page of the original or amended tax return, write “AB 91 – Section 16 election”.
  • Mail all “AB 91 – Section 16 election” returns* to:
    Franchise Tax Board
    PO Box 942857
    Sacramento, CA 94257-0500

Like-Kind Exchanges (IRC § 1031)

• For exchanges fully completed after Jan. 10, 2019, California will follow the federal treatment that personal property exchanges no longer qualify for income deferral.
  • The provisions do not apply to an exchange where the property to be disposed of by the taxpayer in the exchange is disposed of on or before Jan. 10, 2019, or where the property to be received by the taxpayer in the exchange is received by the taxpayer on or before Jan. 10, 2019.
• California only follows the federal rule for individual taxpayers whose adjusted gross income for the taxable year during which the exchange occurs exceeds $250,000 (single) or $500,000 (married-filing-jointly).

Section 338(h)(10) Election

• For transactions on or after July 1, 2019, California will follow the federal election made under Internal Revenue Code 338(h)(10). Taxpayers will no longer have the option to make a separate state election.
• If the transaction is subject to a contract which is executed prior to July 1, 2019, then the taxpayer can make a separate state election.

*Note: You must paper-file these returns.