How Will California React to Tax Reform?


This article is reproduced with permission from Spidell Publishing, Inc.

California will not automatically conform to most of the federal changes in the tax reform. It will take California legislation to conform to most of the federal changes, and it is highly likely that we will not see full conformity.

Excluding rate reductions, it seems most of the individual changes will increase federal taxable income, while business changes will decrease net income. A pessimist may say California will conform to the individual changes, but not the business changes. The following are the most talked about changes that will create new adjustments on the California return.

Individual changes
Most of these changes will increase federal taxable income:

  • Principal residence:
    • Reduction or elimination of property tax deduction;
    • Reduction of mortgage interest limit; and
    • Under the House bill, elimination of deduction for interest on a second home.
  • Other Schedule A deductions eliminated:
    • Medical expenses (House version only);
    • Federal increase to 60% adjusted gross income for charitable contribution deduction;
    • Casualty losses not deductible (disaster losses still deductible); and
    • Miscellaneous itemized deductions, specifically tax preparation fees and unreimbursed employee business expenses.
  • Moving expenses: not deductible, other than for military personnel.

Business and investment changes
There are some of the major changes that will impact our business clients:

  • Internal Revenue Code (IRC) Section 1031 exchange treatment only available for exchange of real property: While California would still allow IRC Section 1031 treatment, this change would effectively eliminate exchange of nonreal property, such as artwork and tangible personal property;
  • Increase bonus depreciation to 100% (California does not allow bonus depreciation);
  • Disallow entertainment expenses except for meals;
  • No longer allows transportation fringe or commuting benefit deductions;
  • Limits net operating loss to 90%.

What will the California Franchise Tax Board (FTB) do?
Absent conformity, California taxpayers will be more likely to itemize deductions for California than for federal purposes, and the federal Schedule A will have major changes. FTB may create their own Schedule A and certainly Publication 1001, Supplemental Guidelines to California Adjustments, will be pages longer.

For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).

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