Federal Tax Conformity Will Come Late, If at All, in California

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By Laura Mahoney

Bills to conform California law to sweeping changes in the new federal tax act won’t emerge until late in the 2018 session if they do at all, the chair of the Senate tax committee said.

Lawmakers won’t have their first estimates on the revenue impacts of the federal tax act until at least April, when the Franchise Tax Board must provide a report to them. Sen. Mike McGuire (D), chair of the Senate Governance and Finance Committee, said Jan. 10 that lawmakers will also want to hear from those who are affected by the changes before deciding whether to conform to specific provisions.

“There are going to be a thousand opinions on each of the ways the state could potentially conform with the federal tax bill,” McGuire said during an informational hearing. “This will become more of a sprint if we take this up rather than a marathon here in 2018 if a conformity bill will move forward.”

SALT Cap, Repatriation

McGuire said lawmakers are having initial conversations about conformity, and at least six bills could emerge to respond to the federal tax act ( Pub. L. No. 115-97), signed by President Donald Trump Dec. 22. Some of those bills may go in the opposite direction and attempt to get around the federal law, such as S.B. 227 by Senate President Pro Tempore Kevin De Leon (D).

The bill would allow individuals to make charitable contributions to the state to satisfy personal income tax liabilities and get around a new $10,000 cap on federal deductions for property taxes, and state and local income or sales taxes. The committee approved S.B. 227 Jan. 10 and it will be heard in the Senate Appropriations Committee Jan. 16.

Senate Republican Leader Patricia Bates is proposing to use an expected windfall from repatriated foreign income to fund state transportation projects. She said Jan. 10 she will introduce a new bill that is similar to S.B. 337, a 2017 bill she authored that didn’t pass. Bates is offering her bill as voters may be asked in November to repeal a gas tax increase enacted in 2017 to fund transportation infrastructure.

Two-Thirds Vote

The California Legislature’s two-thirds vote requirement for bills that would increase taxes on even one individual will complicate the already difficult task of deciding whether to conform to sweeping federal changes, FTB officials told the committee.

California automatically conforms to federal tax law only with regard to retirement sections of the Internal Revenue Code and real estate investment trusts. All other provisions require legislation to conform, and California typically lags several years. The last federal conformity bill was enacted in 2015.

In 2010, voters approved Proposition 26 to apply a two-thirds vote requirement for bills that increase taxes on any individual. Before Proposition 26, lawmakers could package revenue raisers and cuts in one bill as long as the overall measure was revenue neutral.

Bruce Langston, chief of the FTB Technical Services Bureau, said Proposition 26 will make conformity more difficult than it was after the last major federal tax overhaul in 1986. Then, California took a few years to conform on specific items.

“It’s quite possible that we will have a year or two where we have a pretty complex California return,” Langston told the committee.

Time Lag

A time lag in data from tax returns filed under the 2017 tax act, and unknown behavioral responses from individuals and corporations make revenue estimates that would frame the Legislature’s decisions in 2018 even more difficult, said Allen Prohofsky, with the FTB Economic and Statistical Research Bureau.

The FTB won’t know until the end of 2019 what actual revenue will be from 2018 personal income tax filers, and won’t know until the end of 2020 about revenue from 2018 corporate income tax filers, he said.

He said it’s difficult to predict the ripple effects on revenue from sometimes competing provisions, such as a lower corporate income tax rate and a new deduction for pass-through entities, and repatriation of foreign corporate income under California’s water’s edge election scheme for apportionment purposes.

Feb. 16 is the deadline for lawmakers to introduce new bills for 2018, although they can amend bills throughout the session to contain conformity items if necessary. The session ends Aug. 31.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., at lmahoney@bloomberglaw.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

For More Information

More information about the bills is at http://src.bna.com/vBd.

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