This article is from Cal-Tax Digest, published
by the California Taxpayers' Association.
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As part of the 1998-99 California state budget compromise, the Legislature passed significant tax relief for individuals and businesses, a package of three bills that includes major conformity to federal tax law.

One bill, SB 27 (Maddy), contains $40 million annually in license fee relief for California's horseracing industry. The other two bills, AB 2797 (Cardoza) and AB 2798 (Machado), contain a number of significant tax cuts, several of which are important to the business community.

Among other provisions, AB 2797 enacts state conformity to selected parts of federal tax laws in the Taxpayer Relief Act of 1997 (81 provisions), Balanced Budget Act of 1997 (two provisions), and Omnibus Budget Reconciliation Act of 1993 (one provision). In addition, SB 1383 (Leslie) partially conforms California law to the federal Taxpayer Browsing Protection Act of 1997.

As a result of the enactment of AB 2797, California's specified date of conformity to the Internal Revenue Code (IRC) has now been changed to January 1, 1998. It should also be noted that this new law retroactively conforms state law to the federal provisions relating to employee stock ownership plans for the 1995 tax year.

There was a late bump in the 1998 road toward conformity. As requested by the business taxpayer community, Governor Pete Wilson vetoed AB 1469 (Ortiz) on September 30. That bill would have enacted the Taxpayer's Bill of Rights Act of 1998 by providing several taxpayer-friendly procedures. It sought to conform to these four provisions of the IRS Restructuring and Reform Act of 1998: innocent spouse relief; suspension of statute of limitations on certain refund claims; changes for calculating the exclusion for gain on sales of principal residence, and Roth IRA rollovers changes.

(Editor's Note: Governor Wilson, in his veto message, said he rejected AB 1469 because of a late amendment unrelated to conformity that would have altered the water's-edge determination for multinational corporations. He said this amendment had "the potential to result in a tax increase." The governor said he otherwise would have signed the bill, and he urged the Legislature "to move swiftly (in 1999) to enact the Taxpayer Bill of Rights, and to fully evaluate and debate the water's-edge provision." Meanwhile, the Franchise Tax Board on October 26 issued a ruling to administratively conform to the federal Roth IRA rollovers law. FTB lawyers determined that this item of conformity did not require an act of the Legislature.)

Prior Conformity Efforts
Earlier in 1998, the Legislature and Governor Wilson enacted SB 519 (Lockyer), a measure that provides retroactive conformity to selected provisions of federal tax law. It also makes a number of technical corrections to 1997's billion-dollar tax cut "mega-deal."

As SB 519 was signed into law prior to March 15, 1998 (the due date for corporate tax returns), selected conformity provisions were made retroactive to January 1, 1997, consistent with the federal Taxpayer Relief Act of 1997. With the recent enactment of AB 2797, California has now conformed to most of the 1997 federal act.

In 1997, the Legislature enacted a bill that conformed California law to a majority of the federal provisions enacted in 1993 through 1996. Also, in 1996, the Legislature enacted SB 38 (Lockyer and Pringle), which contained a number of conformity provisions.

From the enactment of the federal Omnibus Budget Reconciliation Act (OBRA) of 1993 until 1996, the California Legislature struggled to conform state tax law to those changes in the IRC. After Congress' overhaul of the IRC in 1986, and the subsequent enactment of several federal tax reform acts, California has generally followed with a conformity measure in the year immediately following the year in which the federal law was enacted. This was usually done by urgency legislation, so that the changes were effective simultaneously with the new federal provisions.

For example, in 1987, a state law was passed to conform California tax law to reforms made by Congress in 1986. That was the normal course of events until 1993. In 1993, Congress enacted President Clinton's budget plan, which passed both Houses of Congress without a single Republican vote.

This fact, coupled with the large number of revenue-raising tax changes, caused Republicans in the California Legislature to reject most attempts to conform to the OBRA of 1993. That position finally changed in 1996 and SB 38 was approved with a number of important conformity provisions.

Conformity provisions in AB 2797 include: elimination of adjusted current earnings (ACE) adjustment for alternative minimum tax; Medicare Plus Choice distributions; deduction for student loan interest; qualified state tuition programs; contributions of computer equipment to schools; cancellation of certain student loans;

Repeal of alternative minimum tax depreciation adjustment; repeal of throwback rules; home office deduction qualifications, and expensing of environmental remediation costs.

Major Items of Nonconformity
California has not conformed to a number of federal tax law provisions. The following is a sampling of federal provisions without corresponding state tax law provisions: They include: reduced tax rate on capital gains; denial of the deduction of lobbying expenses; denial of the deduction for compensation of certain employees in excess of $1 million; denial of the dependent exemption for failing to provide a proper taxpayer identification number; denial of the reserve method for bad debts for thrift savings associations, and deduction for self-employed health insurance.

While 1998 represents another important year for California's conformity to provisions of the Internal Revenue Code, recent enactment of the federal IRS Restructuring and Reform Act of 1998, as well as the Tax and Trade Relief Extensions Act of 1998, means California must pursue another omnibus conformity measure during the 1999 legislative session.

Besides seeking urgency enactment of taxpayer-friendly provisions that were vetoed in AB 1469, the Legislature is likely to turn to preliminary work of the "conformity working group" - legislative staff and representatives of interested parties - as it prepares legislation for action in 1999.

Gina Rodriquez

Chris Micheli

Gina Rodriquez is an enrolled agent and the Sacramento editor for Spidell Publishing, Inc. (530/676-0662). Chris Micheli is an attorney and registered lobbyist for Carpenter Snodgrass & Associates in Sacramento (916/447-2251). These tax specialists authored a comprehensive comparison of California and federal tax laws that ran in the March and April 1997 issues of Cal-Tax Digest. They reported on 1997 conformity legislation in the December 1997 issue.