A Detailed Comparison of California and Federal Tax Laws: Will California Conform?
Part II

By Chris Micheli and Gina Rodriquez

Editor's Note: Conformity is expected to be one of the significant tax issues before the Legislature this year. In the March issue, we began this two-part series on the subject. In this issue, we publish chapters VII through IX - Corporate Tax Law Differences, Personal Income Tax Law Differences, and Conclusion.

VII. Corporate Tax Law Differences

Following are the major nonconforming corporate tax law provisions and the likelihood of California conforming to the applicable federal law.

1. Federal law allows a deduction for foreign income taxes paid (IRC Sec. 164). California law specifically denies such a deduction (CRTC Sec. 24345). California probably will not conform to this provision.

2. Federal law allows a deduction for state, local and foreign income, war profits, and excess profits taxes paid (IRC Sec. 164). California law specifically denies such a deduction (CRTC Sec. 24345). California probably will not conform to this provision.

3. Federal law excludes from gross income interest received on federal obligations (for franchise taxpayers only) (IRC Sec. 61). California law provides that all interest received on federal obligations is to be included in net income (CRTC Sec. 24272). California probably will not conform to this provision.

4. Federal law excludes from gross income interest on bonds issued by state and local governments (IRC Sec. 103). California law provides that all interest received on state and local obligations is included in net income (CRTC Sec. 24272). California probably will not conform to this provision.

5. Federal law allows a carryback of capital losses in excess of capital gains in the current year (IRC Sec. 1212). California law does not allow capital loss carrybacks (CRTC Sec. 24990.5). California probably will not conform to this provision.

6. Federal law computes depreciation on assets acquired between 1981 and 1986 under the Accelerated Cost Recovery System (ACRS) and for those assets acquired after 1986 under a modified ACRS (IRC Secs. 167, 168 and 280F). California law essentially conforms to the pre-1981 federal method utilizing the mid-range of the Asset Depreciation Range (ADR) to determine the useful life of assets (CRTC Secs. 24349, 24349.1 and 24350-56). California may conform to these provisions.

7. Federal law allows special amortization deductions for pollution control facilities (IRC Sec. 169). California law allows these deductions with respect to property located in California only and certified by state agencies (CRTC Sec. 24372.3). California probably will not conform to this provision.

8. Federal law expenses certain tangible personal property to an aggregate limit of $18,000 to $25,000 over the next seven years, rather than depreciating it (IRC Sec. 179). California law partially conforms to federal law by increasing the limit to $15,000 (CRTC Sec. 24355). California may conform to this provision.

9. Federal law repeals the expensing deduction for clean-fuel vehicles and refueling property in 2004 (IRC Sec. 179A). California law conformed to federal law for assets purchased prior to 1994 (CRTC Sec. 24356.5). California probably will not conform to this provision.

10. Federal law amortizes up to $10,000 in forest land improvements over seven years (IRC Sec. 194). California law does not cap the amount of improvements and places the amortization period at five years (CRTC Sec. 24372.5). California probably will not conform to this provision.

11. Federal law amortizes certain expenditures for a child care facility between 1972 and 1981 (IRC Sec. 188). California law permanently conformed to the federal law, which has since expired (CRTC Sec. 24371.5). California may repeal this provision because it no longer exists at the federal level and the state provides a tax credit for such expenditures.

12. Federal law amortizes goodwill and certain other intangibles acquired after August 10, 1993 (IRC Sec. 197). California law conformed to federal law after 1994 (CRTC Secs. 24353, 24355, 24916, 24966.3, 24990.8 and 24990.9). Therefore, there is a gap in conformity prior to 1994. California probably will not conform to this provision.

13. Federal law depreciates property placed in service between January 1, 1994 and December 31, 2003 on Indian reservations under a special modified accelerated cost recovery system (ACRS) (IRC Sec. 168(j)). California law does not have a comparable provision. California may conform to this provision.

14. Federal law allows a deduction of expenditures for tertiary injectants, a third stage oil recovery process (IRC Sec. 193). California law requires these expenses to be capitalized and recovered through depreciation (CRTC Sec. 24349). California may conform to this provision.

15. Federal law includes non-cash patronage allocations in gross income in the year the allocation is received (IRC Sec. 1385). California law allows an election to be made for either the year received or the year in which they are redeemed (CRTC Sec. 24273.5). California probably will not conform to this provision.

16. Federal law does not subject bonds issued by the government of Poland to the rules for recharacterizing income and principal where the obligation has below market stated interest (IRC Sec. 7872). California law does not follow the federal treatment of these obligations (CRTC Sec. 24993). California may conform to this provision.

17. Federal law allows a reduction in taxable income for depositing part of a commercial fisherman's income into a fund to acquire or construct vessels (Merchant Marine Act Sec. 607(d)). California law does not have a comparable provision. California probably will not conform to this provision.

18. Federal law defers gain on the sale of publicly traded securities on or after August 10, 1995, rolled over into certain investment entities which will invest in small business investment companies (SBICs) (IRC Sec. 1044). California does not have a comparable provision. California may conform to this provision.

19. Federal law allows an exclusion from income for energy conservation subsidies received on rental residential property (IRC Sec. 136). California law partially conformed to this provision prior to 1995 (CRTC Sec. 24326). California may conform to this provision.

20. Federal law does not treat distributions as annuities on certain policies first as income, then as a nontaxable return of capital investment (IRC Sec. 72). California law considers these distributions that are not treated as an annuity first as a return of capital, then as previously untaxed earnings (CRTC Sec. 24302). California probably will not conform to this provision. Please note that under the California Personal Income Tax Law, there is conformity.

21. California law allows a credit for hiring certain residents in Enterprise Zones, the Los Angeles Revitalization Zone, and Local Area Military Base Recovery Areas (CRTC Secs. 23622, 23623, 23623.5 and 23625). Federal law does not have any comparable provisions. California probably will retain these provisions.

22. Federal law prohibits the deduction for dues paid to all types of clubs (IRC Sec. 274(a)). California law permits these dues to be deducted, except in cases where the club restricts membership on the basis of age, sex, religion, color, or natural origin (CRTC Sec. 24343.2). California probably will not conform to this provision.

23. California law denies a deduction for abandonment fees and recoupment fees for timberland preserves (CRTC Sec. 24441). Federal law is unclear whether such fees are deductible or not (IRC Sec. 161). California will probably retain this provision.

24. California law allows a credit for establishing and operating a child care program in this state (CRTC Sec. 23617.5). Federal law does not have a comparable provision. California will probably retain this provision.

25. California law restricts interest expense deductions for corporations subject to allocationand apportionment (CRTC Sec. 24344(b)). Federal law does not have a comparable provision. California will probably retain this provision.

26. Federal law requires large banks (more than $500 million in assets) to use the specific charge-off method for deducting bad debts, rather than the reserve method (IRC Secs. 585 and 593). California law treats all banks alike and does not provide for specific rules for large banks (CRTC Sec. 24348). California probably will not conform to this provision.

27. Federal law allows a three-year carryback of net operating losses (NOL) (IRC Sec. 172). California law does not allow NOLs to be carried back (CRTC Sec. 24416). California probably will not conform to this provision.

28. Federal law allows a 15-year carryforward of net operating losses (IRC Sec. 172). California law permits only a 50 percent carryforward for five years, except in certain limited circumstances (CRTC Sec. 24426). California may conform to this provision.

29. California law allows certain businesses operating in Enterprise Zones, the Los Angeles Revitalization Zone or Local Area Military Base Recovery Areas to elect to use special rules to calculate the amount of their NOLs (CRTC Secs. 24416.1 and 24416.2). Federal law does not have any comparable provisions. California will probably retain these provisions.

30. Federal law allows taxpayers to deduct disaster losses in a manner similar to the federal treatment of NOLs (IRC Secs. 165 and 172). California law identifies specific disasters for certain loss treatment (CRTC Sec. 24347.5). California probably will not conform to these provisions.

31. Federal law allows the nonrecognition of gains on the sale or exchange of certain vessels (IRC Sec. 1061). California law requires the full gain to be included in gross income because there is not a comparable provision. California probably will not conform to this provision.

32. Federal law defers dividends between affiliated corporations which file consolidated returns (IRC Secs. 243-247 and 1501). California law eliminates intercompany dividends from income to the extent they are paid out of unitary income (CRTC Sec. 25106). California probably will not conform to this provision.

33. Federal law includes in the measured tax certain deductible dividends (IRC Secs. 243-247). California law excludes from income a portion of certain dividends received after 1989 (CRTC Sec. 24402). California probably will not conform to this provision.

34. Federal law allows normal deductible dividend rules for dividends received from an insurance company subsidiary (IRC Secs. 243-247). California probably will retain this provision. California law permits state corporations to deduct dividends received from certain insurance company subsidiaries in California (CRTC Sec. 24410).

35. California law allows employers a business expense deduction for specific benefits paid relating to employee ridesharing (CRTC Sec. 24343.5). Federal law does not have a comparable provision. California will probably retain this provision.

36. Federal law denies a deduction for expenses relating to production of income which is exempt from federal tax (IRC Sec. 265). California law denies a deduction for expenses relating to production of income which is exempt from California tax (CRTC Sec. 24425). California probably will not conform to this provision.

37. California law defers the gain on the sale of qualified low-income housing projects (CRTC Sec. 24955). Federal law does not have a comparable provision. California will probably retain this provision.

38. California law excludes from income amounts received from a recycling center for recycling empty beverage containers (CRTC Sec. 24315). Federal law does not have a comparable provision. California will probably retain this provision.

39. Federal law denies a deduction for expenses of advertising in a convention program of a political party or for admission to political fundraising functions (IRC Sec. 276). California law does not have a comparable provision. California may conform to this provision.

40. Federal law includes that state income tax refunds in gross income in the year received (IRC Secs. 61 and 111). California law excludes these refunds from gross income (CRTC Sec. 24345). California probably will not conform to this provision.

41. Federal law requires that the following credits be reduced by the amount of the federal credit: research, disabled access and Indian employment (IRC Secs. 44, 45A and 280C). California law does not require reduction in expenses with respect to federal credit. However, such expenses must be reduced by the amount of any California credit (CRTC Secs. 23622, 23623 and 24440). California probably will not conform to these provisions.

42. Federal law includes water conservation rebates in gross income (IRC Sec. 61). California law provides an exclusion from income for amounts received as rebates from a local water agency or supplier for installing certain conservation items (CRTC Secs. 24323). California probably will not conform to this provision.

43. Federal law allows a deduction for certain cost-sharing payments for forest landowners (IRC Sec. 126). California law allows taxpayers to exclude from income all cost-share payments received (CRTC Sec. 24308.5). California probably will not conform to this provision.

44. Federal law denies a deduction for lobbying expenditures (IRC Secs. 163, 170(f) and 6033). California law allows these expenses to be deducted (CRTC Sec. 24343). California probably will not conform to this provision.

45. Federal law does not have an adjusted current earnings (ACE) adjustment for depreciation (IRC Sec. 56). California law (CRTC Sec. 23456) does not have a comparable provision. California may require this adjustment.

46. Federal law provides an eligible small business with a 50 percent nonrefundable tax credit for expenses in making the business accessible to disabled individuals (IRC Sec. 44). California law allows a similar credit beginning in 1996 based on only the first $250 in expenses (CRTC Sec. 23642). California probably will not increase the eligible expenses threshold.

47. Federal law provides that the basis of enhanced recovery oil projects must be reduced by the amount of the credit (IRC Sec. 43(d)). California law applies the federal credit, but only for California projects and denies it to certain refiners and retailers (CRTC Sec. 23604). California probably will not modify its credit.

VIII. Personal Income Tax Law Differences

Following are the major nonconforming personal income tax law provisions and the likelihood of California conforming to the applicable federal law.

1. Federal law allows shareholders in mutual funds to exclude exempt interest dividends from gross income if they represent nontaxable interest (IRC Sec. 852). California law applies the exclusion to interest that is exempt under state law (CRTC Sec. 17145). California may conform to this provision.

2. Federal law requires interest earned on federal bonds to be included in gross income in the year earned (IRC Sec. 61). Only interest earned on certain bonds is taxed by California if they are not obligations of the federal government (CRTC Sec. 17143). California probably will not conform to this provision.

3. Federal law excludes from gross income interest on bonds issued by state and local governments (IRC Sec. 103). California law provides that all interest received on state and local obligations is included in net income (CRTC Sec. 17133). California probably will not conform to this provision.

4. Federal law allows a reduction in taxable income for depositing part of a commercial fisherman's income into a fund to acquire or construct vessels (Merchant Marine Act Sec. 607(d)). California law does not have a comparable provision (CRTC Secs. 17137 and 18040). California probably will not conform to this provision.

5. Federal law does not subject bonds issued by the government of Poland to the rules for recharacterizing income and principal where the obligation has below-market-stated interest (IRC Sec. 7872). California law does not follow the federal treatment of these obligations (CRTC Sec. 18180). California may conform to this provision.

6. Federal law includes non-cash patronage allocations in gross income in the year the allocation is received (IRC Sec. 1385). California law allows an election to be made for either the year received or the year in which they are redeemed (CRTC Sec. 17086). California probably will not conform to this provision.

7. Federal law requires state income tax refunds to be included in the gross income in the year received (IRC Secs. 61 and 111). California law excludes these refunds from gross income (CRTC Sec. 17142). California probably will not conform to this provision.

8. California law allowed the Accelerated Cost Recovery System (ACRS) for certain residential rental property constructed in this state between July 1, 1985 and December 31, 1986 (CRTC Sec. 17250). Federal law allowed ACRS for any tangible personal property (IRC Sec. 168). California probably will not conform to this provision.

9. Federal law allows a deduction of expenditures for tertiary injectants, a third stage oil recovery process (IRC Sec. 193). California law requires these expenses to be capitalized and recovered through depreciation (CRTC Sec. 17260). California may conform to this provision.

10. Federal law expenses certain tangible personal property to an aggregate limit of $18,000 to $25,000 over the next seven years, rather than depreciating it (IRC Sec. 179). California law partially conforms to federal law by increasing the limit to $15,000 (CRTC Sec. 17255). California may conform to this provision.

11. Federal law repeals the expensing deduction for clean-fuel vehicles and refueling property in 2004 (IRC Sec. 179A). California law conformed to federal law for assets purchased prior to 1994 (CRTC Sec. 17256). California probably will not conform to this provision.

12. Federal law requires that the research credit be reduced by the amount of the federal credit (IRC Sec. 280C). California law does not require reduction in expenses with respect to the federal credit. However, such expenses must be reduced by the amount of the California credit (CRTC Sec. 17270). California probably will not conform to these provisions.

13. Federal law provides an eligible small business with a 50 percent nonrefundable tax credit for expenses in making the business accessible to disabled individuals (IRC Sec. 44). California law allows a similar credit beginning in 1996 based on only the first $250 in expenses (CRTC Sec. 17053.42). California probably will not increase the eligible expenses threshold.

14. Federal law establishes a nonrefundable tax credit for certain wages and health insurance costs paid by the employer for certain Indian tribe members (IRC Sec. 45A). California law does not have a comparable provision. California probably will not conform to this provision.

15. Federal law provides that the basis of enhanced recovery oil projects must be reduced by the amount of the credit (IRC Sec. 43(d)). California law applies the federal credit, but only for California projects and denies it to certain refiners and retailers (CRTC Sec. 17052.8). California probably will not modify its credit.

16. Federal law prohibits the deduction for dues paid to all types of clubs (IRC Sec. 274(a)). California law permits these fees to be deducted, except in cases where the club restricts membership on the basis of age, sex, religion, color, or natural origin (CRTC Sec. 17269.2). California probably will not conform to this provision.

17. Federal law denies a deduction for lobbying expenditures (IRC Secs. 163, 170(f) and 6033). California law allows these expenses to be deducted (CRTC Sec. 17201). California probably will not conform to this provision.

18. Federal law depreciates property placed in service between January 1, 1994 and December 31, 2003 on Indian reservations under a special modified accelerated cost recovery system (ACRS) (IRC Sec. 168(j)). California law does not have a comparable provision. California may conform to this provision.

19. Federal law amortizes goodwill and certain other intangibles acquired after August 10, 1993 (IRC Sec. 197). California law conformed to federal law after 1994 (CRTC Secs. 17201 and 17279). Therefore, there is a gap in conformity prior to 1994. California probably will not conform to this provision.

20. Federal law allows special amortization deductions for pollution control facilities (IRC Sec. 169). California law allows these deductions with respect to property located in California only that has been certified by state agencies (CRTC Sec. 17550(c)). California probably will not conform to this provision.

21. Federal law denies a deduction for expenses of advertising in a convention program of a political party or for admission to political fund-raising functions (IRC Sec. 276). California law does not have a comparable provision (CRTC Sec. 17283). California may conform to this provision.

22. Federal law includes water conservation rebates in a taxpayer's gross income (IRC Sec. 61). California law provides an exclusion from income for amounts received as rebates from a local water agency or supplier for installing certain conservation items (CRTC Sec. 17138).

23. Federal law allows an exclusion from income for energy conservation subsidies received on rental residential property (IRC Sec. 136). California law partially conformed to this provision prior to 1995 (CRTC Sec. 17139). California may conform to this provision.

24. Federal law allows a deduction for certain cost-sharing payment for forest landowners (IRC Sec. 126). California law allows taxpayers to exclude from income all cost-sharing payments received (CRTC Sec. 17135.5). California probably will not conform to this provision.

25. California law denies a deduction for abandonment fees and recoupment fees for timberland preserves (CRTC Sec. 17275). Federal law is unclear whether such fees are deductible or not (IRC Sec. 161). California will probably retain this provision.

26. Federal law exempts taxpayers who materially participate in rental real estate activities from the limitations on the deduction of passive activity losses (IRC Sec. 469). California law does not have a comparable provision (CRTC Sec. 17551). California may conform to this provision.

27. Federal law increases the recovery period for nonresidential rental property for property placed in service on or after May 13, 1993 (IRC Sec. 168). California law conformed to federal law by extending the recovery period for depreciation of non-residential real property to 39 years beginning January 1, 1997 (CRTC Sec. 17250). Hence, there is a lack of conformity between 1993 to 1996.

28. Federal law provides that the basis of inherited property is determined as of the date of death of the decedent (IRC Sec. 1014). California law provides that, for property inherited on or after January 1, 1987, the basis shall be the same as the federal basis (CRTC Sec. 18031). California probably will not conform to this provision.

29. Federal law requires certain undistributed capital gains to be included in the gross income of the mutual fund shareholder ("RIC shareholder") and allows a tax credit for the gains tax paid by the investment company (IRC Sec. 852). California law excludes the undistributed capital gains from gross income, and does not allow a tax credit (CRTC Sec. 17088). California probably will not conform to the provision.

30. California law allows the nonrecognition of gain upon the sale of an assisted low-income housing development (CRTC Sec. 18041.5). Federal law does not have a comparable provision. California will probably retain this provision.

31. Federal law defers gain on the sale of publicly traded securities on or after August 10, 1995, rolled over into certain investment entities which will invest in small business investment companies (IRC Sec. 1044). California does not have a comparable provision and taxes the gain from the sale of the securities (CRTC Sec. 18031). California law may conform to this provision.

32. Federal law allows the nonrecognition of gains on the sale or exchange of certain vessels (IRC Sec. 1061). California law requires the full gain to be included in gross income because there is not a comparable provision (CRTC Sec. 18040). California probably will not conform to this provision.

33. Federal law requires payments from individual retirement accounts to be included in gross income (IRC Sec. 408). California law conforms to federal law but, prior to 1987, the contributions were not deductible so the pre-1987 basis may be recovered by reducing the amount taxable for federal purposes (CRTC Secs. 17085 and 17507). California probably will not conform further to this provision.

34. Federal law allows an exclusion from gross income for a portion of railroad retirement benefits (in the same manner as Social Security benefits), and requires sick pay to be included in gross income (IRC Secs. 72, 86 and 105). California law provides a specific exclusion from income for the full amount of railroad retirement and sick pay benefits (CRTC Sec. 17087). California probably will not conform to this provision.

35. Federal law contains various rules relating to the inclusion of pensions and annuities in gross income (IRC Sec. 72). Due to past periods of nonconformity, California law may require different gross income amounts (CRTC Sec. 17085). California may conform to these provisions.

36. Federal law treats certain controlled foreign corporations as pass-through entities (IRC Sec. 951). California law continues to treat such corporations as any other corporation. California probably will not conform to this provision.

37. Federal law allows separate elections by S corporations so that undistributed income is included in the gross income of the shareholders (IRC Sec. 1362). California law allows the S corporation to elect to be treated as a C corporation, in which case the undistributed income included in the shareholder's federal adjusted gross income must be subtracted in order to compute California adjusted gross income (CRTC Sec. 17087.5). California probably will not conform to this provision.

38. Federal law allows undistributed losses from an S corporation to be deducted from the gross income of its shareholders (IRC Sec. 1362). California law denies a deduction from gross income where an S corporation elects to be treated as a C corporation (CRTC Sec. 17087.5). California may conform to these provisions.

39. Federal law requires unemployment compensation be included in gross income in the year received (IRC Sec. 85). California law provides a specific exclusion for the full amount of such compensation (CRTC Sec. 17083). California probably will not conform to this provision.

40. Federal law requires one-half of Social Security benefits be included in gross income for individuals who have income in excess of a certain threshold amount (IRC Sec. 86). California law provides a specific exclusion for the full amount of these benefits received (CRTC Sec. 17087). California probably will not conform to this provision.

41. Federal law requires all lottery and gaming winnings to be included in gross income (IRC Sec. 61). California law provides an exclusion from gross income for California lottery winnings (Cal. Govt. Code Sec. 8880.68). California probably will not conform to this provision.

42. Federal law allows a three-year carryback of net operating losses (NOL) (IRC Sec. 172). California law does not allow NOLs to be carried back (CRTC Sec. 17276). California probably will not conform to this provision.

43. Federal law allows a 15-year carryforward of net operating losses (IRC Sec. 172). California law permits only a 50 percent carryforward for five years, except in certain limited circumstances (CRTC Sec. 17276). California may conform to this provision.

44. California law allows certain businesses operating in Enterprise Zones, the Los Angeles Revitalization Zone or Local Area Military Base Recovery Areas to elect to use special rules to calculate the amount of their NOLs (CRTC Secs. 17276.1, 17276.2 and 17276.3). Federal law does not have any comparable provisions. California law will probably retain these provisions.

45. Federal law allows taxpayers to deduct disaster losses in a manner similar to the federal treatment of NOLs (IRC Secs. 165 and 172). California law identifies specific disasters for certain loss treatment (CRTC Sec. 17207). California probably will not conform to these provisions.

46. California law excludes from income amounts received from a recycling center for recycling empty beverage containers (CRTC Sec. 17153.5). Federal law does not have a comparable provision. California will probably retain this provision.

47. California law excludes from income the value of benefits provided by an employer for participation in certain ridesharing activities (CRTC Sec. 17149). Federal law only allows an exclusion from gross income of de minimis fringe benefits (IRC Sec. 132). California will probably retain this provision.

48. Federal law provides special rules relating to nonresident aliens (IRC Secs. 871-879). California law treats nonresident aliens in the same manner as any other person (CRTC Sec. 17024.5). California probably will not conform to these provisions.

49. Federal law excludes from income certain foreign-earned income and employer-provided housing allowances (IRC Sec. 911). California law has no comparable provision (CRTC Sec. 17024.5). California probably will not conform to this provision.

50. Federal law provides that gross income shall reflect the provisions of any treaties entered into by the United States (IRC Sec. 894). California is not affected by U.S. treaties with foreign countries unless the treaty specifically applies to state income taxes. California probably will not conform to this provision.

51. California law excludes from gross income any income which is received as a reward from a crime hotline (CRTC Sec. 17147.7). Federal law includes all income which is not specifically excluded from income (IRC Sec. 61). California probably will retain this provision.

52. Federal law increases the deduction for health insurance costs of self-employed individuals from the current 30 percent to 40 percent in 1997, to 45 percent in 1998, to 50 percent in 2003, to 60 percent in 2004, to 70 percent in 2005, and to 80 percent in 2006 (IRC Sec. 162). California law only allows a deduction of 25 percent for health insurance costs incurred by self-employed individuals (CRTC Sec. 17273). California may conform to this provision.

53. Federal law allows a deduction for state, local and foreign income, war profits, and excess profits taxes paid (IRC Sec. 164). California law specifically denies such a deduction (CRTC Sec. 17220). California probably will not conform to this provision.

54. Federal law provides special rules for state legislators' travel expenses away from home (IRC Sec. 162). California law treats legislators' travel expenses differently without regard to distance traveled (CRTC Sec. 17270). California probably will not conform to this provision.

55. Federal law requires the mortgage interest expense to be reduced by the amount of the federal mortgage interest credit received (IRC Sec. 163). California law does not have a mortgage interest credit and does not require such a reduction. Therefore, the California deduction may be greater than that allowed on the federal return. California probably will not conform to this provision.

56. Federal law denies a deduction for expenses relating to production of income which is exempt from federal tax (IRC Sec. 265). California law denies a deduction for expenses relating to production of income which is exempt from California tax (CRTC Sec. 17280). California probably will not conform to this provision.

57. Federal law established an adoption tax credit effective January 1, 1997. Federal law also allows certain adoption-related employer assistance to be excluded from income (IRC Secs. 23, 137 and 138). California law allows a tax credit equal to 50 percent of the cost of adopting a minor child (the maximum allowable credit is $2,500 per minor child) (CRTC Sec. 17052.25). California probably will not conform to this provision.

58. Federal law requires interest earned on federal bonds to be included in gross income in the year earned (IRC Sec. 61). California law provides that all interest received on federal obligations is to be included in net income (CRTC Sec. 17133). California probably will not conform to this provision.

59. Federal law allows a carryback of capital losses in excess of capital gains in the current year (IRC Sec. 1212). California law does not allow capital loss carrybacks (CRTC Sec. 18155). California probably will not conform to this provision.

60. Federal law computes depreciation on assets acquired between 1981 and 1986 under the Accelerated Cost Recovery System (ACRS) and for those assets acquired after 1986 under a modified ACRS (IRC Secs. 167, 168 and 280F). California law essentially conformed to the modified ACRS for assets placed in service after January 1, 1987 (CRTC Secs. 17250, et al.). California may conform to these provisions.

61. Federal law amortizes up to $10,000 in forest land improvements over seven years (IRC Sec. 194). California law does not cap the amount of improvements and places the amortization period at five years (CRTC Sec. 17201). California probably will not conform to this provision.

62. Federal law taxes amounts paid under an annuity contract, but excludes amounts representing a return of capital from income (IRC Sec. 72). California law generally follows federal law, but if the annuity starting date was after July 1, 1986, and before January 1, 1987, and the "three-year recovery rule" was elected for California, there will be a difference between California and federal income (CRTC Secs. 17081, 17085 and 17131). California probably will not conform to this provision.

63. California law allows a credit for hiring certain residents in Enterprise Zones, the Los Angeles Revitalization Zone, and Local Area Military Base Recovery Areas (CRTC Secs. 17053.8, 17053.10, 17053.17, and 17053.46). Federal law does not have any comparable provisions. California probably will retain these provisions.

64. Federal law does not have an adjusted current earnings adjustment for depreciation for property placed in service after 1993 (IRC Sec. 56). California law still requires this adjustment (CRTC Sec. 17062). California may conform to this provision.

IX. Conclusion

While it is highly unlikely that California will conform to all federal tax law provisions, it is reasonable to expect that the 1997-98 legislative session will produce several selective conformity changes. Legislative staff have been reviewing with interested parties all federal tax law provisions to which California does not conform.

There appears to be a desire to pursue an omnibus federal conformity measure in 1997. However, it is interesting to note that the following federal conformity items were considered, but not adopted (from the 1993 federal acts). It is unlikely that they will be adopted by California because there is little support for them among the business community and legislators:

• Denying the deduction for lobbying expenses;
• Denying the deduction for club dues; and
• Denying the deduction for certain executive compensation.

Finally, the Small Business Job Protection Act of 1996, as well as the Health Insurance Portability and Accountability Act of 1996, are ripe areas for conformity and are being addressed in SB 455 (Alpert) and in AB 1044 (Caldera). The area of Subchapter S corporations, with 16 new federal law changes, is currently being addressed in SB 5 (Lockyer), AB 203 (Takasugi), and AB 1039 (Caldera), which are intended to conform California law to certain S corporation provisions. Legislative leaders have indicated that they will focus their 1997 efforts on tax law changes that affect personal income taxpayers.

Chris Micheli

Gina Rodriguez

Mr. Micheli is an attorney and legislative advocate for the Sacramento governmental relations firm of Carpenter Snodgrass & Associates. Ms. Rodriquez is an enrolled agent and serves as the Sacramento editor for Spidell Publishing, Inc. The authors thank John Pavalasky of the Franchise Tax Board for his assistance with compiling the list of federal conformity items.