While everyone is talking about the changes to federal tax law, what about California? California conforms to certain provisions of the Internal Revenue Code (IRC), and its most recent conformity date is January 1, 2015. After the enactment of the Tax Cuts and Jobs Act (TCJA), what are some of the differences between federal law and California law?
2% Miscellaneous Itemized Deductions
New federal law has eliminated miscellaneous itemized deductions. The most common miscellaneous itemized deductions include investment fees from brokerage accounts, tax preparation fees, and unreimbursed employee expenses. California does not conform to this federal law, and continues to allow these deductions.
Section 199A Deduction
The Section 199A deduction is a new 20-percent deduction of certain businesses’ qualified business income (QBI) and is taken on an individual’s or trust’s tax return. Most QBI is reported on a taxpayer’s schedule C where they report business income or schedule E, which reports rental income and income from K-1s. Individuals may be eligible to take this deduction regardless of whether they itemize deductions reported on schedule A or take the standard deduction (Note: The standard deduction increased significantly under the new tax law). However, this is only a federal deduction for those that qualify. California does not conform to Section 199A, and therefore the 20-percent QBI deduction cannot be taken against California income.
Section 179 Expense
Under IRC section 179, businesses that purchase qualifying equipment are typically able to write off the entire amount of that purchase in the year of acquisition. The TCJA provides an increase to the maximum section 179 expense amount from $500,000 to $1 million, subject to limitations if you put large amounts of qualifying assets into service. The new law also allows non-residential real property such as roofs, HVAC, fire protection and alarm systems, and security systems that are placed in service after December 31, 2017 to be eligible for the deduction.
California does not conform to the changes to section 179. Instead, California allows a corporate or personal taxpayer to deduct up to $25,000. It is important to be aware of these differences when doing year-end tax planning.
The TCJA provides a 100 percent first-year depreciation deduction, an increase from 50 percent under prior law, for certain property placed in service after September 27, 2017. This provision also modifies the type of property that qualifies for this deduction to include the purchases of used equipment, so long as it was purchased in an arm’s-length transaction.
California does not conform to the rules regarding bonus depreciation. Instead, California depreciation is generally deducted under regular tax depreciation methods, or accelerated under section 179 up to $25,000 as discussed above.
Like-Kind Exchanges (Section 1031)
Under IRC section 1031, no taxable gain or loss is recognized if qualifying property held in a business or investment is exchanged solely for similar (“like kind”) property. Before the TCJA, section 1031 could be used to defer tax on exchanges of many types of business & investment property. These include real estate (buildings and land), furniture, fixtures, equipment, vehicles, trademarks, patents, and copyrights, among others. The TCJA restricted the use of section 1031 to real estate only for federal tax purposes, effective January 1, 2018.
California does not conform for the 2018 tax year. Therefore like-kind exchanges completed in 2018 are not limited to real estate for California tax purposes, regardless of income level.
However, California does conform on exchanges completed after January 10, 2019, subject to income thresholds. Starting January 10, 2019, section 1031 conformity applies, and therefore is limited to real estate only, when adjusted gross income is more than $250,000 for single taxpayers ($500,000 married filing jointly).
If you have any questions regarding these differences or any other tax matters, please do not hesitate to contact your L&B professional at (858) 558-9200.