AB 115 conformity: AB 115 conforms state with federal tax acts, with some exceptions.

In October, Gov. Schwarzenegger signed AB 115, a conformity bill that adopts many 2004 federal tax changes in California. The bill conforms to federal tax law as enacted Jan. 1, 2005, for taxable years beginning after 2004, moving California's conformity date four years ahead.

Some of the more significant aspects of the legislation include the liberalized student loan deduction in the Job Creation and Worker Assistance Act of 2002; limited Sec. 179 asset expense election in the Jobs and Growth Tax Relief Reconciliation Act of 2003; and the uniform definition of a qualified child as defined by the Working Families Tax Relief Act of 2004.

AB 115 also conforms to the Economic Growth and Tax Relief Reconciliation Act of 2001; the Medicare Prescription Drug, Improvement, and Modernization Act of 2003; and the American Jobs Creation Act of 2004.

However, several areas of nonconformity remain. The following is an overview of some of AB 115's provisions, according to CCH's review in its Oct. 11, 2005 TAXDAY daily newsletter (reprinted with permission from CCH, Inc.).

IRC SEC. 179

Corporations and franchise income taxpayers now can claim the Sec. 179 asset expense election that was available only to personal income taxpayers in California.

For California franchise and income tax purposes, the maximum Sec. 179 expense allowance is $25,000. Additionally, in California, the deduction's phase-out amount is $200,000 ($400,000 for federal purposes). The election can't be claimed for off-the-shelf software.

One area of nonconformity is the federal provision that allows the taxpayer to revoke a Sec. 179 asset expense election during taxable years 2003-07.

NONCONFORMITY

The following are federal provisions to which California does not conform for personal income, corporate income and franchise tax purposes:

* Passive activity loss rules regarding rental real estate;

* Exclusion of federal subsidies for prescription drug plans;

* Expensing of environmental remediation costs, applicable to expenditures paid or incurred after 2003;

* Treatment of certain passive foreign investment companies;

* Additional first-year bonus depreciation;

* Tax deferral allowed for gains on electric transmission assets;

* Deduction of income attributable to domestic production activities;

* Deduction for clean-fuel vehicles and certain refueling property;

* 15-year recovery period for qualified leasehold improvements and qualified restaurant property;

* Prohibition against taking distribution costs into account for purposes of determining the depreciation deduction using the income forecast method;

* Election to currently expense the cost of qualified film and television production costs;

* Treatment of qualified participations and residuals for purposes of determining the depreciation deduction using the income forecast method for films, recordings, books and similar property;

* Suspension of the 100 percent taxable income limit on percentage depletion deductions for oil and gas production from marginal properties;

* Special tax treatment for electing Alaska native settlement trusts; and

* Seven-year recovery period for Alaska natural gas pipelines (corporate franchise and income tax only).

California does not conform to these federal provisions for personal income tax purposes:

* Health savings account provisions, including the exclusion of employer contributions to an employee's health savings accounts, the deduction for contributions to HSAs and the tax-free rollover of amounts from medical savings accounts to health savings accounts;

* Election to claim an itemized deduction for state and local taxes paid;

* Phase-out and repeal of the limitation on the amount of itemized deductions claimed by high-income taxpayers;

* Repeal of the stepped-up basis rules, applicable with respect to decedents dying after Dec. 31, 2009;

* Eligibility for estates, heirs and qualified revocable trusts to exclude gain from the sale of a primary residence, applicable to estates of decedents dying after 2009.

* Above-the-line deduction for qualified expenses incurred by elementary and secondary school teachers;

* Above-the-line deduction for qualified tuition and related expenses; and

* Recognition of gain on certain transfers to certain foreign trusts and estates under IRC Sec. 684.

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ABUSIVE TAX SHELTERS 

AB 115 repealed the previous tax shelter registration rules and adopted the federal material adviser disclosure provisions of the American Jobs Creation Act of 2004, that mandate disclosure of reportable transactions, such as listed, confidential and loss transactions; transactions with contractual protections, such as contingency fees; transactions with significant book-tax differences; and transactions with a brief asset holding period.

This bill also requires material advisers of reportable transactions to maintain a list of all advisees. Material advisers are defined as:

* Organized in California;

* Doing business in California;

* Deriving business from California; or

* Providing material aid, assistance or advice with respect to organizing, managing, promoting, selling, implementing, insuring or carrying out any reportable transaction with respect to a taxpayer that meets any of the above criteria.