New California Law Marks First Effort to Conform to Federal Tax Reform

On July 1, 2019, California Governor Gavin Newsom signed Assembly Bill (AB) 91, legislation that represents California’s first adoption of some changes introduced in the 2017 tax reform reconciliation act, also known as the Tax Cuts and Jobs Act (TCJA).

While the legislation doesn’t address all of the TCJA, it amends California’s personal and corporate income tax codes to closer conform select California tax provisions with US federal tax law. These changes should help reduce the compliance burden for some California small business taxpayers.

Several important changes of the new law are highlighted below.

Accounting Methods

AB 91 conforms to the TCJA’s increase of the thresholds that permit more taxpayers to use simplified methods of accounting. Specifically, California now follows the TCJA in the increase of average annual gross receipts to $25 million for:

  • Taxpayers permitted to use the cash method of accounting, up from $5 or $10 million depending on the taxpayer’s business
  • Farming corporations exempt from using the accrual method of accounting, up from $5 million
  • Taxpayers exempt from the Uniform Capitalization (UNICAP) provisions, up from $10 million for resellers or $0 for producers

Inventory Maintenance Requirements

California adopted TCJA changes that exempt businesses with average annual gross receipts of $25 million or less from the rules that require taxpayers to maintain inventories. Instead, these taxpayers are permitted to account for inventory items as either:

  • Nonincidental materials and supplies
  • In accordance with the method used for their financial accounting

Construction Contract Exemptions

California exempts certain construction contracts from using the percentage of completion method to determine income from a long-term contract. Exempt contracts include those entered into by the taxpayer with average annual gross receipts not exceeding $25 million, an increase from the prior $10 million threshold. These changes apply to personal income taxpayers and corporate taxpayers.

Effective Dates

These accounting method changes are effective for tax years beginning on or after January 1, 2019. Taxpayers can, however, elect to apply these provision to tax years beginning on or after January 1, 2018. 

Net Operating Losses

California now follows the federal changes that disallow net operating loss carrybacks for losses sustained in tax years beginning after December 31, 2018.

The state retains a 20-year carryforward period under this legislation. These changes apply to individual and corporate taxpayers.

Like-Kind Exchanges

AB 91 conforms California with federal changes to Internal Revenue Code (IRC) Section 1031, also known as like-kind exchanges. With this legislation, like-kind exchange treatment is limited to exchanges of real property under California’s personal income tax and corporate income tax provisions. 

Like-kind exchanges of tangible personal property no longer qualify for tax-deferred treatment in California, except for individual taxpayers with less than $250,000 of federal adjusted gross income or $500,000 for head of household and joint-filers. This change is effective for exchanges completed after January 10, 2019.

Technical Terminations

AB 91 adopts the TCJA’s repeal of the federal technical termination of partnership provisions.

California taxpayers can elect to have this repeal apply retroactively to tax years beginning on or after January 1, 2018.

Notable Exclusions

It’s important to note that AB 91 doesn’t move up California’s broader conformity to the IRC past its current January 1, 2015 date. As a result, areas California conforms to TCJA provisions are limited to those specifically referenced in the law.

AB 91 also doesn’t address IRC Section 965, global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), IRC Section 451 for income recognition by accrual-basis taxpayers, or the IRC Section 163(j) interest limitation. These aspects of the TCJA continue to be inoperative for California tax purposes. 

A more detailed review and guidance of the changes implemented by AB 91 is expected in the near future.

We’re Here to Help

To learn more about how changes brought by AB 91 may affect you or your business, contact your Moss Adams professional.

You can also visit our dedicated tax reform page to learn more.