LEGISLATIVE CHANGE NOTICE 97-20

Senate Bill 455 (Alpert), as enacted on October 3, 1997, made the following changes to California law:

SUBJECT: Conformity Act of 1997

Background:

The Personal Income Tax Law (PITL) and Bank and Corporation Tax Law (B&CTL), in general, conform to the Internal Revenue Code (IRC) either by incorporating the IRC by reference or by stand alone language which mirrors the federal provision. When applying the IRC for state purposes, the IRC as of the "specified date" must be used, unless a specific provision provides otherwise. This act changed the specified date from January 1, 1993, to January 1, 1997, for taxable and income years beginning on or after January 1, 1997. Changing the specified date automatically conforms to all changes in the IRC from January 1, 1993, through December 31, 1996. This act also would make numerous changes to specifically not conform to or modify certain items in the IRC. Additionally, numerous technical changes regarding cross references and deleting unnecessary language that was used to conform to federal law changes subsequent to January 1, 1993, and prior to January 1, 1997, were made by this act.

Subsequent to January 1, 1993 and prior to January 1, 1997, five bills have been enacted into law by Congress that materially affect the IRC. They are:

REVENUE RECONCILATION ACT OF 1993 (RRA)
GENERAL AGREEMENT ON TARIFFS & TRADE ACT OF 1994 (GATT)
SELF-EMPLOYED INSURANCE ACT OF 1995 (SEIA)
SMALL BUSINESS JOB PROTECTION ACT OF 1996 (SBJPA)
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 (HIPAA)

This act primarily addresses changes made by the above federal acts that were not conformed to by California prior to January 1, 1997.

Senate Bill 455 (Alpert), as enacted on October 3, 1997, made the following changes to California law:

Section 17024.5 of the Revenue and Taxation Code is amended.

Date change statute (IRC § None)

This provision changed the specified date from of January 1, 1993, to January 1, 1997. By changing the date, the following federal law changes were conformed to:

A. Real estate investments by pension trusts, educational organizations and other exempt organizations (IRC §514(c))

Under California and federal law, in general, a qualified pension trust or an organization that is otherwise exempt from federal income tax is taxed on income from a trade or business that is unrelated to the organization's exempt purposes (unrelated business taxable income or UBTI). Certain types of income, including rents, royalties, dividends, and interest, are excluded from UBTI, except when such income is derived from "debt-financed property."

An exception to the rule treating income from debt-financed property as UBTI is available to pension trusts, educational institutions, and certain other exempt organizations that make debt-financed investments in real property.

Under current California law and federal law prior to January 1, 1994, the real property exception to the debt-financed property rules have several restrictions regarding a fixed purchase price, seller financing, participating loans, purchase and leaseback, related parties, and a "disqualified person," as defined.

The RRA of 1993 liberalized the federal law restrictions by allowing certain non-fixed purchase price purchases, seller financing purchases, participating loans and leaseback to related or disqualified persons not to be treated as UBTI.

This act conforms to the 1993 federal changes.

B. Treatment of storage of product samples (IRC §280A)

Under California and federal law, a taxpayer's business use of the taxpayer’s home may give rise to a deduction for the business portion of expenses related to operating the home (e.g., a portion of rent or depreciation and repairs). Business deductions generally are allowed only for the portion of a home that is used exclusively and regularly in one of the following ways: (1) as the principal place of business for a trade or business; (2) as a place of business used to meet with patients, clients, or customers in the normal course of the taxpayer's trade or business; or (3) in connection with the taxpayer's trade or business, if the portion so used constitutes a separate structure not attached to the dwelling unit. In the case of an employee, the law further requires that the business use of the home must be for the convenience of the employer. These rules apply to houses, apartments, condominiums, mobile homes, boats, and other similar property used as the taxpayer's home.

A special rule permits deductions for expenses related to a storage unit in a taxpayer's home regularly used for inventory of the taxpayer's trade or business of selling products at retail or wholesale, provided that the home is the sole fixed location of such trade or business.

Home office deductions may not be claimed if they create (or increase) a net loss from a business activity, although such deductions may be carried over to subsequent taxable years.

Beginning in 1996, federal law expands the special rule relating to a storage unit in a taxpayer’s home to include a storage unit used for inventory or product samples.

This act conforms California law to federal law regarding home office deductions without exceptions.

C. Class life for gas station convenience stores and similar structures (IRC §168)

For structures placed in service after August 20, 1996, federal law provides that for purposes of the Modified Accelerated Depreciation System (MACRS), 15-year property includes generally, any depreciable real property that is a retail motor fuels outlet (regardless of whether food or other convenience items are sold at the outlet). A retail motor fuels outlet does not include any facility related to petroleum or natural gas pipelines or to any depreciable real property used only to an insubstantial extent in the retail marketing of petroleum or petroleum products.

It is understood that taxpayers generally have taken the position that convenience stores and other buildings installed at retail motor fuels outlets have a 15-year recovery period. The IRS, in a position described in a recent Coordinated Issues Paper, generally limits the application of the 15-year recovery period to instances where the structure: (1) is 1,400 square feet or less or (2) meets a 50% test. The 50% test is met if: (1) 50% or more of the gross revenues that are generated from the building are derived from petroleum sales and (2) 50% or more of the floor space in the building is devoted to petroleum marketing sales.

This act conforms the PITL to the federal law regarding the useful life of a retail motor fuel outlet. This act does not conform the B&CTL to federal law.

D. Provisions to prevent conversion of ordinary income into capital gain (IRC §1258)

Federal law provides that capital gain from the disposition of property that was part of a "conversion transaction" is to be recharacterized as ordinary income, with certain limitations. A conversion transaction is a transaction, generally consisting of two or more positions taken with regard to the same or similar property, where substantially all of the taxpayer's return is attributable to the time value of the taxpayer's net investment in the transaction. In a conversion transaction, the taxpayer is in the economic position of a lender that has an expectation of a return from the transaction (which in substance is in the nature of interest) and he undertakes no significant risks other than those typical of a lender. However, a transaction is not a conversion transaction subject to this provision unless it also satisfies one of the following four criteria: (1) the transaction consists of the acquisition of property by the taxpayer and a substantially contemporaneous agreement to sell the same or substantially identical property in the future; (2) the transaction is a straddle; (3) the transaction is one that was marketed or sold to the taxpayer on the basis that it would have the economic characteristics of a loan, but the interest-like return would be taxed as capital gain; or (4) the transaction is described as a conversion transaction in regulations promulgated by the Secretary of the Treasury. Property or positions may be part of a conversion transaction, and transactions of options dealers and commodities traders in the normal course of their trade or business of dealing in options generally will not be considered to be conversion transactions, except as provided in special rules.

Federal law provides that gain realized by a taxpayer from a conversion transaction that would otherwise be treated as capital gain will be treated as ordinary income (but not as interest) for all purposes of the IRC. The amount of gain so recharacterized will not exceed the amount of interest that would have accrued on the taxpayer's net investment for the relevant period at a yield equal to 120% of the "applicable rate" (which is specified in the IRC).

This act conforms California law to the federal provisions regarding the recharacterization of the capital gain from a conversion transaction to ordinary income.

E. Repeal of certain exceptions to the market discount rules (IRC §1276,§1277)

Generally, a market discount bond is a bond that is acquired for a price that is less than the principal amount of the bond. Market discount generally arises when the value of a debt obligation declines after issuance (typically, because of an increase in prevailing interest rates or a decline in the credit-worthiness of the borrower).

Under federal law, the gain on the disposition of a tax-exempt obligation or any other market discount bond, purchased by the taxpayer after April 30, 1993 (regardless of the date the bond was issued) and acquired for a price that is less than the principal amount of the bond, generally will be treated as ordinary income (instead of capital gain) to the extent of accrued market discount.

This act conforms state law to the federal provision treating gains from the disposition of bonds purchased after April 30, 1993 (regardless of the date the bond was issued) as ordinary income to the extent of the accrued market discount.

F. Accrual of income by holders of stripped preferred stock (IRC §167(e))

In general, if a bond is issued at a price approximately equal to its redemption price at maturity, the expected return to the holder of the bond is in the form of periodic interest payments. In the case of original issue discount (OID) bonds, however, the issue price is below the redemption price, and the holder receives part or all of the expected return in the form of price appreciation. The difference between the issue price and the redemption price is the OID, and a portion of the OID is required to be accrued and included in the income of the holder annually. Similarly, for certain preferred stock that is issued at a discount from its redemption price, a portion of the redemption premium must be included in income annually.

Under federal law a stripped bond (i.e., a bond issued with interest coupons some of which are subsequently "stripped" so that the ownership of the bond is separated from the ownership of the interest coupons) generally is treated as a bond issued with OID equal to (1) the stated redemption price of the bond at maturity minus (2) the amount paid for the stripped bond. Stripped preferred stock is stripped of some or all of its dividend rights. Stripped preferred stock purchased after April 30, 1993, is subject to the same rules that apply to stripped bonds or to the rules that apply to bonds and certain preferred stock issued at a discount.

This act conforms state law to the federal provision regarding the treatment of stripped preferred stock acquired after April 30, 1993.

G. Treatment of net capital gains as investment income (IRC §1(h), §463(d))

Under federal law prior to 1993, and current California law, in the case of a taxpayer other than a corporation, deductions for interest on indebtedness that is allocable to property held for investment (investment interest) are limited to the taxpayer's net investment income for the taxable year. Disallowed investment interest is carried forward to the next taxable year. Investment income includes gross income from investment property and the sale or disposition of investment property.

Subsequent to 1992, under federal law, investment income generally does not include any capital gain from the disposition of property. An exception applies to taxpayers who elect to have the capital gain taxed at their regular tax rate (the highest federal regular tax rate is 38.5%: the highest federal tax rate on capital gains is 28%). Taxpayers who elect to use the regular tax rate may include the capital gain from the disposition of investment property as investment income.

This act conforms state law to federal law regarding the definition of net investment income.

H. Treatment of appreciated inventory distributions from partnerships (IRC §751(d))

Under California and federal law, amounts received by a partner in exchange for his interest in a partnership are treated as ordinary income to the extent they are attributable to substantially appreciated inventory of the partnership. In addition, distributions by a partnership in which a partner receives substantially appreciated inventory in exchange for his interest in certain other partnership property are treated as a taxable sale or exchange of property, rather than as a nontaxable distribution. For these purposes, inventory is treated as substantially appreciated if the value of the partnership's inventory exceeds 120% of its adjusted basis. California law, prior to enactment of SB 455, additionally requires that substantially appreciated inventory exceed 10% of the value of all partnership property, other than money.

This act conforms state law to federal law by removing the requirement that substantially appreciated inventory exceed 10% of the value of all partnership property, other than money.

I. Treatment of housing provided to employees by academic health centers (IRC §119))

The SBJPA expanded the federal law definition of "educational institutions" by treating certain medical research institutions (academic health centers) that engage in basic and clinical research, have a regular faculty and teach a curriculum in basic and clinical research to students in attendance at the institution, as an educational institution. In addition, an entity organized under state law and composed of public educational institutions (university systems) will qualify as an educational institution.

This act conforms California law to federal by expanding the definition of an educational institution to include the above for purposes of treatment of housing provided to employees.

J. Nonrecognition treatment for certain transfers by common trust funds to regulated investment companies (IRC §584)

Under federal law, a common trust fund can transfer substantially all of its assets to one or more Regulated Investment Companies (RICs) without gain or loss being recognized by the fund or its participants. The fund must transfer its assets to the RICs solely in exchange for shares of the RICs, and the fund must then distribute the RIC shares to the fund's participants in exchange for the participants' interests in the fund. The basis of any asset received by a RIC will be the basis of the asset in the hands of the fund prior to transfer (increased by the amount of gain recognized by reason of the rule regarding the assumption of liabilities). In addition, the basis of any RIC shares that are received by a fund participant will be an allocable portion of the participant's basis in the interests exchanged. If stock in more than one RIC is received in exchange for assets of a common trust fund, the basis of the shares in each RIC shall be determined by allocating the basis of common fund assets used in the exchange among the shares of each RIC received in the exchange on the basis of the respective fair market values of the RICs. The tax-free transfer is not available to a common trust fund with assets that are not diversified.

This act conforms state law to federal law regarding nonrecognition of gain or loss for transfers by common trust funds to RICs.

K. Repeal of exclusion for punitive damages and for damages not attributable to physical injuries or sickness (IRC §104))

Under federal law, the SBJPA codified the treatment of punitive damages received on account of physical injury or sickness. The SBJPA provides that generally punitive damages are not to be excluded from income.

The SBJPA also provides that the exclusion from gross income only applies to damages received on account of a personal physical injury or physical sickness. If an action has its origin in a physical injury or physical sickness, then all damages (other than punitive damages) that flow therefrom are treated as payments received on account of physical injury or physical sickness regardless of whether the recipient of the damages is the injured party.

The SBJPA also specifically provides that emotional distress is not considered a physical injury or physical sickness. The exclusion from gross income does not apply to any damages received (other than for medical expenses to treat the emotional distress) based solely on a claim of emotional distress. This is because the damages are received on account of a non-physical injury or non-physical sickness.

The exclusion from gross income applies to any damages received based on a claim of emotional distress that is attributable to a physical injury or physical sickness. In addition, the exclusion from gross income specifically applies to the amount of damages received that is not in excess of the amount paid for medical care attributable to emotional distress.

This act conforms California law to the codified changes made by the SBJPA to the exclusion from gross income of damages received on account of personal injury or sickness. However, California has treated punitive damages as taxable under current law.

L. Adoption assistance (IRC §137)

Federal law excludes a maximum $5,000 ($6,000 for certain special needs adoptions) from the gross income of an employee for qualified adoption expenses paid by the employer. The limit is a per child limit, not an annual limitation. The exclusion is phased out ratably for taxpayers with modified AGI above $75,000 and is fully phased out at $115,000 of modified AGI. Qualified adoption expenses are reasonable and necessary adoption fees, court costs, attorney fees and other expenses directly connected to the adoption of a child. Qualified adoption expenses do not include expenses incurred in violation of state or federal law, incurred in carrying out any surrogate parenting arrangement, or in connection with the adoption of a child of the taxpayer's spouse.

Federal law also allows a credit with a maximum $5,000 ($6,000 for certain special needs adoptions) for qualified adoption expenses paid or incurred by a taxpayer for the adoption of a qualified child.

This act conforms California law to federal law as it relates to the exclusion from the gross income of an employee the qualified adoption expenses paid by the employer.

This act does not conform California law to the federal adoption credit discussed above.

M. Exclusion of self-employed insurance benefits from income (IRC §104)

Federal law provides that payments for personal injury or sickness through an arrangement having the effect of accident or health insurance (and that is not merely a reimbursement arrangement) are excludable from income. In order for the exclusion to apply, the arrangement must be insurance (e.g., there must be adequate risk shifting). This provision equalizes the treatment of payments under commercial insurance and arrangements other than commercial insurance that have the effect of insurance. Under this provision, a self-employed individual who receives payments from such an arrangement could exclude the payments from income.

This act conforms state law to federal law as it relates to exclusion of self-employed insurance benefits.

N. Exception to penalty for premature distribution from an IRA (IRC §72)

California and federal law provide for an exception to the 10% federal and 2.5% state penalty tax for a premature distribution from a tax-deferred retirement account. The exception applies to premature distributions from a employer-sponsored pension plan used for medical expenses in excess of 7.5% of adjusted gross income (AGI).

Beginning in 1997, the federal exception was extended to premature distributions from IRAs used for medical expenses in excess of 7.5% of AGI. In addition, federal law provides that the 10% additional tax does not apply to withdrawals for medical insurance (without regard to the 7.5% of AGI floor) if the individual (including a self-employed individual) has received unemployment compensation under federal or state law for at least 12 weeks, and the withdrawal is made in the year such unemployment compensation is received or the following year. Special rules apply if a self-employed individual is not eligible for unemployment compensation under applicable law.

This act conforms state law to federal law regarding the exceptions to the penalty tax on early distributions from tax deferred pension plan arrangements.

O. Reduction in compensation taken into account in determining contributions and benefits under qualified retirement plans (IRC §401)

This act conforms state law to federal law reducing the compensation limit to $150,000 from $235,840 for purposes of determining employer’s deductions and participant’s benefits under a tax-qualified pension plan and certain other provisions relating to compensation limits.

P. Treatment of excess pension assets used for retiree health benefits

Federal law allows for qualified transfers from a defined benefit plan to a retiree health benefits account made before taxable years beginning on or after January 1, 2001. Prior to GATT, qualified transfers from a defined benefit plan to a retiree health benefits account had to be made before taxable years beginning on or after January 1, 1996. GATT also changed the requirement of minimum dollar level to be based on the preceding tax year as opposed to the preceding two tax years and clarified rules regarding the calculation of amounts previously contributed to a health benefits account.

This act conforms state law to federal law regarding the qualified transfers of excess pension assets used for retiree health benefits

Q. Pension plan funding requirements and premiums (IRC §412)

GATT made several changes to federal law as it relates to the funding of defined benefit plans effective for plan years beginning after December 31, 1994. Pension plan sponsors are required to meet their existing pension commitments in a reasonable period of time. Employers that sponsor both underfunded defined benefit pension plans and defined contribution plans are required to fully fund their underfunded defined benefit plans more rapidly. Plan sponsors are required to provide participants in defined benefit pension plans that are underfunded with a simple explanation each year of the extent to which the plan is underfunded and an explanation of which benefits will or will not be guaranteed by the Pension Benefit Guaranty Corporation (PBGC), and the extent of the PBGC’s guarantee, if the plan is terminated. The PBGC was provided with better access to the records of certain troubled plans that it insures. The premium for underfunded plans was significantly raised through phases to insure high risk underfunded plans pay their fair share of premiums. The phase-in of higher premiums is to encourage underfunded plans to contribute more or otherwise reduce underfunding in order to avoid the payment of additional premiums.

California law was conformed as of January 1, 1993, by reference to federal law and does not have a state duplication of federal enforcement and regulation of pension plans by the Internal Revenue Service or the Department of Labor enforcement and regulation under ERISA.

This act conforms California law to the changes made by GATT to the federal pension law provisions.

R. Repeal of five-year income averaging for lump-sum distributions (IRC §407)

Under federal law, effective for years beginning after December 31, 1998, the SBJPA repeals the five-year averaging for lump-sum distributions from qualified plans, thus repealing the separate tax paid on a lump-sum distributions and the deduction from gross income for taxpayers who elect to pay the separate tax on a lump-sum distribution. Certain individuals still may elect ten-year averaging and capital gain treatment as provided under the Tax Reform Act of 1986.

This act conforms state law to federal law by repealing the five-year income averaging for lump-sum distributions. Certain individuals would still be able to elect ten-year averaging and capital gain treatment.

S. Other pension plan provisions (IRC §72, §401-S424)

This act conforms to 22 other pension related provisions enacted by the federal government subsequent to January 1, 1993, and not previously discussed in this analysis or conformed to in a prior state act. Except for tax rates and the imposition of some excise taxes California was in full conformity to the various pension provisions as of January 1, 1993. California does not have a separate program dedicated to monitoring and enforcing pension plan rules. By being fully conformed to the federal provisions, California benefits from the federal government’s monitoring and enforcement of pension plans.

The 22 additional items this act conforms to are:

S.a. Simplified method of taxing annuity distributions.

If a taxpayer made after-tax contributions to a retirement plan, the distributions are not taxable. The simplified method excludes from income a portion of each annuity equal to the recipient’s original after-tax investment, divided by an expected number of payments. The number of expected payments is based on the taxpayer’s age.

S.b. Age at which pension distributions are required.

Under prior law, distributions from pension plans and IRAs had to begin by age 70½, even if the individual was still working. The new federal law states that an individual aged 70½ who has not yet retired is not required to take a distribution from a pension plan. Distributions are still required from an IRA.

S.c. Tax-exempt organizations permitted to offer 401(k) plans.

This provision removes the prohibition on 401(k) plans for tax-exempt organizations. States and local governments are still prohibited from forming 401(k) plans unless they had elected to do so before May 1986.

S.d. Definition of highly-compensated employee changed.

This provision changes the definition of "highly compensated employee" – which is used to test if benefit plans discriminate in favor of higher-paid employees – from an employee who received more than $100,000 in compensation or who received more than $66,000 and was one of the top 20% in pay of all employees to an employee who received more than $80,000 of pay in the prior year and was in the top 20% of pay. The $80,000 amount shall be adjusted for inflation in the future. The old rule that required the highest paid officer to be treated as a highly compensated employee was repealed.

S.e. Modification of participation requirements.

Under prior law, a retirement plan was not qualified for tax benefits unless it benefited the lesser of 50 employees or 40% of all employees. The SBJPA changed the minimum participation rule only as it applies to defined benefit plans. The participation rule is changed so that at least two employees (one employee if the firm has only one employee) must participate.

S.f. 401(k) nondiscrimination rules.

The new law allows the nondiscrimination tests to be based on prior-year, rather than current-year, deferrals made by non-highly-compensated employees.

S.g. Compensation definition.

Changed the definition of compensation to include deferrals made to a 401(k) plan or 457 plan or a cafeteria plan.

S.h. Plans for self-employed individuals.

Eliminates special aggregation rules for retirement plans maintained by self-employed individuals.

S.i. Distributions for rural cooperative.

Expanded the definition of rural cooperative to include a public utility district. Allows rural cooperative retirement plans to permit distributions before age 59½ or on account of hardship.

S.j. Treatment of governmental pension plans.

Modifies limits on contributions and benefits in defined benefit plans.

S.k. Contributions for disabled employees.

Allows continued contributions on behalf of permanently and totally disabled employees if they are highly compensated if continued contributions are available for all employees who become permanently and totally disabled.

S.l. Deferred compensation for government and tax-exempt organizations.

Allows indexing (in $500 increments) of the dollar limit on contributions to 457 plans.

S.m. Trust requirement for 457 plans.

Requires that 457 retirement plans held by a government employer be held in trust for the exclusive benefit of its employees.

S.n. Interest rate assumptions in GATT bill.

Corrects interest rate and actuarial assumptions used in adjusting benefits and retirement limitations that were originally contained in GATT legislation. This act adopts the federal correction.

S.o. Salary reduction agreements under 403(b).

Uses the same rules relating to compensation limits for salary reduction agreements that are used for 401(k) arrangements.

S.p. Waive 30-day period for distributions.

Under prior law, there was a minimum waiting period between the time an explanation of the benefits available under a joint and survivor annuity was sent and the annuity starting date. The new law waives the waiting period if waived by the participant and, if applicable, the participant’s spouse.

S.q. Repeal combined plan limit.

Repeals overall limits on contributions and benefits if an individual participates in both a defined benefit plan and a defined contribution plan. This change is effective in the year 2000.

S.r. Volunteer firefighters.

Clarifies that 457 plan requirements do not apply to length-of-service awards to volunteers.

S.s. Alternative nondiscrimination rules.

Makes technical changes to nondiscrimination rules used in certain pension plans.

S.t. Pension plans for self-employed clergy.

Allows self-employed ministers to set up a qualified church pension plan.

S.u. Church pension plans.

Makes technical changes to pension plans administered by churches.

S.v. Indexing of amounts for 401(k), employee annuities and IRAs.

Conforms to the 1993 Revenue Reconciliation Act (RRA) provisions: (1) the dollar limit on benefits under a defined benefit pension plan is indexed in $5,000 increments, (2) the dollar limit on annual additions under a defined contribution plan is indexed in $5,000 increments, (3) the limit on elective deferrals is indexed in $500 increments, and (4) the minimum compensation limit for a simplified employee pension (SEP) participation is indexed in $50 increments. In addition, the provision provides that the cost-of-living adjustment with respect to any calendar year is based on the increase in the applicable index as of the close of the calendar quarter ending September 30 of the preceding calendar year so that the adjusted dollar limits would be available before the beginning of the calendar year to which they apply. No limit is reduced below the limit in effect for plan years beginning in 1994.

T. Contributions in aid of construction (IRC §118)

Under federal law, a shareholder’s contribution to capital of a corporation is not income to the corporation. Generally, contributions to capital of a corporation do not include contributions in aid of construction (CIAC) by customers or potential customers. An exception is provided for CIAC made to regulated public water and sewerage disposal utilities. In order for the CIAC not to be considered income, the contribution must be used within two taxable years of receipt to acquire tangible property used 80% or more to furnish water or sewerage disposal services. The amount of the CIAC cannot be included in the public utility’s rate base for rate-making purposes.

This act conforms the B&CTL to federal law relating to contributions in aid of construction made to regulated public water and sewerage disposal utilities.

Sections 17008.5 and 23038.53 of the Revenue and Taxation Code are amended.
Publicly Traded Partnerships (PTP) continuation of partnership treatment (IRC § 7704)

When the federal PTP rules were enacted in 1987 (California has conformed without exception), a 10-year grandfather rule provided that corporate tax treatment would not apply to certain "existing PTPs" only for taxable years beginning before January 1, 1998. An existing PTP is any partnership if (1) it was a PTP on December 17, 1987, (2) a registration statement indicating that the partnership was to be a PTP was filed with the Securities and Exchange Commission with respect to the partnership on or before December 17, 1987, or (3) with respect to the partnership, an application was filed with a state regulatory commission on or before December 17, 1987, seeking permission to restructure a portion of a corporation as a PTP. A partnership that otherwise would be treated as an existing PTP ceases to be so treated as of the first day after December 17, 1987, on which there has been an addition of a substantial new line of business with respect to such partnership.

Effective for taxable or income years beginning on or after January 1, 1998, this act provides that a "existing PTP" that is presently exempt from corporate tax under the grandfather rule may elect to continue its partnership status indefinitely. An "electing 1987 partnership" would lose its partnership status on the first day it adds a substantial new line of business. A PTP that previously used the 90% of passive-type income exception cannot elect to continue to be treated as a partnership (but still may qualify for the 90% of passive-type income exception).

This act provides that an electing 1987 partnership must consent to pay an annual tax of 1% of its trade or business gross income. The tax cannot be offset by any credits. Trade or business gross income includes the electing 1987 partnership’s distributive share of the trade or business income of any other partnership in which the electing 1987 partnership has an interest. A similar applies rule to lower-tiered partnerships. The election to remain a partnership and the consent to be taxed on gross income remains in effect until revoked by the partnership (the Internal Revenue Service’s or Franchise Tax Board’s consent is not required). Once revoked, the election cannot be reinstated.

This act conformed California law to federal law, as amended by the Taxpayer Relief Act of 1997 (P.L. 1105-34), with one exception; the federal tax on trade or business gross income is 3.5%. This act also requires that the federal treatment of a PTP (corporation or partnership) is binding for California tax law. A separate state election is not allowed.

Sections 17020.6 and 23045 of the Revenue and Taxation Code are amended.
Long-term care insurance and services (IRC §7702B)

Starting in 1997, California conformed to new federal provisions which allow a deduction for medical expenses for the unreimbursed expenses of qualified long-term care services provided to the taxpayer, the taxpayer’s spouse or the taxpayer’s dependents (subject to the present-law floor of 7.5% of adjusted gross income) and provide that long-term care insurance premiums are explicitly treated as medical expenses. The same portion is deductible for state purposes as allowed under federal law. California did not conform to: (1) the exclusion from income for certain employer contributions to an employee benefit plan; (2) the exclusion from income for benefits received under long-term care insurance; (3) the requirements on insurance companies issuing long-term care insurance; and (4) the reporting requirements contained in federal law (discussed in item 43 of this analysis).

This act conforms state law to federal law regarding the four items mentioned above. California law is now in 100% conformity with federal law as it relates to long-term care insurance and services.

Section 17041 of the Revenue and Taxation Code is amended.
Inflation indexing of the "kiddie tax" (IRC §1(g))

This provision updates how the kiddie tax is calculated to conform with present federal law. This provision provides that California calculates kiddie tax using the same methodology as federal; however, a lower percentage of 1% is used in lieu of the federal 15%. This method uses the standard deduction in the computation, which is adjusted annually for inflation. Prior to this act, the methodology used to compute the tax did not incorporate indexing for inflation.

Sections 17052.12 and 23609 of the Revenue and Taxation Code are amended.
Research & Development Credit (IRC §41)

Prior to July 1, 1996, except for two exceptions, California was in conformity with the federal research and development credit. The two exceptions are the credit rates and California has not conformed to the university credit for PITL taxpayers. The general credit rate is 20% and 11% for federal and California, respectively. The university credit rate for federal is also 20%. The university credit rate under the B&CTL is 24%.

The federal credit was revised by the Small Business Job Protection Act of (SBJPA) in 1996 by modifying the credit for contract research expenses and start-up firms. The SBJPA also created an "alternate incremental method" of computing the credit.

The contract research special rule increased from 65% to 75% the amount of contract research expenses that may be treated as qualified research expenses eligible for the research credit if those expenses are paid to certain nonprofit research consortia. To qualify, the research consortia must be a tax-exempt organization (other than a private foundation) organized and operated primarily to conduct scientific research, and the qualified research must be conducted by the consortium on behalf of the taxpayer and one or more persons not related to the taxpayer.

The SBJPA also expands the definition of "start-up firms" to include any firm if the first taxable year in which the firm had both gross receipts and qualified research expenses began after 1983. Because this change would allow these companies to use a base period for computing the credit based on the current five-year period, this change would allow the credit to qualifying companies who would not have been eligible for the prior law credit (because the research expenses in the current year do not exceed their expenses for the base year period of 1984-1988).

In addition, the 1996 Act allows taxpayers to elect an alternative incremental research credit, which is substituted for the regular research credit. For taxpayers who elect the alternative incremental credit for their first tax year beginning after June 30, 1996, and before July 1, 1997, the research credit applies to all qualified research expenses paid or incurred during the first 11 months of that tax year. If a taxpayer makes this election, the taxpayer is assigned a three-tiered fixed base percentage that is lower than the fixed base percentage allowed under the general research credit, and the credit rate is likewise reduced. An election to use this alternative incremental credit may be made only for the taxpayer’s first taxable year beginning after June 30, 1996, and before July 1, 1997, and the election applies to that taxable year and all subsequent years (in the event that the credit subsequently is extended by Congress) unless the election is revoked with the consent of the Secretary of the Treasury.

This act explicitly did not conform to the 1996 federal changes. However, the code sections (17052.12 and 23609) that explicitly do not conform to the 1996 federal changes were "chaptered out" by AB 1042 (Stat. 1997, Ch. 613). AB 1042 inadvertently conformed California law to the 1996 federal changes, without modifications, for 1997. AB 1042 intentionally conformed California law, with modification, to the 1996 federal changes for 1998. For 1997 and thereafter, the changes made to contract research expenses (consortia) and start-up companies apply to California at the 11% credit rate. For 1997 only, the credit rates for the alternative incremental credit are the same as federal. For 1998 and thereafter, the credit rates for the alternative incremental credit are eleven-twentieths (11/20)of the federal rates.

Legislation may be enacted to correct inadvertently conforming to the 1996 federal changes for the 1997 tax and income years.

Section 17054 and 18624 of the Revenue and Taxation Code are amended.
Identification numbers for dependents (IRC §151)

California has conformed to federal requirement that taxpayers provide identification numbers on tax returns, statements and other documents (IRC §6109), except that California specifically does not require identification numbers of certain dependents to be furnished to the FTB. Federal law requires identification numbers at birth for dependent exemptions and expands the identification number requirement to the child care credit. Prior to the enactment of SB 455, §18624 contained the exception that California does not require the identification number for dependents. In 1996, the SBJPA moved the requirement from §6109 to §151(e) and expanded it to apply to the child care credit (§21(e)). The SBJPA also made the denial of a deduction or credit based on the lack of a identification number a mathematical error (IRC §6213). This act moved this exception from §18624 to §17054.

Sections 17062, 17063, 23453 and 23457 of the Revenue and Taxation Code are amended.
Alternative minimum tax (IRC §55(d), §56(g), §57(d))

Federal law does not require the unrecognized gain portion of a charitable contribution of appreciated capital gain property be treated as an alternative minimum tax (AMT) preference item. In addition, no adjustment related to earnings and profits effects of any charitable contribution is required to be made in computing the adjusted current earnings (ACE) component of the corporate AMT. California law treats the appreciation of capital gain property contributed as a preference item and corporations must consider charitable contributions in determining its ACE adjustment. These provisions preserve these state/federal differences.

Additionally, by changing the specified date, California conformed to the federal AMT exemption amounts of $45,000, $33,750, and $22,500 for married taxpayers filing a joint return, single taxpayers and married taxpayers filing separate, respectfully. The AMT exemption amounts were $40,000, $30,000 and $20,000.

Section 17062 is double-joined to SB 1106 (Stat. 1997, Ch. 604). SB 455 was chaptered after SB 1106. Therefore, this section, as initiated by SB 1106, also will clarify the definition of "qualified taxpayer" by defining "aggregate gross receipts, less returns and allowances," "gross receipts less returns and allowances" and "proportionate interest." The amendments also modified the AMT rules regarding California Qualified Stock Options (CQSOs) by requiring the difference between the stock’s fair market value when it was purchased and the option price to be an item of adjustment for AMT.

Section 17062 was also double-joined to SB 1233 (Stat. 1997, Ch. 612). For taxable years beginning on or after January 1, 1998, SB 1233 increases the AMT exemption amount to $57,260, $42,945 and $28,360 for married taxpayers filing a joint return, single taxpayers and married taxpayers filing separate, respectfully. These amounts are indexed for inflation beginning in 1999. Because SB 1233 was chaptered after SB 455, the amendments to §17062 initiated by SB 1106 and the AMT exemption amounts set by SB 455 will remain in effect only for taxable years beginning in 1997. The amendments initiated by SB 455 preserving state differences will remain in effect indefinitely. SB 1233 chaptered out this section from this act.

Sections 17072, 19184 and 24343.3 of the Revenue and Taxation Code are amended.
Sections 17138.5, 17141.5, 17150, 17201.5, 17213 and 17267 of the Revenue and Taxation Code are repealed.
Section 17215 is added to the Revenue and Taxation Code.
Medical Savings Account (IRC §220)

California conformed to the federal medical savings account (MSA) deduction in 1996, operative for years beginning on or after January 1, 1997. State law conformed to the federal law using stand-alone language. By virtue of this act changing the specified date from January 1, 1993, to January 1, 1997, stand alone language is no longer needed. This act repeals six sections that exclusively address MSA deductions, amend §17215 by removing a sub-section added to the §17215 by prior law to conform to MSAs and amend §24343.3 to change a cross-reference to the IRC.

This act also reduced the additional tax on distributions from MSAs not used for qualified medical expenses from 15% to 10% (§17215). The act also imposes a $50 penalty for each report not filed by the trustee of the MSA with the FTB (§19184). The amendments made to §19184 by this act were chaptered out by SB 1233 (Stat. 1997, Ch. 612). However, SB 1233 makes the same amendments to §19184, operative for taxable and income years beginning on or after January 1, 1998. Therefore the $50 penalty for failure to file a report is not applicable until years beginning in 1998.

Section 17077 of the Revenue and Taxation Code is amended.
Overall limitation on itemized deductions (IRC §68)

California and federal law place an overall limit on itemized deductions. California conforms to the federal computation but applies state amounts.

This act removes the sunset date of taxable years beginning after December 31, 1996 from the statute, thus making the overall limitations permanent.

Section 17085 of the Revenue and Taxation Code is amended.
Establishment of savings incentive match plans for employees of small employers. (IRC § 408)

By changing the specified date in §17024.5, California law conformed to the "savings incentive match plan for employees" (SIMPLE) in §17507. This act provides for an exception to the penalty amount in §17085 as outlined below.

Under federal law, the SBJPA created a simplified retirement plan for small business called a SIMPLE retirement plan. SIMPLE plans can be adopted by employers who employ 100 or fewer employees with at least $5,000 in compensation for the preceding year and who do not maintain another employer-sponsored retirement plan. Employers who no longer qualify are given a two-year grace period to continue to maintain the plan. A SIMPLE plan can be either an individual retirement account (IRA) for each employee or part of a qualified cash or deferred arrangement ("401(k) plan"). Generally, if established under an IRA, SIMPLE plans are not subject to the nondiscrimination rules applicable to other qualified plans. If adopted as part of a 401(k) plan, SIMPLE plans are not subject to the top-heavy nondiscrimination rules, but are subject to other nondiscrimination tests applicable to 401(k) plans.

An employee can elect to defer up to $6,000 per year in a SIMPLE plan, and this amount will be indexed for inflation in the future. Under an IRA established plan, the employer generally is required to match the employee elective contributions on a dollar-for-dollar basis up to 3% of the employee's compensation up to $6,000 maximum per year. Under a special rule, the employer can elect a lower percentage matching contribution for all employees (but not less than 1% of each employee's compensation). A lower percentage cannot be elected for more than two out of any five years. Under a 401(k) SIMPLE plan, a safe harbor rule may apply and is satisfied if, for the year, the employer does not maintain another qualified plan and (1) employees' elective deferrals are limited to no more than $6,000, (2) the employer matches employees' elective deferrals up to 3% of compensation (or, alternatively, makes a 2% of compensation nonelective contribution on behalf of all eligible employees with at least $5,000 in compensation), and (3) no other contributions are made to the arrangement. The employer cannot reduce the matching percentage below 3% of the employee’s compensation.

All contributions to an employee's SIMPLE account have to be fully vested.

Contributions to a SIMPLE account generally are deductible by the employer. In the case of matching contributions, the employer is allowed a deduction for a year only if the contributions are made by the due date (including extensions) for the employer's tax return. Contributions to a SIMPLE account are excludable from the employee's income. SIMPLE accounts are not subject to tax. Distributions from a SIMPLE plan are includible in taxable income when withdrawn. Early withdrawals from a SIMPLE plan are subject to the 10% early withdrawal tax applicable to all (with exceptions) salary reduction pension plans; however, early withdrawals within the two-year period beginning on the date the employee first participated in the SIMPLE plan are subject to a 25% early withdrawal tax.

The SBJPA repealed "salary reduction simplified employee pensions" (SARSEPs). Under SARSEPs, which are not qualified plans, employees could have elected to have contributions made to the SARSEP or to receive the contributions in cash. The amount the employee elected to have contributed to the SARSEP was not currently includible in income.

This act conforms state law to federal law regarding the establishment of SIMPLE plans and the repeal of SARSEP plans. This act assesses a 6% tax, in lieu of the federal 25% rate (§17085), on early withdrawals made by an employee within the first two years after the employee first participated in the SIMPLE plan.

Sections 17088 and 24870 of the Revenue and Taxation Code are amended.
Section 24875 is added to the Revenue and Taxation Code.
Financial asset securitization investment trusts (IRC §860H)

Effective September 1, 1997, the SBJPA creates a new type of statutory entity called a "financial asset securitization investment trust" (FASIT) to facilitate the securitization of debt obligations such as credit card receivables, home equity loans, and auto loans. An entity must elect to be treated as a FASIT and cannot terminate that election without the consent of the IRS. A FASIT is not subject to tax and is not treated as partnership, trust, corporation, or taxable mortgage pool. Interests in a FASIT can only be held by one "ownership interest" and by one or more "regular interests." The holder of ownership interest is taxed on the income of the FASIT. A regular interest is treated as a debt instrument and amounts includible in gross income with respect to such interest shall be determined under the accrual method of accounting.

The ownership interest must be designated as such and be held by an eligible domestic C corporation. The C corporation cannot be exempt from tax, a REIT, RIC, REMIC or a cooperative. All assets, liabilities, and items of income, gain, deduction, loss and credit of the FASIT are treated as those of the holder of the ownership interest. The Secretary of the Treasury may prescribe regulations to defer gain with respect to property that supports any regular interest in a FASIT.

A regular interest entitles the holder to an unconditional specified principal amount and is treated as a debt instrument of the FASIT. The issue price for the regular interest cannot be more than 125% of the principal amount. The regular interest cannot have a maturity date in excess of 30 years. Special rules apply based on the interest rate specified.

A FASIT is permitted to hold: 1) cash or cash equivalents, 2) certain debt instruments, 3) contract rights to acquire debt instruments, 4) certain foreclosure property, 5) certain letters of credit, and 6) any "regular interest" in another FASIT or REMIC.

A 100% excise tax is assessed on the holder of the ownership interest on the net income from a "prohibited transaction." A prohibited transaction is defined as the receipt of income derived from 1) an asset that is not a permitted asset, 2) the disposition of certain assets, 3) any loan originated by the FASIT, and 4) compensation from certain services or fees.

For alternative minimum tax purposes, the alternative minimum taxable income (AMTI) of the holder of the ownership interest or a high-yield interest is computed without regard to the income of the FASIT; however, the AMTI of the ownership interest holder cannot be less than the FASIT’s net income.

The SBJPA made nine conforming amendments to other provisions of the Internal Revenue Code (IRC) to make a FASIT’s treatment consistent with the treatment of a REMIC under current law. A transition rule applies for entities that were in existence between June 10, 1996, and August 31, 1997, that subsequently elect to be treated as a FASIT. Under this transition rule, gain is not recognized on property contributed to the FASIT by the holder of the ownership interest to the extent the property is allocable to interests issued prior to August 31, 1997.

This act conforms state law to federal law by adopting the federal provisions regarding FASITs with exceptions. This act provides that all the activities of a FASIT are to be treated as activities of the holder of the ownership interest and a FASIT would be subject to the minimum franchise tax (presently $800). This act also provides that no California excise tax is imposed on the net income of a prohibited transaction; however, the net income from a prohibited transaction is included in the income of the holder of the ownership interest. Additionally, this act makes the applicable conforming amendments and allow a transitional rule.

Elections made for federal purposes are generally treated as being made in the same manner for state purposes. Therefore, under this act, if an entity makes an election to be a FASIT for federal purposes, it would automatically be a FASIT for state purposes unless a separate election is filed requesting separate treatment. For purposes of determining whether the holder of the ownership’s interest in the FASIT is "doing business" in California, the activities of the FASIT shall be attributed to the holder.

This provision of the bill has the same effective date as federal of September 1, 1997.

Sections 17088.3 and 24272.5 are added to the Revenue and Taxation Code.
Section 17137 and 18040 of the Revenue and Taxation Code is repealed.
Merchant marine capital construction fund accounts (IRC §7518)

Federal law provides for commercial fisherman and certain carriers to enter into an agreement with the U.S. Department of Commerce to deposit part of their earnings into a fund to acquire or construct vessels. Some carriers have used the funds to double hull their existing ships.

Federal law provides that deposits to the fund up to certain limits are deductible from income. Earnings on the deposits are deferred from income until the amounts are withdrawn. For corporations, the deferred income is included in alternative minimum taxable income. Qualified withdrawals are included in income. Disqualified withdrawals are generally taxed at the highest marginal tax rate. A vessel’s basis must be reduced under certain situations.

This act conforms state law to federal law regarding the establishment, operation and closing of a merchant marine capital construction accounts. This act substitutes the state’s highest marginal tax rate for the federal highest marginal tax rate. This act does not required the deferred income to be included in alternative minimum taxable income for corporations. Legislation is expected to be enacted to make deferred income from deposits included in AMT for 1997 and thereafter.

Section 17131.5 of the Revenue and Taxation Code is repealed.
Accelerated death benefits (IRC §101)

Since 1991, §17131.5 excluded from income certain death benefits received prior to death by persons who are diagnosed to be terminally ill. In 1996, IRC §101 was amended to exclude certain accelerated death benefits received by terminally ill individuals. California conforms to IRC §101 by reference (§17131), therefore, conformity to the 1996 federal change is accomplished through date change. §17131.5 is repealed because it was obsolete.

Section 17132 of the Revenue and Taxation Code is repealed.
Gross income does not include expense reimbursement of state official (IRC N/A)

Enacted in 1983, this section stated that reimbursements received by state officials under a Government Code section that no longer exists is not includible in income. Because the Government Code section no longer exists, this section was repealed.

Section 17132.5 is added to the Revenue and Taxation Code.
Repeal of $5,000 exclusion of employees’ death benefits (IRC §101(b))

Under federal law, effective for individuals dying after August 20, 1996, the SBJPA repealed the $5,000 exclusion for employer-provided death benefits.

This act conforms state law to federal law by eliminating the $5,000 exclusion paid by or on behalf of an employer by reason of the employee's death. Conformity is achieved through date change. Section 17132.5 is added to the law to clarify the effective date of the repeal of the death benefit exclusion to apply to decedents dying after August 20, 1996, for amounts received on or after January 1, 1997.

Sections 17139 and 24326 of the Revenue and Taxation Code are amended.
Exclusion for energy conservation subsidies limited to subsidies with respect to dwelling units (IRC §136)

Federal law provides an exclusion from the gross income of a customer of a public utility for the value of any subsidy provided by the utility for the purchase or installation of an energy conservation measure for a dwelling unit. In addition, for subsidies received after 1994, federal law provided a partial exclusion from gross income for property that is not a dwelling. For non-dwellings, the amount of the exclusion is 40% of the value for subsidies received in 1995, 50% of the value for subsidies received in 1996, and 65% of the value for subsidies received after 1996.

The SBJPA repealed the partial exclusion for any subsidy provided by a utility for the purchase or installation of an energy conservation measure with respect to property that is not a dwelling unit. The repeal was applicable for amounts received after December 31, 1996.

This act conforms state law to federal law regarding the exclusion from income of the amounts received from a public utility company for the installation of an energy conservation measure in dwelling units.

Section 17154 is added to the Revenue and Taxation Code.
Employer-provided educational assistance (IRC §127, §132)

In 1996, California conformed to the federal changes made in 1993 affecting employer-provided educational assistance. A new §17151 was added to decouple the state exclusion from the federal exclusion and made it permanent for expenses relating to courses beginning after June 30, 1996.

This act corrects a reference in IRC §132(j) (incorporated by reference) from IRC §127 to PITL §17151.

Section 17210 of the Revenue and Taxation Code is repealed.
Spousal IRA deduction (IRC §219, §408)

California conformed to spousal IRA in 1996 by stand alone language. This act repeals the stand alone language because conformity to spousal IRAs is accomplished through date change.

Section 17249, 17748, 18035, 18060, 18166, 18173 24966.3, 24990.8, and 24990.9 of the Revenue and Taxation Code are repealed.

Section 17279 24355 and 24355.5 of the Revenue and Taxation Code are amended.
Amortization of goodwill (IRC §197)

California conformed to the amortization of goodwill in 1994, by stand alone language with minor exceptions. This act repeals (either the entire section or part thereof that relates to the amortization of goodwill) the stand alone language because conformity to the amortization of goodwill is accomplished through date change.

Section 17250 of the Revenue and Taxation Code is amended.
Indian reservation depreciation (IRC §168)

Federal law allows a shorter depreciable life for property used in a trade or business conducted within an Indian reservation. This act does not provide for special depreciation for trades or businesses conducted on a Indian reservation.

This act section is double joined to AB 122 (Stat. 1997, Ch. 607). Because AB 122 was chaptered before SB 455, this act also allows a vineyard planted in California to replace a vineyard infested with Pierce’s Disease to be depreciated over five year period rather than a 10 year period applicable to other vineyards. For AMT purposes, a vineyard planted to replace one infested with Pierce’s disease is assigned a 10-year class life.

Section 17250.5 is added to the Revenue and Taxation Code.
Depreciation under income forecast method (IRC §167)

Under federal law, the SBJPA expanded the definition of "income" used in the computation, clarified what amounts are to be included in the cost of the property and provided for a "look back" rule for re-computing depreciation under certain conditions.

Income that is to be taken into account under the income forecast method includes all estimated income to be generated by the property. Generally, income expected to be generated after the close of the tenth taxable year after the year the property was placed in service is not taken into account. Income was expanded to include the financial exploitation of characters, designs, scripts, scores, and other incidental income associated with films or shows, but only to the extent the income is earned in connection with the ultimate use of such items by, or the ultimate sale of merchandise to, persons who are not related to the taxpayer.

Special rules are provided for a television series that initially is not anticipated to be syndicated.

The adjusted basis of property under the income forecast method includes only amounts that satisfy the economic performance test. For this purpose, if the taxpayer incurs a noncontingent liability to acquire, from another person, property subject to the income forecast method, economic performance will be deemed to occur with respect to such noncontingent liability when the property is provided to the taxpayer.

Any costs that are taken into account after the property is placed in service are treated as a separate piece of property to the extent (1) such amounts are significant and are expected to give rise to a significant increase in the income from the property that was not included in the estimated income from the property, or (2) such costs are incurred more than 10 years after the property was placed in service. To the extent costs are incurred more than 10 years after the property was placed in service and give rise to a separate piece of property for which no income is generated, such costs may be written off and deducted as they are incurred.

Any costs that are not recovered by the end of the tenth taxable year after the property was placed in service may be taken into account as depreciation in such year.

Taxpayers using the income forecast method are required to pay (or would receive) interest based on the recalculation of depreciation under a "look-back" method. The look-back method is applied in any "recomputation year" by (1) comparing depreciation deductions that had been claimed in prior periods to depreciation deductions that would have been claimed had the taxpayer used actual, rather than estimated, total income from the property; (2) determining the hypothetical overpayment or underpayment of tax based on this recalculated depreciation; and (3) applying the overpayment rate (interest rate on amounts owed by the IRS to taxpayers as refunds) as specified in the IRC. Property that has a cost basis of $100,000 or less is not subject to the look-back method.

Except as provided in Treasury regulations, a recomputation year is the third and tenth taxable year after the taxable year the property was placed in service.

The SBJPA provides a simplified look-back method for pass-through entities.

This provision conforms California law to the changes made to the federal income forecast method of depreciation by the SBJPA. This act provides that the interest paid or received under the look-back rule is computed under the state statute in lieu of the federal rate.

This provision does not conform California law to the changes made to the federal income forecast method of depreciation by the Taxpayer Relief Act of 1997 (P.L. 105-34).

Section 17251.5 is added to the Revenue and Taxation Code.
Contributions of appreciated stock to private foundations (IRC §170(e))

Until June 30, 1998, federal law permits a charitable contribution deduction for contributions of appreciated stock to certain private foundations of the full fair market value of appreciated stock that is listed on a established securities exchange market. California generally only allows the basis of that stock as a charitable contribution. This provision specifically does not conform to this federal rule.

Section 17255 is repealed and added to the Revenue and Taxation Code.
Increase in expense treatment for small business (IRC §179)

Federal law provides that in lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment may elect to deduct up to $18,000 of the cost of qualifying property placed in service in a taxable year beginning after December 31, 1996. In general, qualifying property, commonly referred to as section 179 property, is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business. The limitation amount is reduced (but not below zero) by the amount by which the cost of section 179 placed in service during the taxable year exceeds $200,000. In addition, the amount eligible to be expensed for a taxable year may not exceed the taxable income of the taxpayer for the year that is derived from the active conduct of any trade or business (determined without regard to this provision). Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding taxable years (subject to similar limitations).

The federal expense amount increases from $18,000 to $25,000. The increase is phased in as follows:

This provision conforms the California PITL to federal law. The federal expensing amounts would be phased in over two years. Under the PITL, the maximum amount that can be expensed is $13,000 in 1997 and $16,000 in 1998. From 1999 and forward the maximum amount matches the federal amounts.

This provision does not conform the B&CTL to federal law. Corporations still are allowed to use additional first-year depreciation.

Sections 17270.5, 24343.7 and 24429 are added to the Revenue and Taxation Code.
Section 17283 of the Revenue and Taxation Code is repealed.
Lobbying expenses (IRC 162(e))

Federal law does not permit a deduction for any amount paid or incurred in connection with (1) business deductions for expenses of grass roots lobbying and participation in political campaigns, (2) lobbying of foreign governments, (3) influencing federal or state legislation, or (4) any communication with certain covered Federal executive branch officials in an attempt to influence the official actions or positions of such officials. Items one and two have been federal law since 1987, items three and four became federal law in 1993. California law is conformed to items one and two only. These provisions preserve California’s non-conformity to items three and four.

Denial of indirect contributions to political parties (IRC §276).

Federal law provides that no deduction is allowed for any amount paid or incurred for advertising in a political party convention program or any admission to any dinner or program, if any part of the cost inures or is intended to inure to a political party.

This act repeals the current state exception and thus conforms state law to federal law denying of any deduction for indirectly contributing to a political party. Direct contributions to a political party are not allowable as a deduction under current federal or state law.

Section 17271 is repealed and added to the Revenue and Taxation Code.
Section 24443 of the Revenue and Taxation Code is amended.
Denial of the deduction for club dues (IRC §274(a))

Under federal law no deduction is allowed for club dues, including but not limited to business, social, athletic, luncheon, or sporting clubs. Specific business expenses (e.g., meals) incurred at the club are deductible if they are otherwise deductible. California permits the deduction of club dues if the expense is primarily for the furtherance of the taxpayer’s trade or business and the club does not restrict membership based on age, sex, race, religion, color, ancestry or national origin. These provisions preserve California’s non-conformity to the denial of the deduction for club dues.

Section 17273 of the Revenue and Taxation Code is amended.
Deduction of health insurance costs for self-employed individuals (IRC §162(l)

Beginning in 1997, federal law allows self-employed individuals to deduct from gross income 40% of their health insurance cost. The 40% will increase gradually to 100% in the year 2007. California permits 25% of a self-employed person’s health insurance cost to be deducted from gross income. This provision preserves California’s non-conformity to the higher percentage of the health insurance cost of self-employed individuals that is deductible. However, SB 1233 (Ch. 97-612) chaptered out this provision. For the 1997 taxable year, California is conformed with the federal deduction amount of 40% of the health insurance cost paid by self-employed individuals. For taxable years beginning on or after January 1, 1998, the amount deductible for California purposes will return to 25% of the health insurance cost paid by self-employed individuals.

Section 17275.5 is added to the Revenue and Taxation Code.
Section 24357 of the Revenue and Taxation Code is amended.
Substantiation requirements for the deduction of certain charitable contributions (IRC §170(f)

Under California and federal law, an individual taxpayer who itemizes deductions must separately state the aggregate amount of charitable contributions made by cash or check and the aggregate amount of donated property other than cash or check.

Subsequent to 1993, federal law additionally provides that no deduction is allowed for a separate contribution of $250 or more unless the taxpayer has written substantiation from the donee organization of the contribution (including an estimate of the value of any good or service the donee provided to the taxpayer in exchange for making the gift to the donee).

Taxpayers must obtain substantiation prior to filing their return. Taxpayers may not rely solely on a canceled check as substantiation for a donation of $250 or more. Substantiation is not required if the donee organization files a return with the IRS (in accordance with Treasury regulations) reporting information sufficient to substantiate the amount of the deductible contribution. Also substantiation is not required for contributions of $250 or more to a religious organization, where a donor receives an intangible religious benefit that generally is not sold in commercial transactions outside the donative context (e.g., admission to a religious ceremony).

This provision conforms the PITL and B&CTL to federal law requiring taxpayers to obtain and maintain written substantiation of contributions of $250 or more. However, this provision provides that if the federal requirements are met, the state requirements are also met.

Section 17278.5 is added to the Revenue and Taxation Code.
Sections 24372.5 is repealed and added to the Revenue and Taxation Code.
Seven-year amortization of reforestation expenses (IRC §194)

Federal law permits the amortization ratably over 84 months of reforestation expenses for qualified timber property. Qualified timber property must be located in the United States and contain trees in a significant quantities for commercial logging. Reforestation expenses include the site preparation, seed or seedlings, the cost of labor for planting and other direct cost associated with reforestation including but not limited to depreciation of equipment used to plant the trees. A maximum of $10,000 per year may be added to the amortizable basis.

Prior to SB 455, California PITL had conformed to federal without exception. The B&CTL contained stand-alone language that permitted a five-year amortization period with no maximum cap on the amount allowable to be added to the amortizable basis.

Section 24372.5 conforms the B&CTL to federal law and retains the exception that the property must located in California. §17278.5 was added to the code to require the property to be located in California.

Section 17507 of the Revenue and Taxation Code is amended.
Treatment of IRA distributions (IRC §408(d))

The dollar amount for distributions of excess contributions to an IRA was increased to $2,000 to correspond to the increased contribution and deduction amounts allowed for spousal IRAs. This provision increases the amount to $2,250 to conform with the federal amount.

Section 17561 and 24692 of the Revenue and Taxation Code are amended.
Passive loss rules for real estate (IRC §469))

Under federal law, the passive activity limitations (PAL) and rules do not apply to taxpayers who are substantially engaged in a real property trade or business. Under California law taxpayers, otherwise subject to PALs, substantially engaged in rental real estate activities are subject to PALs. This provision preserves this state difference.

Section 17750 of the Revenue and Taxation Code is amended.
Distributions from estates and trusts (IRC §643(d))

This change removes an obsolete subsection that relates to distributions from an estate or a trust made after January 1, 1985, and before January 1, 1986

Section 17860 of the Revenue and Taxation Code is amended.
Partnership distributions of marketable securities (IRC §731, §737)

Under federal law, neither a partnership nor its partners generally recognize gain upon a distribution to a partner of partnership property other than cash and "marketable securities." A partner generally recognizes gain to the extent that the sum of the fair market value of marketable securities and money received exceeds the partner’s basis in its partnership interest immediately before the distribution.

The value of the marketable securities is their fair market value as of the date of the distribution. Marketable securities generally means financial instruments and foreign currencies that, as of the date of the distribution, are actively traded. For purposes of the definition of marketable securities, a financial instrument includes financial products such as stocks and other equity interests, evidences of indebtedness, options, futures and forward contracts, notional principal contracts and derivatives. Marketable securities are treated as cash equivalents in this context. Additionally, federal law contains several provisions regarding expanding and contracting the definition of marketable securities, securities not marketable when acquired, securities contributed to the partnership by the distributee, and distributions by investment partnerships.

This provision conforms California law to federal law as it relates to partnership distributions of marketable securities to partners.

Section 18037 of the Revenue and Taxation Code is amended.
Application of involuntary conversion rules to Presidentially declared disasters (IRC §1033(h))

Under federal law, if property held for productive use in a business or for investment is involuntarily converted as a result of a Presidentially declared disaster, any tangible property held for productive use in a trade or business qualifies as similar or replacement property (e.g., insurance proceeds from the destruction of store fixtures could be used to purchase a delivery vehicle). Business assets must be replaced under the general replacement period of two years.

This provision conforms California law to federal law relating to involuntary conversions as a result of a Presidentially declared disaster without exception.

Sections 18044 and 24956 are added to the Revenue and Taxation Code.

Section 24916 of the Revenue and Taxation Code is amended.
Rollover of gain from sale of publicly traded securities into specialized small business investment companies (IRC §1044)

Federal law permits any corporation or individual to elect to roll over without payment of tax any capital gain realized upon the sale of publicly-traded securities where the corporation or individual uses the proceeds from the sale to purchase common stock or a partnership interest in a "specialized small business investment company" (SSBIC) within 60 days of the sale of the securities. To the extent the proceeds from the sale of the publicly-traded securities exceed the cost of the SSBIC common stock or partnership interest, gain will be recognized currently. The taxpayer's basis in the SSBIC common stock or partnership interest is reduced by the amount of any gain not recognized on the sale of the securities.

Estates, trusts, S corporations, and partnerships are not eligible to make this election to roll over gains. In addition, "publicly-traded securities" are defined as stock or debt traded on an established securities market. An SSBIC is defined as certain partnerships or corporations that are licensed by the Small Business Administration.

The amount of gain that an individual may elect to roll over under this provision for a taxable year is limited to the lesser of $50,000 or $500,000 reduced by the gain previously excluded under this provision. For corporations, these limits are $250,000 and $1 million.

These provisions conform California law to the rollover of gain from the sale of publicly-traded securities into a SSBIC as long as a similar federal provision is applicable.

Section 24916 is double joined to AB 1040 (Stats. 1997, Ch. 605). Because of the double joining, this act also makes technical changes to this section.

Section 18152 is added to the Revenue and Taxation Code.
50% exclusion for gain from certain small business stock (IRC §1202)

In 1993 California wrote stand-alone language (§18152.5) to partially conform to the 1993 federal law change creating a new kind of "small business stock.". The two state exceptions contained in §18152.5 are being retained and §18152 is added to modify federal law to substitute state §18152.5 for references in the IRC to §1202 of the IRC.

Sections 18180 and 24993 of the Revenue and Taxation Code are amended.
Polish bonds exempt from original issue discount treatment (IRC §7872)

Federal law provides special treatment of interest from bonds issued by Israel and Poland where the bonds have below-market interest.

This provision conforms state law to federal law regarding the treatment of Polish bonds issued at below-market interest rates.

Sections 18601, 23801, 23802, 23806 and 23813 of the Revenue and Taxation Code are amended.
Sections 17731.5, 19365 and 23800.5 are added to the Revenue and Taxation Code.
S corporation conformity (IRC §§1360-1380)

SB 5 (Stat. 1997, Ch. 610) conformed California law to federal S corporation tax law as amended by the SBJPA. Conformity was achieved using stand alone language. This act and SB 5 are double-joined. Because SB 5 was chaptered first, this act converted SB 5 stand alone language into date change language. Had SB 5 not been enacted into law, amendments made to California’s S corporation tax law by this act would not have occurred.

Section 18645 of the Revenue and Taxation Code is amended.
Certain informational returns (IRC §6050)

Under current California law, the FTB may request from the return filer copies of several different information returns filed by a taxpayer with the IRS. This act requires three additional returns that are presently being filed with the IRS to be filed with the FTB upon request by the FTB.

A. Returns relating to the cancellation of indebtedness by certain financial entities:

A taxpayer's gross income includes income from the discharge of indebtedness. The IRC requires lenders to file information returns with respect to discharged debt. The determination of when a discharge of indebtedness occurs is a question of fact. In general, a debtor has discharge of indebtedness income where a debt is repurchased, extinguished, or otherwise deemed satisfied for less than its outstanding balance. Discharge of indebtedness income is generally not deemed to result merely because the lender (1) has not actively pursued its claim against the debtor, provided a legal claim still exists, (2) claims a deduction for financial or regulatory reporting purposes, or (3) claims a partial or full bad debt deduction for tax purposes. However, the existence of several factors such as these may, when considered collectively, indicate that a discharge of indebtedness has occurred.

Certain "applicable financial entities" are required to file information returns with the IRS regarding any discharge of indebtedness of $600 or more, including the amount of debt discharged and the date on which the debt was discharged. Such information returns are required regardless of whether the debtor is subject to tax on the discharged debt. Financial institutions and agencies are not required to determine whether the debtor qualifies for an exception from including the cancellation of debt in income.

B. Returns relating to the purchasers of fish:

Beginning in 1998, persons engaged in the trade or business of purchasing fish for resale who pay more than $600 in cash in a calendar year for fish or other forms of aquatic life from any seller engaged in the trade or business of catching fish are required to file information reports with the Secretary regarding those purchases.

C. Returns relating to long-term care benefits:

Payors of long-term care benefits are required to file information returns on persons receiving the benefits and are also required to report the type of policy under which the payments are made.

Federal law generally provides for penalties for failing to file the information returns and/or providing a copy to the third party. Generally, the penalty is $50 for each return not filed or incorrectly filed with a maximum of $250,000 per year.

This provision also imposes penalties ($50 for each omission, $250,000 maximum) for not filing information returns and/or providing a copy to the FTB upon request or for not providing a copy to the third party (normally the recipient).

This provision does not require criminal court clerks receiving certain cash amounts (IRC §6050I(g)) to file statements with the FTB.

Sections 18648.5 and 19182.5 are added to the Revenue and Taxation Code.
Disclosure of quid pro quo contributions (IRC §§6115 & 6714)

Under federal law, a charitable organization that receives a quid pro quo contribution in excess of $75 (meaning a payment exceeding $75 "made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization") is required, in connection with the solicitation or receipt of such a contribution, to provide a written statement to the donor that (1) informs the donor that the amount of the contribution that is deductible for income tax purposes is limited to the excess of the amount of any money (and the value of any property other than money) contributed by the donor over the value of the goods or services provided by the organization, and (2) provides the donor with a good faith estimate of the value of goods or services furnished to the donor by the organization.

The disclosure requirement does not apply if only de minimis, token goods or services are given to a donor or the contributor receives only an intangible religious benefit that generally is not sold in a commercial transaction outside the donative context. Furthermore, the provision does not apply to transactions that have no donative element (e.g., sales of goods by a museum gift shop that are not, in part, donations).

Federal law also provides that penalties ($10 per contribution, but capped at $5,000 per particular fundraising event or mailing) may be imposed upon charities that fail to make the required disclosure, unless the failure was due to reasonable cause. The penalties will apply if an organization either fails to make any disclosure in connection with a quid pro quo contribution or makes a disclosure that is incomplete or inaccurate.

These provisions conform state law to the federal reporting requirements and penalty provisions. The state requirements are deemed satisfied when an organization demonstrates the federal requirements have been met.

Section 19136.2 is added to the Revenue and Taxation Code.
Individual estimated tax safe harbor based on last year's tax (IRC §6654)

Under federal law, an individual taxpayer generally is subject to an addition to tax for any underpayment of estimated tax. Income tax withholding from wages is considered to be a payment of estimated taxes. An individual generally does not have an underpayment of estimated tax if he or she makes timely estimated tax payments at least equal to:

1. 90% of the tax shown on the return for the current year, or
2. 100% of the tax shown on the return of the individual for the preceding year. The Taxpayer Relief Act of 1997 (P.L. 105-34) revised the special rule affecting taxpayers with AGI over $150,000 ($75,000 if married filing a separate return). Effective for the 1997 tax year, 110% of the tax shown on the preceding year’s return is required. For 1998, 100% of the preceding years tax is required. For tax years 1999 through 2001, 105% is required. For tax years 2002 and 2003, 112% and 110% is required, respectively. Prior to the enactment of P.L. 105-34, federal law required taxpayers with AGI in excess of $150,000 to make payments of 110% for tax years 1997, and thereafter.

For estimated tax purposes, some trusts and estates are treated as individuals.

This provision requires taxpayers with AGI greater than $150,000 ($75,000 if married filing a separate return) to pay 110% of the preceding year’s tax liability for 1997, 100% for 1998 and 110% thereafter to qualify under the preceding tax year exception to the underpayment of estimated tax penalty. Because of the waiver of estimated tax penalty provision contained in this act (item 41), effectively, only 100% of the prior year’s liability for the 1997 tax year needs to be paid to qualify for the exception.

Section 19136.3 is added to the Revenue and Taxation Code.
Waiver of estimated tax penalty (IRC § N/A)

This provision waives additions to tax imposed for any underpayments of tax or estimated tax for any period before April 15, 1998, with respect to any underpayment for the 1997 taxable or income year to the extent the underpayment was created or increased by any provision of this act.

Section 19141.2 is added to the Revenue and Taxation Code.
Copy of federal form 5471 required to be attached to California tax return (IRC §6038)

Federal law requires each United States taxpayer, who controls a foreign corporation, to file an information return containing specific information about the foreign corporation such as post-1986 undistributed earnings, a balance sheet and related party transactions. Federal law provides for a penalty of $1,000 for failure to file the information return. An additional penalty is assessed if the taxpayer fails to furnish the information return 90 days after the taxpayer has been notified of the original failure. The additional penalty is $1,000 for each 30-day period or fraction thereof after the 90 day period. The total penalty that may be assessed for failure to file the information return is $25,000.

For income years beginning on or after January 1, 1997, this provision requires a taxpayer to attach a copy of the federal form to the California tax return. This act also provides for a penalty, computed under federal law, for failure to attach a copy of the federal form to the California tax return. The penalty does not apply until income years beginning on or after January 1, 1998. The penalty is not assessed if the failure was due to reasonable cause, the taxpayer provides a copy of the form within 90 days of request from the FTB and the taxpayer agrees to attach a correct copy for subsequent years to all subsequent timely filed tax returns.

Section 19144 of the Revenue and Taxation Code is amended.
Corporate estimated tax rules (IRC §6655)

Under federal law, a corporation is subject to an addition to tax (a penalty) for any underpayment of estimated tax. To avoid the penalty, a corporation is required to base its estimated tax payments on 100% (prior to 1993, 97%) of the tax shown on its return for the current year, whether such tax is determined on an actual or annualized basis. For certain small corporations there is also an exception to the penalty if the small corporation makes four timely estimated tax payments each equal to at least 25% of the tax liability shown on its return for the preceding taxable year.

Effective for income years beginning on or after January 1, 1998, this provision conforms state law to federal law by requiring corporations to make estimated tax payments based on 100% of its actual or annualized income.

Section 19164 of the Revenue and Taxation Code is amended.
Modifications to accuracy-related penalty (IRC §6662)

California and federal laws provide for a 20% accuracy related penalty for any portion of an underpayment of tax required to be shown on a return that is due to one or more of the following: (a) negligence or disregard of rules or regulations, (b) any substantial understatement of income tax, (c) any substantial valuation misstatement of property or services, or (d) any substantial overstatement of pension liabilities.

Subsequent to 1993, federal law regarding items (b) and (c) above were modified. Prior to the modifications, the rules were:

Substantial understatement of income tax:

An understatement is considered "substantial" if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal holding company). Generally, the amount of an "understatement" of income tax is the excess of the tax required to be shown on the return, over the tax actually shown on the return (reduced by any rebates of tax). The substantial understatement penalty does not apply if there was a reasonable cause for the understatement and the taxpayer acted in good faith with respect to the understatement (the "reasonable cause exception"). The determination as to whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Additionally, in determining whether an understatement is substantial, the understatement generally is reduced by the portion of the understatement that is attributable to an item for which there was substantial authority or adequate disclosure. In the case of tax shelter items, however, the understatement is reduced only by the portion of the understatement that is attributable to an item for which there was substantial authority and, with respect to which, the taxpayer reasonably believed that the claimed treatment of the item was more likely than not the proper treatment. Disclosure made with respect to a tax shelter item does not affect whether of an understatement is substantial.

Substantial valuation misstatement of property or services.

A substantial valuation misstatement occurs if property is valued at 200% or more than the correct valuation or the net "section 482 transfer price adjustment" for the taxable year exceeds $10 million. The law provides for an analogous "gross valuation misstatement," which is a 400% or more overstatement of value or a net section 482 transfer price adjustment of $20 million. The net section 482 transfer price adjustment is the net increase in taxable income for a taxable year resulting from adjustments under section 482 in the price for any property or services (or use of property). However, a net increase in taxable income attributable to a price re-determination is disregarded, for this purpose, if it is shown that there was a reasonable cause for the taxpayer's determination of the price, and that the taxpayer acted in good faith with respect to the price.

A "substantial" valuation misstatement results in a penalty of 20% of the understatement of tax attributable to the substantial valuation misstatement. The penalty for a "gross" valuation misstatement is 40% of the tax understatement. No valuation misstatement penalty is imposed if it is shown that there was reasonable cause for the underpayment and that the taxpayer acted in good faith.

The federal law changes regarding the two items above involve more stringent disclosure requirements and the lowering of the threshold for the net section 482 adjustments. The adequate disclosure exception now also requires a taxpayer to have a "reasonable basis" for the tax treatment. Reasonable basis has not been defined in the IRC; however, Congress, in the committee report, stated that it is to "be a relatively high standard of tax reporting, that is significantly higher than patently improper." Additionally, corporations involved in tax shelters may no longer use the substantial authority exception to avoid the penalty; it may now use only the reasonable cause exception.

The threshold for the net section 482 adjustment has been lowered from $10 million to $5 million for substantial valuation misstatement. The gross valuation misstatement for a net section 482 adjustment remains the same at $20 million.

This provision conforms California law to federal law as it relates to the accuracy-related penalty.

This section is doubled-joined to AB 1040 (Stat. 1997, Ch. 605). Because SB 455 was chaptered after AB 1040, this provision also replaces the phrase "bank and corporation" with corporation. AB 1040 change the definition of corporation to include banks.

Section 23456 of the Revenue and Taxation Code is amended.
Depreciation component of adjusted current earnings adjustment (IRC §56)

For property placed in service after December 31, 1993, federal law eliminated the depreciation component of the "adjusted current earnings" (ACE) adjustment. Thus, corporations compute AMT depreciation by using the rules applicable to individuals. This provision specifically does not conform to this 1993 federal change.

Section 23701h is repealed and added to the Revenue and Taxation Code.
Exempt property management corporations (IRC §5019c))

This section was re-structured to incorporate federal law in the same manner as in other sections throughout the Revenue and Taxation Code to enable federal changes to be incorporated by date change.

Section 23732 of the Revenue and Taxation Code is amended.
Treatment of dues paid to agricultural or horticultural organizations (IRC §512(d))

A retroactive federal law was passed in 1996 which provides that if an agricultural or horticultural organization requires annual membership dues not exceeding $100, then in no event will any portion of those dues be subject to the UBIT by reason of any benefits or privileges to which members of such organization are entitled. For taxable years beginning after 1995, the $100 amount will be indexed for inflation. The term ‘dues’ is defined as "any payment required to be made in order to be recognized by the organization as a member of the organization." This federal provision applies retroactively to taxable years beginning after December 31, 1986.

Effective for income years beginning on or after January 1, 1997, this provision conforms California law to federal law as it relates to exempt agricultural and horticultural organization’s treatment of dues and UBIT.

Section 24349 of the Revenue and Taxation Code is amended.
Income forecast method of depreciation and treatment of abandonment of lessor improvements at termination of lease (IRC §167)

For discussion of changes made to the income forecast method of depreciation please see §17250.5. This provision conforms to the SBJPA law changes as it relates to the income forecast method of depreciation.

The SBJPA codified under federal law that a lessor of leased property that disposes of a leasehold improvement which was made by the lessor for the lessee of the property may take the adjusted basis of the improvement into account for purposes of determining gain or loss, if the improvement is irrevocably disposed of or abandoned by the lessee at the termination of the lease. This provision does not apply if the lease is terminated because the building is razed.

This act conforms California law to federal law codifying the treatment of leasehold improvements made by the lessor and disposed of or abandoned at the end of the lease term.

This act section is double joined to AB 122 (Stat. 1997, Ch. 607). Because AB 122 was chaptered before SB 455, this act also allows a vineyard planted in California to replace a vineyard infested with Pierce’s Disease to be depreciated over five-year period rather than a 10-year period applicable to other vineyards. For AMT purposes, a vineyard planted to replace one infested with Pierce’s disease is assigned a 10-year class life.

Section 24371.5 of the Revenue and Taxation Code is repealed.
Amortization of child care facilities (IRC §188)

Federal law from 1972 through 1981 allowed an election, for capital expenditures pertaining to child care facilities, to amortize these expenditures over five years (as opposed to a depreciable life of 30 years or more). This federal provision was repealed.

California law was conformed to the provision allowing capital improvements to child care facilities to be amortized or depreciated over a five-year period. The PITL conformed by date change and was repealed by date change in 1991. The B&CTL conformed to the federal provision with stand-alone language. The B&CTL stand-alone language was not repealed prior to this provision.

This provision conforms state law to federal law by repealing the B&CTL provision allowing the election to depreciate child care facilities over five years.

Section 24947 is repealed and added to the Revenue and Taxation Code.
Basis adjustment to property held by a corporation where stock in the corporation is replacement property under involuntary conversion rules (IRC §1033)

Under federal and California law, in general, gain realized by a taxpayer from certain involuntary conversions of property is deferred to the extent the taxpayer purchases property similar or related in service or use to the converted property within a specified replacement period of time (normally two years).

Under federal law, where the taxpayer satisfies the replacement property requirement by acquiring stock in a corporation, the corporation generally will reduce its adjusted bases in its assets by the amount by which the taxpayer reduces its basis in the stock. The corporation's adjusted bases in its assets will not be reduced, in the aggregate, below the taxpayer's basis in its stock (determined after the appropriate basis adjustment for the stock). In addition, the basis of any individual asset will not be reduced below zero. The basis reduction first is applied to: (1) property that is similar or related in service or use to the converted property, then (2) to other depreciable property, and then (3) to other property.

This provision conforms state law to federal law and requires a reduction in the basis of the underlying assets in a corporation acquired as replacement property under an involuntary conversion.

Section 24949.5 is added to the Revenue and Taxation Code.

Section 24971 of the Revenue and Taxation Code is repealed.
Involuntary conversions in Presidentially-declared disaster areas and sale or exchange of microwave relocations (IRC §1033)

This provision conforms to the federal law regarding the Presidentially-declared disaster areas as outlined under §18037 above.

The federal law relating to involuntary conversions was modified in 1993 as follows:

A. Radio broadcasting stations

Prior to January 15, 1995, federal law provided that if the FCC certifies that a sale or exchange of property is necessary or appropriate to effectuate a change in a policy of, or the adoption of a new policy by, the FCC with respect to the ownership and control of "radio broadcasting stations," a taxpayer may elect to treat the sale or exchange as an involuntary conversion. This federal law was repealed in 1995.

B. Related party transactions

In general, corporations (other than S corporations) and certain partnerships are not entitled to defer gain if the replacement property or stock is purchased from a related person (as defined under the losses between related party in the IRC). An exception is provided where a taxpayer purchases replacement property or stock from a related person when the related person acquired the replacement property or stock from an unrelated person within the replacement period.

The provision applies to a partnership if more than 50% of the capital interest, or profits interest, of the partnership are owned, directly or indirectly, by C corporations at the time of the involuntary conversion.

C. Microwave relocation

In 1993, Congress provided for the orderly transfer of frequencies, including frequencies that can be licensed under competitive bidding procedures. The FCC has adopted rules to conduct auctions for the award of more than 2,000 licenses to provide personal communications services (PCS). PCS would provide for the rapid increase of wireless communication devices, such as multi-function portable phones, portable facsimile and other imaging devices. The PCS auctions, which began in 1994, will constitute the largest auction of public assets in American history and are expected to generate billions of dollars for the United States Treasury.

PCS can operate only on certain frequencies that are currently occupied by various private fixed microwave communications systems (such as those owned by railroads, oil pipelines, and electric utilities). No large blocks of unallocated spectrum are available for PCS. To accommodate PCS, the FCC has reallocated the spectrum. Current occupants of the targeted spectrum allocated to PCS must relocate to higher frequencies not later than three years after the close of the bidding process. In accordance with FCC rules, these current occupants have the right to be compensated for the cost of replacing their old equipment, which will not work at their new spectrum.

The FCC will employ a tax certificate program for PCS to encourage fixed microwave operators voluntarily to relocate from the targeted band to clear the band for PCS technologies.

Beginning in 1995, federal law provides that sales or exchanges that are certified by the FCC as having been made by a taxpayer in connection with the FCC’s reallocation of that spectrum for use by PCS will be treated as involuntary conversions.

This act conforms California law to federal law as it relates to involuntary conversions.

This act will not require any reports by the department to the Legislature.