AB 99 and Cancellation of Debt Income
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October 14, 2015
California law remains out of conformity with the federal statutory exclusion for certain discharges of qualified principal residence indebtedness for discharges of indebtedness occurring on or after January 1, 2014.
However, as explained in detail in FTB's February 2014 Tax News article, California law conforms and incorporates by reference the general rules of the federal tax law governing the forgiveness of nonrecourse and recourse indebtedness. California will follow federal law as it relates to the determination of whether cancellation of debt income ("CODI") exists as a result of the sale of a principal residence. Please note that since the publication of the February 2014 Tax News article, the Internal Revenue Service has issued additional information letters, Information Letter No. 2014-0018, dated April 29, 2014, and Information Letter No. 2014-0024, dated June 20, 2014. To the extent that the two letters revise and clarify the IRS information letter referred to in the February 2014 Tax News article, those revisions and clarification would also apply to the information contained in the Tax News article. For additional information, please see https://www.ftb.ca.gov/aboutFTB/newsroom/Mortgage_Debt_Relief_Law.shtml and https://www.irs.gov/uac/Home-Foreclosure-and-Debt-Cancellation.
To the extent that taxable CODI is determined to exist, California Revenue and Taxation Code ("RTC") section 17144.5 allows a taxpayer to exclude a portion of their CODI for discharges of a qualified principal residence that occurred on or after January 1, 2007 and before January 1, 2014. Although, for federal purposes, this exclusion was extended to include CODI for discharges of a qualified principal residence that occurred on or after January 1, 2014 and before January 1, 2015, California has not conformed to that extension. Legislation was introduced in the California State Assembly, Assembly Bill 99, which would have extended the CODI exclusion to apply to discharges occurring on or after January 1, 2014 and before January 1, 2015. However, the bill was vetoed by Governor Brown on October 10, 2015. Therefore, for California tax purposes, taxable CODI for discharges of a qualified principal residence that occurred on or after January 1, 2014 remains includable in the computation of California taxable income.
Unfortunately, some taxpayers with CODI who expected AB 99 to be enacted may have failed to make sufficient payments before the original due date of the return, and so may incur penalties when the 2014 return is filed which includes the appropriate CODI. As a general rule, taxpayers are obligated to follow the law in effect and applicable to the tax year at issue. The law does not provide a reasonable cause exception for reliance on pending legislation. However, where other factors are present, the Franchise Tax Board will continue to consider reasonable cause requests for penalty abatement for taxpayers in this situation on a case by case basis.
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