Is it time for a federal tax conformity bill in California?

OPINION – The tax laws of most states are an offshoot of the federal tax laws contained in the Internal Revenue Code (IRC). States conform to the IRC on either a “rolling” or “static” basis for purposes of computing the state’s tax base.

A rolling-conformity state generally adopts provisions of the IRC for purposes of its tax base computation as the federal government enacts those provisions. In other words, a rolling-conformity state automatically conforms to the current version of the IRC, unless otherwise provided by state law. Currently, 23 states conform to the IRC on a rolling basis.

A “static” conformity state generally conforms to the IRC as of a “specified date” or “fixed date.” Regardless of any subsequent federal changes, the IRC as of the date specified by state law continues to apply for state income/franchise tax purposes until state legislation is enacted to update the conformity date. Currently, there are 19 states that conform to the IRC as of a specified date.

Then there are states that use “selective conformity.” States with selective conformity adopt specific provisions of the IRC on a rolling or fixed basis.  California uses a cross between “static” conformity and “selective conformity.” Currently, California conforms to the IRC, with modifications, as it was in effect on January 1, 2015.

What does this mean? Unless California changes its specified conformity date, or if the state specifically enacts a statute that incorporates any federal tax law changes enacted by Congress after 2014, then California generally does not conform to any federal tax law changes. This raises the obvious question: Is it time to update California’s “specified date?

Because California taxpayers and practitioners are working with the IRC in effect from nine taxable years ago, there are countless differences between California and federal tax laws. As a result, the fundamental problem for taxpayers with these state and federal differences is that they are required to keep separate state records and adjust the financial figures from their federal tax returns to properly prepare their California tax returns.

In some cases, like with individuals’ itemized deductions, they also are faced with a heavy compliance burden. For example, many individuals must prepare a “pro forma” federal Schedule A, Itemized Deductions, for California. This is because the federal standard deduction is often higher than taxpayers’ federal itemized deductions. These taxpayers claim the high standard deduction on their federal returns, but must itemize their deductions for California purposes because the standard deduction is so low.

The Franchise Tax Board (FTB) provides a thorough discussion of specific areas of nonconformity for individuals in FTB Publication 1001, Supplemental Guidelines to California Adjustments.

Why does federal tax conformity matter to taxpayers and the state? While California and other states have their individual approaches to state taxation, such as rates, exemptions, etc., they all rely in part on the federal IRC. The main purpose of conformity to federal tax law is to reduce the compliance burden of having an entirely separate state tax system.

Conformity allows taxpayers, practitioners, and state tax administrators alike to rely on federal statutes, regulations, IRS rulings, etc. States also rely upon consistent definitions, the work done by federal audits, and tax enforcement.

The last successful federal tax conformity bill with a specified date change in this state was enacted on September 30, 2015. That measure was AB 154, which updated California’s specified date from January 1, 2009, to January 1, 2015. Taxpayers and practitioners waited six taxable years for that specified date change bill.

During the wait, increased state and federal differences often are traps for the unwary, as a mistake could lead to an audit. After more than nine taxable years, it might be time to have California update its specified date of reference to the Internal Revenue Code and begin the selective conformity process.

Gina Rodriquez is a Principal with Ryan, LLC. Chris Micheli is a Principal with Snodgrass & Micheli, LLC.