CTEC Qualifying Education California Adjustments

Transcription

1 CTEC Qualifying Education California Adjustments CALIFORNIA ADJUSTMENTS ADDITIONS AND SUBTRACTIONS ADJUSTMENTS TO INCOME ITEMIZED DEDUCTIONS READING For this session read: California tax publications: Form A Booklet, pages 8-10, and FTB Tax Information for Registered Domestic Partners FTB Tax Information for Same-Sex Married Couples FTB 1001 Supplemental Guidelines to California Adjustments Final analysis of Senate Bill 401 for updated information on California conformity to federal tax law changes (access this document at: OBJECTIVES By the end of this session, you should: Know the layout of California Form 540 and Schedule CA Be familiar with common adjustments made in figuring California income Know how to figure California itemized deductions Be aware of conformity issues between federal and California tax law 1

2 CALIFORNIA TAX LAW AND FEDERAL TAX LAW California income tax law is based on federal income tax law. This means that California tax law and federal tax law are generally but not always the same. When California law differs from federal law, California requires adjustments be made to the California tax return. This session discusses how to identify areas where California tax law differs from federal law and how to enter adjustments for differences on the California tax return. California tax law refers to a specified date where California law was conformed to federal law. For 2010, the specified date is January 1, 2009 (see explanation below). As of the specified date, California law either: Conforms to federal law, or Does not conform and requires specific modifications. On April 12, 2010, SB 401, the Conformity Act of 2010 was enacted. The Act changes California s conformity date to the Internal Revenue Code from January 1, 2005, to January 1, 2009, for taxable years beginning on or after January 1, California s conformity results in numerous substantive changes to both the Personal Income Tax Law and the Corporation Tax Law with respect to those areas of preexisting conformity that are subject to changes under federal laws enacted after January 1, The Act would also conform to the February 17, 2009, federal legislation providing an exclusion from gross income in any taxable year for energy grants provided in lieu of federal energy credits. California does not automatically conform to federal law, so future changes in federal law may or may not be adopted by California at a later time. For more information on conformity issues, recent federal changes and their effects in California, see the California Franchise Tax Board website at PREPARING THE CALIFORNIA RETURN California tax forms are designed to start with the results of your federal tax return. You then account for differences between federal and California law by making changes to your California income and tax by applying California: Additions, Subtractions, Adjustments, and Credits 2

3 Accounting for the differences between federal and California tax law by identifying and computing California additions, subtractions, adjustments and credits is the heart of preparing a California state tax return. Calculating and Reporting California Differences Forms 540A, 540 and Schedule CA California has a short form, Form 540A, which can be used if income is limited to certain sources. It allows a few of the most common adjustments for differences between federal and California income. Form 540A can be used if all of the following criteria for adjustments are met: Adjustments to income are the same for federal and California Educator expenses and the Tuition and Fees Deduction were not claimed Standard deduction is used, or federal and California itemized deductions are the same (except for state, local and foreign taxes paid) Calculating Differences on Form 540A Form 540A provides space on Lines 14a-f to enter specific adjustment items. A separate schedule for computing adjustments is not required however only adjustments shown on Lines 14a-f can be entered. If you need to claim an adjustment for an item not shown on Line 14, you cannot use Form 540A and must file long form 540. Calculating Differences on Form 540 The long form, Form 540, allows for many more California differences. Form 540 does not provide lines for computing each difference. Differences are reported 3

4 on Schedule CA. Schedule CA has sections to show California changes to federal: Income, Adjustments, and Itemized deductions. Schedule CA is used to calculate California additions, subtractions and itemized deductions. Amounts calculated for each item are then carried to Form 540 and entered on: Line 14 (subtractions), Line 16 (additions), and Line 18 (itemized deductions or standard deduction) Total California taxable income is then entered on Line 19. Calculating Differences on Form 540NR If you were a nonresident of California for part or all of the year, report your adjustments on Schedule CA (540NR). We cover Schedule CA (540NR) in our course California Part-Year and Nonresident Returns. Completing Form 540 Before beginning your California return you must complete your federal return. After you complete your federal return, complete California Form 540 as follows: Form 540, Line 12 State Wages Enter the total from all your forms W-2 (including W2s from any state other than California). 4

5 Form 540, Line 13 Federal Adjusted Gross Income Generally, you will enter the AGI amount from federal Form 1040, line 37; Form 1040A, line 21; or Form 1040EZ, line 4. Same-Sex Married Couples and Registered Domestic Partners California Same-Sex Married Couples (SSMCs) and Registered Domestic Partners (RPDs) cannot file joint federal returns. If they choose to file jointly for California, they must combine their separate AGIs from their federal returns on line 13. However, they may need to make some adjustments before doing so. SSMCs and RDPs filing separately for California may also need to calculate adjustments. Same-sex married individuals filing as married/rdp filing separately, former spouses of a same-sex marriage filing separately, and SSMCs with SSMC adjustments will use the California SSMC Adjustment Worksheet in FTB Pub. 776, Tax Information for Same-Sex Married Couples or complete a federal pro forma Form RDPs filing as married/rdp filing separately, former RDPs filing separately, and RDPs with RDP adjustments will use the California RDP Adjustments Worksheet in FTB Pub. 737, Tax Information for Registered Domestic Partners, or complete a federal pro forma Form Completing Schedule CA (540) Schedule CA Columns The right-hand side of Schedule CA has three columns: A For reporting amounts entered on your federal return B For any subtractions to your federal income or adjustments to income items C For additions to your federal income or adjustments to income items Begin completing Schedule CA as follows: In Column A, lines 7 through 21 and 23 through 36, enter the amounts from the same line numbers of your federal Form If you used Forms 1040A or 1040EZ, enter the amounts on the lines appropriate for the type of income or adjustment. 5

6 Part I Section A: Income items recognized under federal law are also recognized under California law in most cases. Part I Section A is used to account for differences between federal and California treatment of income. Use Column A to report federal income amounts as they were reported on the federal return. Use Column B to subtract income items taxed on the federal return that are not taxed by California. Use Column C to add income items taxed by California that were not included in federal income. Schedule CA(540) Part I Column A Sections A & B: On each line, enter all amounts from the corresponding lines of your federal Form Column B Section A: On each line, enter the amount of the income item included in Column A that is NOT taxed by California. Column B Section B: Enter the amount of each adjustment item that was deductible on the federal return that is NOT deductible on the California return. Column C Section A: On each line enter the amount of the income item that IS taxed by California that was not included in Column A. Column C Section B: Enter the amount of each adjustment item that was not deductible on the federal return but IS deductible on the California return. Part I Section B: Federal and California law allow generally allow the same adjustments to income. Section B is used to account for differences between federal and California law. Use Column A to show federal adjustment amounts as they were reported on the federal return. Use Column B to subtract from California adjustments, items deductible on the federal return that are not deductible on California. Use Column C to add adjustment items not deductible on the federal return that are deductible on the California return. Line 37 Column A This is the total federal AGI Column B Total California subtractions - enter this amount on Form 540, Line 14 Column C Total California additions enter this amount on Form 540, Line 16 6

7 Schedule CA (540) Part II Use Part II to show differences between California and federal itemized deductions. Line 38 - Begin by entering the total of your federal itemized deductions from Schedule A. Line 39 Enter the amount deducted on federal Schedule A that was for state and local income taxes, general sales tax, SDI, new motor vehicle tax, or foreign taxes paid. Line 40 Subtract all taxes included on Line 39 from your federal itemized deductions to arrive at your CA itemized deductions. Line 41 Other adjustments including California lottery losses California and federal itemized deductions are generally the same. If you added to or subtracted from federal amounts in Part I of Schedule CA (540), you may need to change your California itemized deductions. Use Line 41 to increase or decrease your California itemized deductions. Increase your California itemized deductions by entering a positive number on Line 41. Reduce your California itemized deductions by entering a negative number on Line 41. Line 43 Is your AGI (Form 540, Line 13) more than the amount shown for your filing status? You must reduce your allowable itemized deductions for California if your income is greater than the amounts shown for your filing status. If your income is greater than the amount shown, complete the Worksheet for Line 43 to determine your allowable California itemized deductions. If your income is less than the amount shown for your filing status, your itemized deductions are the same as the amount shown on Line 42. Line 44 Enter the larger of the amount on Line 43 or your standard deduction. Enter on line 44, the greater of your allowable California itemized deductions or your standard deduction. Carry the amount from Line 44 to Form 540, Line 18. 7

8 ADDITIONS AND SUBTRACTIONS TO FEDERAL INCOME Schedule CA Line 7 Wages, Salaries, Tips, Etc. In general, California wages are the same as federal wages so most people will not make adjustments on this line. However, the following income items are included in federal AGI but are not taxable in California: (Certain) military active duty pay Certain sick pay Employee benefits for transportation Earnings of American Indians Medical expenses for RDPs Military Active Duty Pay Military pay taxed by California Military pay is taxed by California if: The service member is both domiciled and stationed in California. Military pay not taxed by California Military pay is not taxed by California: If you are member of the military stationed in California and domiciled in a state other than California, or For the period of time you are a member of the military domiciled in California and stationed outside of California on Permanent Change of Station (PCS) Orders. If you were a member of the military with wages not taxed by California, enter a subtraction on Schedule CA, Line 7, Column B equal to the wages not taxed by California. Refer to FTB Publication 1032 Tax Information for Military Personnel for specific instructions on how to figure the amount to enter on Schedule CA, Line 7. Sick Pay Sick pay received under the Federal Insurance Contributions Act or the Railroad Retirement Act is not taxed by California. Enter any qualifying sick pay that was included in your federal AGI as a subtraction on Line 7, Column B. 8

9 Employee Benefits for Transportation Under federal law an employer may offer the following qualified transportation benefits to employees as a tax-free fringe benefit: A ride in a commuter highway vehicle between the employee s home and work place A transit pass Qualified parking or Qualified bicycle commuting reimbursement. Federal rules limit the maximum tax-free benefit an employer may provide to an employee. For 2010 the maximum benefit is: $230 per month for combined commuter highway transportation and transit passes. $230 per month for qualified parking. $20 per qualified bicycle commuting month. Under federal law, your employer must include the cost (value) of transportation benefits above these amounts in your income. (See IRS Pub. 15-B Employer s Tax Guide to Fringe Benefits, Page 20 for more information.) Under California law, there are no monthly limits for the exclusion of these benefits and California's definitions are more expansive. If you received fringe benefits for parking, transit passes, private commuter busses, or participation in a ridesharing arrangement that were included in your federal income you can subtract the amount included in your federal income from your California income. Enter the amount of qualifying benefits received and included in federal income as a subtraction on Schedule CA - Line 7, Column B. Earnings of American Indians Federal law taxes income received by American Indians from reservation sources. California law does not tax income earned by tribal members who: Live in Indian Country affiliated with their tribe, and Receive earnings from the same tribal source of which they are members. Military compensation is considered income from tribal sources. Indian Country means any federally recognized Indian reservation or other land that has been set aside for the residence of tribal Indians under federal protection. Refer to California FTB Pub. 674, Frequently Asked Questions About the Income Taxation of Native Americans for more information. 9

10 Enter the amounts of qualified income that were included in your federal AGI as a subtraction on Schedule CA - Line 7, Column B. Employer-provided adoption benefits exclusion Federal law increased the maximum amount of employer-provided adoption benefits exclusion per child to $13,170. California does not conform to the federal increase. The exclusion amount for California is $12,170. Enter on Schedule CA (540 or 540NR), line 7, column C an addition for the excess employer-provided adoption benefits exclusion allowed for federal over the California exclusion. Exclusion for In-Home Supportive Services (IHSS) supplementary payments For taxable years beginning on or after January 1, 2010, California law allows an exclusion from gross income for IHSS supplementary payments received by IHSS providers. The IHSS Program helps pay for services provided to certain individuals who are over 65 years of age, or disabled, or blind. IHSS is considered an alternative to out-of-home care, such as nursing homes or board and care facilities. Enter on Schedule CA (540 or 540NR), line 7, column B a subtraction for the IHSS supplementary payments included in federal wages. Adult children not qualified for tax-free medical coverage Federal law allows medical coverage provided through your employer that includes your adult children as tax-free. For California, adult children who provide more than one-half of their own financial support in the year are not qualified for tax-free medical coverage. Your employer should impute additional income for California on your federal Form W-2. Enter on Schedule CA (540 or 540NR), line 7, column C the imputed income for California. Medical Expenses of RDPs If you are a RDP and received employer-provided accident or health insurance, and medical expense reimbursement for your RDP partner or your partner s dependent that were included in your federal income, you can subtract these amounts from your California income if they were not previously deducted. If you are self-employed, you may also claim a deduction for health insurance costs paid for RDPs and the RDP s dependents. If you are filing as a RDP, refer to Pub 737 and complete the California RDP Adjustments Worksheet or prepare a pro-forma federal Form 1040 using the same filing status you would use on your California tax return. Then enter the amount 10

11 of medical expenses included in federal income as a negative number on California Schedule CA line 7, column C. 11

12 Clergy Housing Exclusion Both California and federal law allow members of the clergy to exclude from income either: The rental value of a home furnished as part of their compensation, or A rental allowance paid as part of their compensation to the extent it is used to provide a home. Federal law limits the rental exclusion to the fair rental value of the home (including furnishings and a garage) and the cost of utilities. California does not limit the exclusion for the rental allowance to the fair rental value of the home. Enter the amount of housing allowance that was included in federal income because it was more than the amount used to provide housing as a subtraction on Schedule CA, Line 7, Column B. Housing Exclusion for State-Employed Clergy Beginning 01/01/03, clergy members who are employed by the State of California, may allocate up to 50% of gross salary for either: The rental value of a home furnished, or The rental allowance paid to them to rent or provide a home. Enter the amount of housing allowance paid to a California state employed clergy member that was included in federal income as a subtraction on Schedule CA, line 7, column B. If the amount of housing allowance excluded from federal income exceeds 50% of the clergy member s gross salary, enter the excess amount as an addition to California income on Schedule CA 540, line 7, column C. Schedule CA Line 8 Taxable Interest Income Interest on U.S. Government Bonds and Notes Generally, the federal government does not tax bond interest of any U.S. state, local government or territory. In turn, the states do not tax most U.S. government interest. If you included in your federal AGI interest income from: U.S. savings bonds, U.S. Treasury bills, notes or bonds, or Bonds of U.S. territories or possessions, such as Guam, Puerto Rico, the U.S. Virgin Islands, or American Samoa, you will have a subtraction on your California return. 12

13 Enter the amount of federal interest included in federal income as a subtraction on Line 8, Column B. The federal bond interest exclusion does not apply to the following housing bonds: FNMA ( Fannie Mae ), GNMA ( Ginnie Mae ), or FHLMC bonds. Do not subtract interest on these housing bonds on your California return. Mutual Funds investing in U.S. government bonds Many mutual funds invest in U.S. government obligations. Funds invested in U.S. government obligations pay the interest to investors as exempt interest dividends. California does not tax this interest if the fund has at least 50% of its assets invested in U.S. or California bonds that are tax-exempt in California. If this 50% requirement is not met, the interest is taxed by California. A mutual fund investing in U.S. government obligations is required to issue investors a statement regarding whether it has met this requirement for a tax year. It will also issue a document reporting the percentage of income from the fund that is U.S. government interest income. If the fund has met the 50% requirement, you can subtract the portion of income that is attributable to U.S. government interest income. Enter the amount of federal bond interest not taxed by California on Schedule CA (540) Line 8, Column B. Example 1: Selma receives $1,500 of interest income from Lucky Investors Fund. The fund states that 20% of its assets were invested in U.S. government obligations and 10% of its income came from those bonds. Selma will enter $1,500 of interest income on her federal Form 1040, Line 8. She cannot claim a subtraction for the U.S. bond portion of the interest on her California return because the fund did not meet the 50% requirement. 13

14 Example 2: In addition to receiving $1,500 of interest income from Lucky Investor s Fund, Selma also received $1,000 of interest income from U.S. Investors Fund. U.S Investor s Fund states that 75% of its assets were invested in U.S. government obligations and 70% of its income was from those bonds. Selma will enter $2,500 of interest income on her federal Form 1040, Line 8. Because U.S Investor s Fund met the 50% requirement, she will enter a subtraction of $700 on her Schedule CA (70% X $1,000 = $700 of U.S. government interest income not taxable by California). Selma received interest income as follows: $1,500 (ordinary interest from Lucky Investor s Fund) $1,000 ($700 US Bond interest + $300 ordinary interest from US Investor s Fund) All $2,500 is reported on Selma s federal Form 1040, Line 8a. Selma will claim a subtraction on her California return for the portion of the U.S. Investor s fund interest that is U.S. Bond interest. Selma completes Schedule CA (540) as follows: Enter $2,500 from Federal Form 1040 on Schedule CA (540) Line 8, Column A. Enter $700 on Schedule CA (540), Line 8, Column B. 14

15 Interest on State and Local Bonds California State and Local Bond Interest State bond interest income is not taxable on the federal return. California does not tax interest income from California state or local bonds. Since California bond interest is not included in federal AGI, no addition or subtraction is made on the California return for California state or local bond interest income. Interest on Bonds of Other States California does tax interest income from state and local bonds of states other than California. Since bond interest income from other states is not included in federal AGI, you must add other state bond interest to your California income. Enter the amount of non-california state or local bond interest as an addition to California income on Schedule CA - Line 8, Column C. Municipal Bond Fund Interest A state or municipal bond fund is a fund that invests in bonds issued by U.S. states, territories and municipalities. Interest earned from state and municipal bond funds is not taxable on your federal return, but may be taxable by California. If you invested in a state or municipal bond mutual fund, you should receive a Form 1099-INT reporting Tax Exempt Interest in Box 8. The fund should also issue a year-end statement showing how much of the fund s income is allocable to each state. The percentage of the bond fund income that is not based on California bonds is an addition to income on your California return. Enter the amount of non-california interest as an addition on Schedule CA - Line 8, Column C. Box 3 Interest is U.S. Bond interest. California does not tax U.S. Bond interest. The amount in 1099 INT Box 3 is entered as a subtraction on Schedule CA, Line 8, Column B. Box 1 interest is ordinary interest. It is fully taxable on federal and California returns. No adjustment is made to the California return for the amounts reported in Box 1 of Form 1099-INT. Box 8 interest is tax exempt interest. Amounts in Box 8 of Form 1099 INT are reported on federal Form 1040, Line 8b. If any of the amount reported in Box 8 of Form 1099 INT represents interest income from bonds of other states, enter the amount of other state bond interest as an addition on Schedule CA, Line 8, Column B. 15

16 Example 3 Wall E received $2,200 of interest during the year from the following sources: Port of Seattle bond interest $200 California state bond interest $500 Arizona state bond interest $200 Ordinary savings interest $400 U.S. bond interest $900 All state bond interest is tax exempt on the federal return. Enter $900 on Form 1040, Line 8b. Ordinary interest and U.S. bond interest totaling $1,300 is reported on Form 1040, Line 8a. $900 of the $1,300 of interest income reported on Form 1040, Line 8a is U.S. Bond interest. Enter $1,300 on Schedule CA (540). Enter $900 as a subtraction from California income on Line 8, Column B. $400 of the tax exempt interest income reported on Form 1040, Line 8b is interest income from other states (AZ $200 and WA $200). Enter $400 of tax exempt interest as an addition to California income on Schedule CA (540), Line 8, Column C. 16

17 Loans made to a business located in an enterprise zone If you received interest income from a loan you made to a trade or business located inside an enterprise zone you may claim a subtraction from California income. To claim this subtraction, complete Form FTB 3805Z, Enterprise Zone Deduction and Credit Summary. Enter the net interest deduction from form FTB 3805Z as a subtraction on Schedule CA, Line 8, Column B. Write FTB 3805Z next to the dotted line on Form 540, Line 14. Interest Income from a Health Savings Account (HSA) Federal law allows taxpayers to exclude from gross income the interest earned on HSAs. California does not conform. If you earned interest on amounts invested in your HSA, you will have an addition on your California return. Enter the current year interest earned as an adjustment on Schedule CA, line 8, column C. Interest Income of Children Federal law allows parents to elect to report the interest income of their child on the parents return. Beginning in 2008, this federal option applies to a child who is: Under age 19, or Age and a full-time student at the end of the year. Beginning in 2010, California conforms to federal law for elections made by parents reporting their child s interest and dividends. Parents may elect to report their child s income on their California income tax return by completing form FTB If you make this election, the child will not have to file a return. You may report your child s income on your California income tax return even if you do not do so on your federal income tax return. If the amount of your child s income you are reporting on your California income tax return is different than the amount you reported on your federal income tax return, enter the difference on line 21f, column B or column C and write FTB 3803 on the line 21f. Get form FTB 3803 for more information Prior to 2010, California law allowed reporting of a child s interest and dividend income on the parents return only for children under age 14. Children age 14 and above were required to file a California state income tax return if they met the minimum income tax filing requirements. 17

18 Schedule CA Line 9 Ordinary Dividends Dividends on U.S. Government Bonds and Notes If you included in your federal AGI, dividend income from: U.S. savings bonds U.S. Treasury bills, notes or bonds Bonds of U.S. territories or possessions, such as Guam, Puerto Rico, the U.S. Virgin Islands, or American Samoa you will have a subtraction on your California return. Many mutual funds invest in U.S. government obligations. They may report the income from these bonds as dividends when it is actually interest. The California 50% investment rule for U.S. government interest earned by mutual funds, explained earlier, applies to this income. Enter the amount of federal bond dividend income not taxed by California on Schedule CA - Line 9, Column B. Dividends from State and Local Bonds California State and Local Bond Dividends State bond dividend income is not taxable on the federal return. California does not tax dividend income from California state or local bonds. Since California bond dividends are not included in federal AGI, no addition or subtraction is made on the California return for California state or local bond dividend income Dividend Income on Bonds of Other States California does tax dividend income from state and local bonds of states other than California. Since dividend income from other states is not included in federal AGI, you must add dividend income from other states to your California income. Enter the amount of non-california state or local bond dividends as an addition on Schedule CA - Line 9, Column C. Dividend Income from State and Municipal Bond Funds A state or municipal bond fund is a fund that invests in bonds issued by U.S. states, territories and municipalities. If you invested in a state or municipal bond mutual fund, you should receive a Form 1099-DIV reporting your dividend income from investments in the fund. The fund should issue a year-end statement showing how much of the fund s income is allocable to each state. The percentage of the bond fund income that is not based on California bonds is an addition to income on your California return. 18

19 Enter the amount of non-california dividends as an addition on Schedule CA - Line 9, Column C. Dividend Income from a Health Savings Account (HSA) Federal law allows taxpayers to exclude from gross income dividends earned on HSAs. California does not conform. If your HSA earned dividend income during the year, you will have an addition on your California return. Enter the current year taxable dividends as an adjustment on Schedule CA, line 9, column C. Dividend Income of Children Federal law allows parents to elect to report the dividend income of their child on the parents return. Beginning in 2008, this federal option applies to a child who is: Under age 19, or Age and a full-time student at the end of the year. Beginning in 2010, California conforms to federal law for elections made by parents reporting their child s interest and dividends. Parents may elect to report their child s income on their California income tax return by completing form FTB If you make this election, the child will not have to file a return. You may report your child s income on your California income tax return even if you do not do so on your federal income tax return. If the amount of your child s income you are reporting on your California income tax return is different than the amount you reported on your federal income tax return, enter the difference on line 21f, column B or column C and write FTB 3803 on the line 21f. Get form FTB 3803 for more information Prior to 2010, California law allows reporting of a child s interest and dividend income on the parents return only for children under age 14. Children age 14 and above were required to file a California state income tax return if they met the minimum income tax filing requirements. Schedule CA Line 10 Taxable Refunds of State and Local Income Taxes Federal law taxes state and local income tax refunds if you received a tax benefit from deducting the state tax which was refunded on a prior year return. California does not tax state and local tax refunds. If you included tax refunds from California or another state in your federal AGI, you will have a subtraction on your California return. Enter the amount of refunds included in federal income as a subtraction on Schedule CA - Line 10, Column B. 19

20 Schedule CA Line 11 Alimony Received Most people will have no entry to make on this line, even if they received alimony. However, if you are a nonresident alien and received alimony that was not included in your federal income, you will have an addition. Enter the amount of alimony taxed by California that was not included in your federal AGI on Schedule CA - Line 11, Column C. Schedule CA Line 12 Business Income or Loss If you reported income from self-employment or a sole proprietorship business on Schedule C of your federal return, you may have several different adjustments because of many differences in rules affecting businesses. Depreciation Differences Depreciation is the method businesses use to write-off, over a period of years, the cost of assets they purchase. Depreciation is covered in our 1040 Tax Pro Series course Depreciation Made Easy. California does not conform to some federal rules allowing faster depreciation. In some cases, California has adopted rules at different times, or with different limits or not at all. If you have business assets in California, you should maintain separate depreciation schedules for federal and California depreciation calculations. If the amount of depreciation or amortization allowed under California law is different than the depreciation or amortization you claimed on your federal return, use FTB Form 3885A to calculate adjustments to make on Schedule CA. File Form 3885A with your California return. ACRS Depreciation Differences ACRS rules applying to assets placed in service after 1981 and before 1987, allowed accelerated depreciation for many types of assets. California allowed ACRS depreciation for residential real property only. Assets placed in service prior to 1987 may be depreciated differently on the California return. Section 179 Expense Differences Federal law allows you to expense certain depreciable assets under section 179. The following federal limits apply to assets expensed under section 179 in 2010: The deduction is limited to maximum amount of $500,000 for the year, and If the total cost of all assets placed in service for the year exceeds $2,000,000, the deduction begins to phase out. 20

21 California law allows section 179 expensing with the following lower limits: The deduction is limited to $25,000, and Phase out begins at $200,000. Bonus Depreciation Differences Federal law allows an extra 50% first year depreciation allowance for property acquired after 01/01/2007 and before 01/01/2013 for certain qualified property. Other special depreciation allowances of 30% or 50% were available for different periods between 2001 and California did not adopt these provisions. Also, federal law allows first-year depreciation for a qualified vehicle placed in service in 2010 to be increased by $8,000 if special depreciation allowance is claimed for the vehicle. California does not allow this additional depreciation. The maximum California depreciation allowed for a passenger automobile placed in service during 2010 is limited to $3,060. Depreciation of qualified leasehold improvements and qualified restaurant property acquired before 01/01/2013 IRC section 168 requires a 15-year recovery period for qualified leasehold improvements and qualified restaurant property acquired before 01/01/2013. California specifically does not conform to the federal statutory 15-year recovery period for qualified leasehold improvements and qualified restaurant property contained in IRC section 168. For California purposes, qualified leasehold improvements and qualified restaurant property must be recovered over a 39 year recovery period. (Refer to FTB Pub 1001 and FTB Summary of Federal Income Tax Changes 2008 for updated information on how California continues to not conform to federal 15-year life for leasehold and restaurant improvements through tax-year 2012.) Use form FTB 3885A to figure the adjustment to make on Schedule CA (540 or 540NR). Illustration Diego Gonzalez operates Diego Manufacturing, a sole-proprietorship. He placed assets in service for his business during the year. Diego Manufacturing shows a net profit for the year of $82,750 which is reported on Line 12 of his federal form Diego s federal and California depreciation schedules are shown next. 21

22 Federal Depreciation Schedule Description Date Cost % Bus Use Leasehold Improvements Assembly Line Sect 179 Bonus Dep Depr. Basis Life Method Rate Current Accum Dep n 2010/01/01 10, ,000 5, DB HY , /01/01 100, , EXP 0 100, ,000 Network 2010/06/30 20, ,000 10, DB HY 20 2,000 12,000 Totals 130, ,000 15,000 15, , ,250 California Depreciation Schedule Description Date Cost % Bus Use Leasehold Improvements Assembly Line Sect 179 Bonus Dep Depr. Basis Life Method Rate Current Accum Dep n 2010/01/01 10, , SL MM /01/01 100, ,000 75,000 7 EXP 0 25,000 25,000 Network 2010/06/30 20, , DB HY 20 4,000 4,000 Totals 130,000 25, ,000 29,246 39,960 The following differences between federal allowable depreciation and California depreciation must be accounted for on Diego s tax return: Qualified leasehold improvement difference o Federal 50% Bonus + first-year depreciation (15 year recovery) $5,250 o California first-year depreciation (39 year recovery) $246 5,250 - $246 = $5,004 Assembly line section 179 deduction difference o Federal $100,000 o California $25,000 $100,000 - $25,000 = $75,000 Network depreciation difference due to bonus depreciation o Federal $12,000 o California $4,000 $12,000 - $4,000 = $8,000 Total difference between California and federal depreciation: $5,004 + $75,000 + $8,000 = $88,004 22

23 Complete a California section 179 worksheet to calculate the allowable California section 179 deduction. The worksheet is comparable to Part I of 4562 but applies the California limits to the section 179 deduction rather than the federal limits. Use the Stated Depreciation Difference Worksheet to calculate the total difference between California and federal depreciation. If the difference is a positive number, you will have a California addition to income. If the difference is a negative number, you will have a California subtraction. 23

24 Complete California Form 3885A then carry the amount form Line 8b to Schedule CA (540). This illustration relates to self-employment income and shows California depreciation is $88,004 less than federal depreciation. Enter $88,004 as an addition on Line 12, Column C. Diego s net federal income from his business is $82,750. After factoring for the difference in depreciation, his net California income from his business is $170,754 ($82, ,004). 24

25 Other depreciation differences In addition to differences in bonus and section 179 deductions, California also does not conform to the federal return with regards to the following items. (Refer to the instructions for CA Form 3885 for more information.) No increase for business start-up expenses Federal law increased the amount of deductible startup expenses beginning on or after January 1, 2010 to $10,000. The deduction is reduced to the extent startup expenses exceed $60,000. California does not conform and continues to allow a deduction for startup expenses as provided for under federal rules prior to For California, deductible business startup expenses are limited to $5,000 and a phaseout applies to the extent expenses exceed $50,000. Cellular telephones remain listed property for California California does not conform to the federal removal of cellular phones and similar telecommunications equipment from the definition of listed property for tax years beginning on or after January 1, Cell phones are still considered listed property on the California return. If business use is not more than 50%, ADS rather than GDS must be applied. Business Expense Deductions There are some differences between federal and California law with regards to certain business expense deductions. FTB Pub describes many of these differences. Some important differences are as follows: No California Deduction for Expenses Paid to Clubs Which Discriminate Federal law allows a deduction for qualified business expenses incurred at clubs. California law does not allow a deduction for expenses incurred at clubs if payments were made to a club which restricts membership or the use of its services or facilities on the basis of age, sex, race, religion, color, ancestry, or national origin. Enter any amounts claimed on the federal return for expenses paid to clubs who discriminate as an addition to California income on Schedule CA - Line 12, Column C. Example: Jason Jones paid $500 for entertainment expenses at Club Macho, a men s-only dinner club. He claimed a $250 entertainment deduction (after applying the 50% limit) for the expense on his federal return. Club Macho is a club which discriminates. Jason must enter $250 as an addition to income on Schedule CA, Line 12, Column C. 25

26 Other Business Expense Differences Federal and California law also differ on many credits that are allowed for businesses. When you claim federal business credits, you may have to adjust your expense deductions, since you are not allowed to claim both a credit and a deduction for the same expenses. If California does not have the same credit, or has different limits, you may need to add back some expenses adjusted out of your federal return. Refer to FTB Pub for more information on business credits and the necessary adjustments. Schedule CA Line 13 Capital Gain or Loss Capital gains or losses are profits or losses from the sale of property such as stocks and bonds, real estate, or collectibles. Capital gains is covered in our 1040 Tax Pro course Sale of Assets and in the Basic Tax Course Under federal law, lower tax rates apply to long-term capital gains. There is no special California tax rate for long-term gains therefore California taxes long- and short-term capital gains at the same tax rates as ordinary income. Most taxpayers have no adjustments to make on this line. In some cases the asset basis used to calculate gain or loss may be different under federal and California law. You may need to research to see if adjustments to basis under California law must be made, especially if assets were moved into California from another state or depreciation has been taken. California follows federal law in limiting the capital losses deductible in a year to $3,000 ($1,500 if married/rdp filing separately), and allowing unused losses to be carried forward up to five years. However, carryforwards are not allowed if the loss is from a transaction that occurred while the taxpayer was a California nonresident. California does not allow losses to be carried back to previous tax years. Example: George moved to California in Prior to moving to California, George sold stock with a long-term loss of $10,000. George claimed the loss on his 2009 tax return. Since George had no other capital gain income in 2009 to offset his loss, he claimed a $3,000 loss on his 2009 federal return and is carrying the remaining $7,000 of loss forward to California does not allow deductions for losses sustained while the taxpayer was a California nonresident. George must enter the amount of loss claimed on his 2010 federal return as an addition to income on Schedule CA Line, 13, Column C. 26

27 Capital gain distribution income of children Federal law allows parents to elect to report the capital gain income of their child on the parents return. Beginning in 2008, this option applies to a child who is: Under age 19, or Age and a full-time student at the end of the year. California conforms to federal law for elections made by parents reporting their child s interest and dividends. Parents may elect to report their child s income on their California income tax return by completing form FTB If you make this election, the child will not have to file a return. You may report your child s income on your California income tax return even if you do not do so on your federal income tax return. If the amount of your child s income you are reporting on your California income tax return is different than the amount you reported on your federal income tax return, enter the difference on line 21f, column B or column C and write FTB 3803 on the line 21f. Get form FTB 3803 for more information. Schedule CA Line 14 Other Gains or Losses This line number of your federal Form 1040 and Schedule CA is used to report gains or losses from the sale of business property. Generally, no adjustments are made on this line. However, the California basis of your other assets may differ from your federal basis due to differences between California and federal law, especially if depreciation was taken. Therefore, you may have to adjust the amount of other gains or losses. Schedule CA Line 15 Total IRA Distributions Generally, no adjustments are made on this line. An adjustment may be required if there is a difference in the taxable amount of your distributions under federal and California law. Your IRA basis under California law may be different than under federal law if: You changed your residency status after you first began making contributions, or Your California IRA contribution deductions were different from your federal ones because of differences in your California and federal selfemployment income. You will need to re-calculate your IRA basis as if you were a California resident for all prior years. If the taxable amount using California law is: Less than the amount taxable under federal law, enter the difference as a subtraction on Line 15, Column B. 27

28 More than the amount taxable under federal law, enter the difference as an addition on Line 15, Column C. Schedule CA Line 16 Total Pensions and Annuities Generally, no adjustments are made on this line. However, Railroad Tier II benefits are a notable exception. Railroad Retirement Tier 2 benefits California does not tax Railroad Retirement Tier 2 benefits. If you received benefits reported to you on Form RRB-1099-R, enter any amount that was included in your federal AGI as a subtraction on Line 16, Column B. Additional tax on early distributions Both the IRS and California impose an additional tax, commonly referred to as the early withdrawal penalty, if you received a taxable distribution from a qualified retirement plan before the age of 59½. If you were required to report additional tax on your federal return, you may also be required to report additional tax on your California return. The additional federal tax is generally 10%. The additional California tax is generally 2.5% of the amount of the distribution included in income or 6% in the case of an early distribution from a SIMPLE plan during the first two-year period beginning on the date the taxpayer first began participation in the plan. The additional California tax is calculated and reported on Line 63 of Form 540. Schedule CA Line 17 Rental Real Estate, Royalties, Partnerships, etc. Depreciation differences Your allowable California depreciation may be different than your federal depreciation. Reasons why California depreciation may be different than federal depreciation include: The federal recovery period for commercial real estate is 39 years after May 13, California did not conform to the 39 year recovery period until 1/1/97. If you are claiming depreciation on commercial rental property placed in service between 5/13/93 and 1/1/97, you will have an adjustment on your California return. If you moved to California, your depreciable basis in property acquired before you became a California resident may be different than your federal basis. 28

29 California does not conform to special federal 30%, 50% and 100% bonus depreciation provisions. If you claimed bonus depreciation on your federal return, you will have an adjustment on your California return. In the year you claim bonus depreciation, you will have a California addition. In subsequent years you will have a California subtraction. Example 1 In 2010, Sylvester Kat installed new appliances in his residential rental property costing $2,000. He claimed $1,000 of bonus depreciation on his federal return, and $200 of MACRS depreciation making his total federal depreciation deduction $1,200. (Assume a 5-year recovery period and half-year convention applies for this illustration). California allows Sylvester to claim a MACRS depreciation deduction of $400 only. Since Sylvester s federal depreciation deduction is $800 more than his California depreciation, Sylvester must enter $800 as an addition to income on his 2010 Schedule CA, Line 17, Column C Depreciation Cost Bonus MACRS Balance to 2011 Federal 2,000 1, California 2, ,600 Example 2 For 2011 Sylvester s federal depreciation deduction for these same appliances is $320. His California depreciation deduction is $640. Sylvester s 2011 California depreciation deduction is $320 greater than his federal depreciation. Sylvester will enter a subtraction of $320 on his 2011 Schedule CA, Line 17, Column B Depreciation Cost Prior 2011 Balance to Depreciation MACRS 2012 Federal 2,000 1, California 2, Because California depreciation rules can be different than federal rules, you should maintain separate depreciation schedules for federal and California. years where your California depreciation deductions are different than your federal deductions, you will need to complete FTB Form 3885A to calculate adjustments to make on Schedule CA. File Form 3885A with your return. For Substandard housing California law does not allow deductions for interest, taxes, amortization, or depreciation expenses for substandard housing. 29

30 Substandard housing is property that has been found in violation of California state or local health and safety codes by city or county regulatory agencies. The property is considered substandard from the time a Notice of Noncompliance is issued until a Notice of Compliance is issued. You must forward copies of the notices to the Franchise Tax Board. If you had rental housing properties that were considered substandard during any part of the tax year, and you deducted expenses for them on your federal return, you will have an addition on your California return. Enter on Schedule CA, Line 17, Column C, the total of the amounts you deducted on your federal return for interest, taxes, amortization and depreciation on the substandard properties. If the properties were noncompliant for less than the full year, calculate 1/12 of the total for each month the properties were in noncompliance. Passive losses Under federal tax law, rental real estate activities are generally considered passive activities. Losses are subject to rules limiting their deductibility. (This subject is discussed in our 1040 Tax Pro Series course Passive Activity Loss Limits and Rental Income.) Under federal rules, rental real estate activities conducted by individuals considered to be real estate professionals are not considered passive activities. California does not conform to this provision. If you are a real estate professional who deducted losses on your federal return, you may need to adjust your active and passive losses on your California return. Schedule CA Line 18 Farm Income or Loss Depreciation differences As with other forms of business income already discussed in this session, you may need to make adjustments to your California return if you claimed depreciation deductions relating to farm income (or loss). California has not adopted some of the federal rules allowing faster depreciation. Other rules were adopted at different times, or with different limits. If you have farm assets in California, you should maintain two separate depreciation schedules, for the federal and California rules. For your California tax return, you may need to use FTB Form 3885A to calculate adjustments to make on Schedule CA. 30

31 Schedule CA Line 19 Unemployment Compensation California does not tax unemployment compensation. If you had unemployment compensation included in your federal AGI, you will have a subtraction on your California return. Enter the amount of unemployment compensation and paid family leave insurance included in your federal income as a subtraction on Line 19, Column B. Schedule CA Line 20 U.S. Social Security California does not tax U.S. social security benefits or the equivalent Railroad Retirement Tier 1 benefits. If you had benefits included in your federal AGI, you will have a subtraction on your California return. Enter the amount of taxable social security and Railroad Retirement Tier 1 benefits included in your federal income as a subtraction on Line 20, Column B. Schedule CA Line 21 Other Income This line is used to report other types of adjustments that apply to very few taxpayers. Some are identified by their own alphabetic line. The rest must be entered by writing a description on line 21f. Line 21 a. California lottery winnings California does not tax California lottery winnings. If you had California lottery winnings included in your federal AGI, you will have a subtraction on your California return. Enter the amount of California lottery winnings included in your federal income as a subtraction on Line 21a, Column B. Do not make any adjustment for lottery winnings from any other state. California taxes lottery winnings from other states. Also do not make an adjustment for any other gambling winnings from California, such as casino winnings. California taxes all gambling winnings except for California lottery. Both California and federal laws allow the deduction of gambling losses only up to the amount of reported gambling winnings. If you deducted California lottery losses or other gambling losses based on your California lottery winnings, you may need to reduce your California itemized deduction by the losses included in your federal itemized deductions for winnings not taxed by California. Do not make an adjustment for gambling losses not deductible on the California return on Schedule CA, Line 21a. The adjustment for losses based on winnings not taxed by California is entered on Schedule, CA Line 41 as a negative number. 31

32 Illustration Wilbur Post won $50,000 in the California Lotto. His W-2 shows he earned $80,000 of wage income and had $10,000 of federal withholdings for the year. He claimed the following expenses on Schedule A: 10,000 gambling losses, $2,000 real estate taxes, $15,000 mortgage interest, $4,000 California income tax withholding. Prepare his California return as shown next. Schedule CA Part I, Section A Line 7, Column A Enter federal wages. No entries in Columns B or C because California wages and federal wages are the same. Line 21, Column A Enter $50,000 of CA Lotto wins included in federal income. Line 21a, Column B Enter California Lotto wins as a subtraction of $50,000. Line 22, Column A Enter total federal income $130,000 Line 22, Column B Enter total California subtractions $50,000 Part I, Section B Line 37, Column A Enter total federal AGI $130,000 Line 37, Column B Enter total California adjustments $50,000 Use Part I, Section A of Schedule CA to report California additions and subtractions to federal income. Use Part I, Section B of Schedule CA to report California additions and subtractions to federal adjustment items. 32

33 Schedule CA, Line 38 (Federal itemized deductions) Gambling losses $10,000 Real estate taxes 2,000 Mortgage interest 15,000 California income tax withholding 4,000 Total $31,000 Schedule CA Part II Line 38 Federal itemized deductions from Schedule A, $31,000. (Note the allowable itemized deductions are not limited by federal AGI) Line 39 State and local income taxes deducted on Schedule A, $4,000. Line 40 Itemized deductions from Schedule A minus state taxes deducted $27,000. Line 41 Enter California adjustment to itemized deductions for gambling losses not included in California income ($10,000). California does not allow a deduction for Wilber s gambling losses because his California gambling Lotto wins are not taxed by California. (Amounts deducted on the federal return that are not deductible on the California return are entered as a negative number. CA Schedule CA Line 41 Statement is attached to describe the amount entered on Line 41.) Line 42 Enter total California itemized deductions $17,000 (31,000 from Schedule A - $4,000 CA income tax - $10,000 gambling losses for wins not taxed by CA.) Line 43 California itemized deductions can be reduced if Wilber s AGI exceeds the amounts shown for his filing status. Wilber s income is less than $162,186 so his California itemized deductions are not reduced. Line 44 Enter $17,000 (The greater of Wilber s CA itemized deductions or the allowable standard deduction for his filing status.) Carry $17,000 to Form 540, Line

34 Form 540 pg 2 Line 7 Exemption credit $99 Line 12 Wages $80,000 Line 13 Federal AGI $130,000 Line 14 From Schedule CA, Line 21a, subtract CA Lotto wins of $50,000 Lines 15 & 17 California AGI $80,000 Line 18 California itemized deductions from Schedule CA, Line 44 $17,000 Line 19 California taxable income $63,000 Line 31 California tax from tables $3,726 Line 32 Exemption credit $99 Lines 33 & 35 California tax $3,627 Line 48 California tax after credits $3,627 Line 64 California tax after other taxes $3,627 Line 71 California withholdings from W2 $4,000 Lines 91 and 93 California refund $373 34

35 California Schedule W-2 CG is attached to report wages earned by Wilber Post. STM 1 provides a description of the entry on CA Schedule CA, Line