2020 CALIFORNIA TAX UPDATE - FOR INDIVIDUALS & BUSINESS JANUARY 2021 - CLIENTWHYS PORTAL
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2020 California
Tax Update
For
Individuals
&
Business
January 2021
Jane Ryder, EA CPA2020 California Tax Update for Individuals
Table of Contents
California legislative changes 2020 .......................................................................... 1
Summary of 2020 California Budget Act ............................................................... 1
Federal CARES Act Conformity & Non-conformity ................................................ 2
Federal SECURE ACT Conformity & Non-conformity ........................................... 3
2019 California Assembly Bill 91 ............................................................................. 4
2020 Tax Year Filing Due Dates .............................................................................. 6
California Individual Income Tax Changes for 2020 ............................................... 7
California Individual Health Care Mandate .............................................................. 7
California Health Care Mandate Exemptions ........................................................... 8
California Business Updates ..................................................................................... 9
California Teleworking FAQs for Business Tax Obligations ................................... 9
California EDD Form DE-4 ..................................................................................... 10
California Taxation of Trusts ................................................................................... 10
California Tax Reminders ........................................................................................ 11
California General Conformity Provisions & Pub 1001.......................................... 12
California General Conformity Provisions for Business ......................................... 16
California AB5 and AB2257 ................................................................................... 17
Jane Ryder, EA, CPA i 2020 CA Tax Update
jane@rydergroup.net January 20212020 CALIFORNIA TAX UPDATE
California Legislative Changes 2020
California Budget Act 2020-2021
The 2020 California Budget Act, signed into law June 29, 2020, extended to sales tax
exemption for diapers and feminine hygiene products, extended the carryover period for
film credits from 6 year to 9 years, and made LLCs and limited partnerships eligible for
the first year “free” minimum tax rule, the same as corporations.
SUMMARY OF 2020 CALIFORNIA BUDGET ACT
• LLCs, Limited Liability Partnerships and Limited Partnerships are now
entitled to the first year “free” rule for tax years beginning January 1, 2021
and ending December 31, 2023. The new law is only one free year per entity, so
if the LLC uses the free year as an LLC then switches to S-Corp status, for
example, they don’t get another free year. Also, be careful of entities formed out
of state that need to register with California Secretary of State, if they register
late, they don’t get the first year free.
• The California Earned Income Tax Credit (EITC) and Young Child Credit has
been expanded to taxpayers that use an Individual Taxpayer Identification
Number (ITIN) rather than a Social Security number for taxpayers with at least
one child age 5 or younger.
• California Net Operating Losses for 2020, 2021, and 2022 for medium and
large businesses with AGI or net income of $1,000,000 or more have been
suspended to raise revenue.
• Business incentive tax credits may not offset more than $5 million of tax
liability for 2020, 2021, and 2022.
• California used car dealers are now required to remit sales tax to the
Department of Motor Vehicles with the registration fees. This makes a lot of
sense, it doesn’t actually raise taxes and it keeps the car dealerships from
holding the money for several months at a time.
Jane Ryder, EA, CPA 1 2020 CA Tax Update
jane@rydergroup.net January 2021FEDERAL CARES ACT: CALIFORNIA CONFORMITY
• Stimulus payments individuals received from the federal government (i.e.,
$1,200 [$2,400 for individuals filing a joint return] and $500 per qualifying child)
under the federal CARES Act are not taxable to California.
• The emergency increase in unemployment compensation benefits (in the
amount of $600 per week) that individuals received under the federal CARES
Act are not taxable to California.
• California conforms to the federal early withdrawal penalty waivers for
distributions from qualified retirement accounts under the CARES Act. This
includes spreading the income over three years and repaying the amounts
withdrawn.
• California conforms to the federal RMD waivers for 2020 for taxpayers
reaching age 70 ½ prior to 2020, including those who did not take their first RMD
before January 1, 2020 and including inherited IRAs.
• California conforms to the 60 rollover of Section 529 plan contributions
FEDERAL CARES ACT: CALIFORNIA NON-CONFORMITY
• California does not conform to the increased retirement plan loan amounts
of $100,000 per person.
• California does not conform to deductible IRA contributions for taxpayers
over age 70 ½.
• Modifications for federal net operating losses (NOLs) in the CARES Act are
not applicable to California for income tax or franchise tax purposes.
• Suspension of the federal business loss limitations in the CARES Act are not
applicable to California for income tax or franchise tax purposes.
• The correction of federal treatment of 15 year recovery property
implemented with the CAREs Act does not apply to California. California has
never had bonus depreciation nor have they ever enacted shortened recovery
periods for real property.
Jane Ryder, EA, CPA 2 2020 CA Tax Update
jane@rydergroup.net January 2021• California does not conform to the federal expansion of tax free tuition
benefits to include employer payments of an employee’s student loans.
• California currently does conform to the CARES Act as written regarding
PPP forgiveness loans. Congress has passed federal legislation with CCA
mandating expenses paid with PPP forgiven loan funds will be fully deductible for
federal tax purposes. California is not expected to conform. In September 2020
California enacted AB 1577 confirming that PPP loans which are forgiven are not
COD income and therefore the underlying expenses paid with those funds are
not deductible. If California had maintained the position that the forgiven portion
of PPP loans is COD income, then taxpayers who could demonstrate insolvency
would actually have a completely free loan for California purposes.
• California business taxpayers will not recognize income related to payroll
tax credits for paid sick leave and paid family leave nor will they be required
to reduce wages and other payroll costs such as health insurance costs
associated with the federal Employee Retention Credit.
• California business taxpayers should consider any deferred employer
payroll taxes when calculating 2020 expenses for cash basis taxpayers.
FEDERAL SECURE ACT: CALIFORNIA CONFORMITY
As a general rule California conforms to most federal retirement plan tax provisions to
avoid having retirement plans fail State compliance regulations and thus have the effect
of invalidating an otherwise eligible retirement plan.
California conforms to following retirement plan provisions of the SECURE Act:
• Increasing age for RMDs from 70 ½ to 72, for taxpayers turning 70 ½ after
December 31, 2019.
• Increased RMD rules for inherited IRA’s
• Allowing pooled retirement plans for unrelated employers
• Broadening the rules for determining earned income by permitting certain
non-tuition student payments for graduate and postdoctoral students and other in
home support services (IHSS) compensation to be qualified earned income for
the purposes of funding retirement plans.
Jane Ryder, EA, CPA 3 2020 CA Tax Update
jane@rydergroup.net January 2021• Expanding the definition of employees who are eligible to participate in
retirement plans to include long-term, part-time employees.
• Extending the due date to establish retirement plans.
2019 California Assembly Bill 91
Loophole Closure & Small Business & Working Families Tax Relief Act of 2019
Assembly Bill 91 raised the AGI limit for the CA Earned Income Tax Credit, created the
Young Child Tax Credit, conformed, with modifications, to several federal TCJA tax
provisions and disallowed a separate state election for certain qualified stock
purchases.
SUMMARY OF AB 91:
Go to California Legislative Information website for more information about AB 91
CA Earned Income Tax Credit: Increases the maximum adjusted gross income
limitation for eligible individuals up to $30,000.
CA Young Child Tax Credit: A new refundable Young Child Tax Credit of up to
$1,000 per year is available for families eligible for CA EITC.
ABLE Accounts and Qualified 529 Plan Distributions: Some modified federal
conformity has been approved to increase the amount of earnings that can be
contributed to the ABLE account and allows rollovers between Section 529 plan
accounts and other Section 529 accounts and ABLE accounts.
These changes also eliminated some differences in the qualification criteria for
ABLE accounts and qualified education expenses paid from 529 plans under
federal tax law and California tax law. Tax free distributions from 529 plans may
now include computer equipment, software, and internet expenses if these
expenses primarily benefit the beneficiary while attending a qualified institution.
Jane Ryder, EA, CPA 4 2020 CA Tax Update
jane@rydergroup.net January 2021 Student Loan Debt Discharge Due to Death or Disability: Some modified
federal conformity has been approved related to the exclusion from an
individual's gross income the amount of student loan indebtedness discharged on
or after December 31, 2018 due to the death or total and permanent disability of
the student.
CA NOL Carrybacks: California net operating losses (NOL) may no longer be
carried back by individual and corporate taxpayers for NOLs attributable to
taxable years beginning after December 31, 2018. California’s carry over period
is 20 years, while federal is unlimited. With TCJA federal limited the NOL carried
forward to 80% of taxable income each year, California did not conform to this
limit. 2020 UPDATE: California has suspended NOL carryovers for
businesses or individuals with federal AGI or business net profit exceeding
$1,000,000.
Excess Business Loss: Some modified federal conformity has been adopted
related to the limitation on business losses from a non-corporate taxpayer for
taxable years beginning after December 31, 2018. This provision will treat any
disallowed excess business loss as a "carryover excess business loss" for the
following taxable year. 2020 UPDATE: California has NOT changed these
2019 regs as were changed by the federal CAREs Act.
Tax Deferred Exchanges: Conforms, with modifications, for exchanges on or
after January 10, 2019, to the limitation on deferral of recognition of any gain or
loss through a Like-Kind exchange to the exchanges of real property. Individual
taxpayers whose income does not exceed $250,000 for single or married filing
separate ($500,000 married filing joint, head of household or surviving spouse)
are exempt from the new real property limitation.
Exemption from Recording Inventory: Small businesses with average annual
gross receipts for 3 preceding taxable years not exceeding $25,000,000 are
exempt from the provisions requiring a taxpayer to take inventories to clearly
determine their income.
Jane Ryder, EA, CPA 5 2020 CA Tax Update
jane@rydergroup.net January 2021 Cash Method of Accounting: Small businesses may use the cash method of
accounting if average annual gross receipts for the 3 preceding taxable years do
not exceed $25,000,000. (Also, applies to corporations engaged in farming.)
Certain Direct, Indirect, Inventory or Capitalized Costs: Taxpayer with
average annual gross receipts for the 3 previous taxable years of $25,000,000 or
less are now exempt from the provisions that preclude the deduction of certain
direct and indirect costs and determine whether those property costs are
inventory costs or are capitalized.
Percentage of Completion Accounting Method: Taxpayers with average
annual gross receipts not exceeding $25,000,000 are exempt from the
requirement that the taxable income from a long-term contract be determined by
the percentage of completion method.
Repeal of Technical Termination of a Partnership: Conforms to federal law
repealing a provision that caused a technical termination of a partnership
resulting from the sale or exchange of 50% or more of the interest in a
partnership within a 12-month period. It is operative for taxable years beginning
on or after January 1, 2019.
Stock Purchases Treated as an Asset Acquisition: A separate state election
is no longer needed for certain stock purchases treated as asset acquisitions, or
where a taxpayer is deemed to have made an election under Section 338(e) of
the Internal Revenue Code, relating to deemed election where the purchasing
corporation acquires assets of the target corporation.
Tax Year 2020 Tax Filing Due Dates
Federal Individual & Trust April 15 falls on a Thursday in 2021 so the Individual,
FBAR and Trust tax deadlines will be Thursday, April 15, 2021 for 2020 calendar year
filers. California conforms to the April 15, 2021 federal due date. October 15, 2020
falls on a Friday for the 2020 Form 1040 extensions.
Federal Business Entities Federal due dates for pass through business tax returns
were changed beginning with the 2016 tax year. For tax year 2020 entities such as
Jane Ryder, EA, CPA 6 2020 CA Tax Update
jane@rydergroup.net January 2021Partnerships and LLC’s filing Form 1065 and S-Corporations and LLC’s filing Form 1120-S March 15, 2021 falls on a Monday and the due date for calendar year C- Corporations filing Form 1120 will be April 15, 2021. California Individual Income Tax Changes for 2020 Head of Household Beginning with tax year 2019, California will be analyzing the information on Form 3532 when the return is processed. If the answers provided on Form 3532 do not indicate the taxpayer qualifies for the HOH filing status or if Form 3532 is missing from a Form 540 tax return selecting HOH filing status California will issue a Notice of Tax Return Change (NTRC) denying the HOH filing status. The Notice of Tax Return Change will include a change in tax due or refund immediately. In previous years the taxpayer would have only received a Notice of Proposed Assessment (NPA), which the taxpayer could then have remedied by submitting Form 3532. Medical Expenses 2020 federal medical expenses are allowed as an itemized deduction if they exceed 7.5% of AGI. California conforms, the limit remains at 7.5% for California. California Individual Health Care Mandate Effective January 1, 2020 California is implementing their own new Minimum Essential Health Care Coverage Individual Mandate. Covered California will begin mailing letters to over 2,000,000 households in January 2020 advising residents of the new law, and possible penalties and exemptions related to the new law. Individuals who fail to maintain qualifying health insurance will owe a penalty unless they qualify for an exemption. Covered California and the Franchise Tax Board will each administer exemptions for qualifying individuals. Jane Ryder, EA, CPA 7 2020 CA Tax Update jane@rydergroup.net January 2021
Taxpayers can access a new Individual Shared Responsibility Penalty Estimator at
ftb.ca.gov/healthmandate to assess their potential costs for forgoing the new mandate.
California residents who do not have coverage for themselves and their dependents in
2020, and who do not qualify for an exemption, will pay a penalty of $750/adult or more
and $375/minor, or 2.5% of their or gross income over the filing threshold for their filing
status, whichever is higher. The penalty for a married couple without coverage can be
$1,500 or more and the penalty for a family of four with two dependent children could be
$2,250 or more.
A short gap coverage exemption will apply for taxpayers who did not have coverage for
3 consecutive months or less. (The federal short gap coverage exemption was for not
having coverage less than 3 consecutive months.)
Exemptions processed by FTB and Covered California
Exemptions Processed
Exemptions Claimed on State Tax Return by Covered California
• Income is below the tax filing threshold • Religious conscience
• Health coverage is considered unaffordable exemption
(exceeded 8.24% of household income for the • Affordability hardship
2020 taxable year) • General hardships
• Families’ self-only coverage combined cost is
unaffordable Visit Covered California for
• Short coverage gap of 3 consecutive months more details.
or less
• Certain non-citizens who are not lawfully
present
• Certain citizens living abroad/residents of
another state or U.S. territory
• Members of health care sharing ministry
• Members of federally-recognized Indian tribes
including Alaskan Natives
Jane Ryder, EA, CPA 8 2020 CA Tax Update
jane@rydergroup.net January 2021Exemptions processed by FTB and Covered California
Exemptions Processed
Exemptions Claimed on State Tax Return by Covered California
• Incarceration (other than incarceration
pending the disposition of charges)
• Enrolled in limited or restricted-scope Medi-
Cal or other coverage from the California
Department of Health Care Services
BUSINESS UPDATES
California has posted FAQs related to teleworking:
Will California treat a corporation that had no previous connections with
California as doing business if it has an employee who is currently teleworking in
California due to Executive Order N-33-20?
No. California will not treat an out-of-state corporation whose only connection to
California is the presence of an employee who is currently teleworking in California due
to Executive Order N-33-20 as being actively engaged in a transaction for the purposes
of financial or pecuniary gain or profit. Also, California will not include the compensation
attributable to an employee who is currently teleworking due to Executive Order N-33-
20 in the minimum payroll threshold set forth in California Revenue & Taxation Code
section 23101(b)(2)(4).
For California franchise tax purposes, what is doing business?
For California franchise tax purposes, corporations are required to file a tax return and
are subject to the minimum franchise tax if they are doing business in California. "Doing
business" means that a corporation has sufficient connections to California so that the
corporation has availed itself of the benefits provided by the state that it can be fairly
subject to the taxing authority of the state. Visit Doing business in California for more
information.
Jane Ryder, EA, CPA 9 2020 CA Tax Update
jane@rydergroup.net January 2021What activities might result in a corporation being considered as doing business
in California? Generally, a corporation will be considered as doing business in
California if the corporation has actively engaged in any transaction for the purpose of
financial or pecuniary gain or profit. Accordingly, the corporation's connections to
California do not need to be extensive in order for it to be considered as doing business
for California franchise tax purposes. If the minimum thresholds for sales, property and
payroll attributed to California are exceeded, a corporation will be considered as doing
business in California.
CA EDD Form DE-4, Employee’s Withholding Allowance Certificate
Beginning January 1, 2020, California’s Form DE-4, Employee’s Withholding Allowance
Certificate, will be required for wages paid to new employees or for employees wishing
to adjust their CA income tax withholding (PIT). Substantial changes to the new IRS
Form W-4, Employee’s Withholding Certificate, do not allow employees to designate
their withholding allowances therefor it no longer qualifies to be used for California
personal income tax (PIT) withholding purposes.
New employees and employees wishing to adjust their CA income tax withholding (PIT)
will now fill out a federal Form W-4 and a California Form DE-4. If an
employee’s withholding allowances for California PIT are unknown, the employer must
use “Single” “Zero” (S-0) for California PIT withholding purposes.
CALIFORNIA TAXATION OF TRUSTS
In September 2020 the California Franchise Tax Board issued information to clarity how
California taxes trusts. A recent court case, Steuer v. Franchise Tax Board, also known
as the Paula Trust Case, affirmed that a trust’s entire California source income is
subject to California taxation, regardless of the residency of the trust’s fiduciaries.
California Franchise Tax Board announcement states that in order for California to tax
the income of a trust one or more of three separate elements must be present:
1) The trust must have income from California sources
2) A trustee of the trust must be a California resident
3) A non-contingent beneficiary of the trust must be a resident of California.
Jane Ryder, EA, CPA 10 2020 CA Tax Update
jane@rydergroup.net January 2021California Tax Reminders Delayed Form 1099-G, State Tax Refund Some timely filed returns, filed later in the year close to the October 15 filing deadline, may require additional FTB review and validation. If this happens, there may be a hold on the return past the year in which it was filed. This hold may affect a refund and cause it not to be paid to the taxpayer until the following calendar year. Form 1099-G will be issued for the year the taxpayer actually receives the refund, which may not correspond to the taxable state refund reported with our tax filing software. Tax practitioners are advised to ask clients for copies of their 1099-Gs to confirm the projected refund was received in the year expected. Tax Deferred Exchanges: California Property for Non-California Property Like-Kind Exchanges For taxable years beginning on or after January 1, 2014, California requires taxpayers who exchange property located in California for like-kind property located outside of California, and meet all of the requirements of the IRC Section 1031, to file an annual information return with the Franchise Tax Board (FTB). For more information, get form FTB 3840, California Like-Kind Exchanges, or go to ftb.ca.gov and search for like kind. Amending California Form 540 For taxable years beginning on or after January 1, 2017, Schedule X, California Explanation of Amended Return Changes, replaced California Form 540X, Amended Individual Income Tax Return. To amend a Personal Income Tax (PIT) return for taxable years 2017 or later, file a corrected form (540, 540 2EZ, 540NR) with the “Check here if this is an amended return” box checked, and include the completed Schedule X. For tax year 2017 to present, only include these following two items: • A corrected form (540, 540 2EZ, 540NR), with supporting documents • Schedule X Do not include a copy of your original return. This may cause a delay in the processing of your amended return. Additionally, starting with tax year 2017, amended returns may be e-filed when the tax software supports this functionality. Jane Ryder, EA, CPA 11 2020 CA Tax Update jane@rydergroup.net January 2021
CALIFORNIA CONFORMITY GENERAL PROVISIONS FTB Publication 1001, Supplemental Guidelines to California Adjustments, is updated annually to summarize federal and California conformity issues. Generally, California Revenue and Taxation Code (R&TC) conforms to federal IRC as of the specified date of January 1, 2015, with modifications. There are continuing differences between California and federal law. When California conforms to federal tax law changes, they do not always adopt all of the changes made at the federal level. CONFORMING PROVISIONS Start-up expenses (IRC Section 195) California conforms to the federal treatment of start-up expenses under IRC Section 195 for tax years beginning on or after January 1, 2011. Federal law increased the deduction for start-up expenses under IRC Section 195 from $5,000 to $10,000 and the phaseout threshold from $50,000 to $60,000 for tax year 2010 but California conforms as of 2011. IRA Recharacterization Federal law repealed the rules permitting IRA recharacterization. California conforms. 401-K Retirement Loan Default Due to Job Termination Federal law now permits a taxpayer who defaults on a 401K loan due termination of service from the employer who sponsored the 401K to repay or rollover the balance of the outstanding loan by the extended due date of the applicable year tax return. California conforms. CONFORMING PROVISIONS WITH MODIFICATIONS ABLE Accounts and Qualified 529 Plan Distributions Some modified federal conformity has been approved to increase the amount of earnings that can be contributed to the ABLE account and allows rollovers between Section 529 plan accounts and other Section 529 accounts and ABLE accounts. These changes also eliminated some differences in the qualification criteria for ABLE accounts and qualified education expenses paid from 529 plans under federal tax law and California tax law. Tax free distributions from 529 plans may now include computer equipment, software, and internet expenses if these expenses primarily benefit the beneficiary while attending a qualified institution. Jane Ryder, EA, CPA 12 2020 CA Tax Update jane@rydergroup.net January 2021
Small Employer Health Insurance Credit Federal allows a credit for small employers who provide health coverage for their employees. For federal purposes, the taxpayer must reduce the insurance deduction for the amount of the credit. For California purposes, the full amount of insurance is deductible. Research credit Federal law allows a credit for research expenses and requires that the deduction for research expenses be reduced by the amount of the credit allowed. California conforms to federal law, but requires the amount of research expenses to be reduced by the amount of the California credit. In addition, California law requires the use of the California tax bracket when determining the elective credit amount. NON-CONFORMING PROVISIONS California Schedule CA for 2019 was redesigned again and is now three pages to accommodate the latest differences in California law related to TCJA. The 2020 Schedule CA has not been released yet. INCOME ITEMS Alimony The changes under the TCJA repealed the alimony deduction for agreements executed after December 31, 2018 and repealed the inclusion of alimony received in gross income. California does not conform. Qualified 529 Plan Distributions for K-12 Education Under TCJA, 529 Plan distributions for primary and secondary school education are tax free. California does not conform. Capital assets The TCJA amended IRC Section 1221 excluding a patent, invention, model or design (whether or not patented), and a secret formula or process held by the taxpayer who created the property (and certain other taxpayers) from the definition of a capital asset. California does not conform. Deferral and exclusion of capital gains in qualified opportunity zone funds The TCJA established Opportunity Zones. IRC Sections 1400Z-1 and 1400Z-2 provide a deferral of inclusion of gross income for capital gains reinvested or invested in a qualified opportunity zone fund, and exclude capital gains from the sale or exchange of an investment of such funds. California does not conform. Jane Ryder, EA, CPA 13 2020 CA Tax Update jane@rydergroup.net January 2021
ITEMIZED DEDUCTION ITEMS Itemized Deductions Phase out California does not conform, the itemized deductions phase out is still applicable for California. Medical Expenses 2020 federal expenses are allowed as an itemized deduction if they exceed 7.5% of AGI, which actually has federal conforming to California. State and Local Taxes (SALT) TCJA suspended any state and local income tax, property tax, sales tax, and deductible car registration taxes that exceed $10,000 ($5,000 if married filing separately). California does not conform. Home mortgage interest The TCJA limited the mortgage interest deduction for acquisition debt from a maximum $1,000,000 ($500,000 for married filing separately) to $750,000 ($375,000 for married filing separately) for loans incurred after December 15, 2017. California does not conform. Federal law suspended the deduction on up to $100,000 ($50,000 for married filing separately) for interest on home equity indebtedness, unless the loan is used to buy, build, or substantially improve the taxpayer’s home that secures the loan. California does not conform. Casualty and theft losses The TCJA suspended the personal casualty and theft loss deduction, with exception for personal casualty gains. Federal allows a deduction for personal casualty and theft loss incurred in a federally declared disaster. California does not conform. California allows personal casualty and theft loss and disaster loss deductions. If you have personal casualty and theft loss and/or disaster loss, complete federal Form 4684 using California amounts Jane Ryder, EA, CPA 14 2020 CA Tax Update jane@rydergroup.net January 2021
Charitable Contributions The previous 50% AGI limitation on cash contributions to public charities and certain private foundations has been increased to 60%. California does not conform. College athletic seating rights Federal law no longer allows a charitable deduction for amounts paid to an institution of higher education in exchange for college athletic seating rights. California does not conform. Unreimbursed employee expenses Under federal law, the deduction for miscellaneous itemized deductions subject to the 2% floor is suspended. California does not conform. Tax preparation fees Under federal law, the deduction for miscellaneous itemized deductions subject to the 2% floor, such as tax preparation fees is suspended. California does not conform. Other Miscellaneous Expenses Under federal law, the deduction for miscellaneous itemized deductions subject to the 2% floor, such as investment advisor fees, legal fees, etc. is suspended. California does not conform. ADJUSTMENTS TO INCOME Educator expenses Federal law allows a deduction for teachers, instructors, counselors, principals, or aides for K-12 grades. California does not conform. Moving expenses California does not conform to the TCJA regarding the suspension of the deduction for moving expenses, except for members of the Armed Forces on active duty. Non-military taxpayers prepare federal Form 3903, Moving Expenses, using California amounts. Self-employed health insurance deduction Federal law allows a deduction for medical coverage of your adult children. For California, adult children who provide more than one-half of their own financial support in the year are not qualified for the deduction. Jane Ryder, EA, CPA 15 2020 CA Tax Update jane@rydergroup.net January 2021
BUSINESS ITEMS Limitation on deduction of business interest Under the TCJA, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjustable taxable income. California does not conform. Limitation on Wagering Losses/Professional Gamblers Under the TCJA, all deductions for expenses incurred in carrying out wagering transactions, and not just gambling losses, are limited to the extent of gambling winnings. California does not conform. Sexual harassment settlements Under the TCJA, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement. California does not conform. Real Estate Professionals – Material participation in a rental real estate activity Beginning with the 1994 tax year and for federal purposes only, rental real estate activities conducted by persons in a real property business are not automatically treated as passive activities. California did not conform to this provision and these activities are still considered passive under California law. Meals and Entertainment Business Expenses TCJA disallowed business expenses for entertainment and limited the deduction for employee meals provided for the convenience of the employer. California does not conform. Listed Property Federal law removed home computers, laptops and other computer equipment from “listed property”. California does not conform. Section 179 Depreciation and Bonus Depreciation Federal Section 179 expensing has been increased to $1,000,000 and the eligible assets has been expanded to include certain improvements and equipment installed on commercial property plus personal property used to furnish rental property provided lodging. Bonus depreciation was increased to 100% for assets placed in service after September 27,2017. California does not conform. Jane Ryder, EA, CPA 16 2020 CA Tax Update jane@rydergroup.net January 2021
Luxury Auto Limits Luxury auto limits for vehicles placed in service after 12/31/2017 has been increased substantially. California does not conform. Section 83i Election Section 83(i) allows certain “qualified employees” of privately held companies an opportunity to elect to defer federal income taxes from the exercise of stock options and/or settlement of restricted stock units (RSUs) for up to five years. By making a Section 83(i) election within 30 days of the exercise of the option or the settlement of the RSU, employees defer federal income taxes with respect to the stock received upon exercise or settlement (deferral stock) until the earliest of several events. California does not conform. AB5 and AB2257 2020 California AB2257 California Assembly Bill 2257 New California legislation, AB 2257, introduced amendments to AB5 to exempt certain creative workers, including “writers, photographers, videographers, photo editors, and illustrators,” acknowledging the “existing flexibility California has allowed in the music industry while protecting the right for musicians to have basic employment protections just like every other worker.” A total of 109 categories of workers are exempt from the ABC test in California under AB 2257. However, even after significant lobbying efforts some industries must still meet the ABC test, these include the California trucking industry, the gig economy companies, and the motion picture and television industries, among others. In addition to exempting other occupation above, AB 2257 also clarified exemptions to the ABC test for certain business relationships. The Business-to-Business Exemption AB 2257 clarifies the business to business exemption by specifying the terms required in a written contract, confirms that business service provider’s residence is a permissible place of business, and limits the type of work materials that must be provided by the business service provider. Jane Ryder, EA, CPA 17 2020 CA Tax Update jane@rydergroup.net January 2021
“Single-Engagement” Business-to-Business Exemption
AB 2257 creates a “single-engagement” exemption from the ABC test for “a stand-alone
non-recurring event in a single location, or a series of events in the same location no
more than once a week.” The new bill indicates requirements that must be met for the
engagement to be eligible for the “single-engagement” exception.
Other Industry Exemptions
AB 2257 also added other exemptions to the ABC test for other business categories;
The Entertainment/Music Industry Exemption, The Referral Agency Exemption, and The
Professional Services Exemption were added to the new bill.
2019 California AB5
California Assembly Bill 5
Assembly Bill 5 was passed in the California legislature to codify, essentially to take the
opportunity to write in to law, the California Supreme Court decision in the Dynamex
Case to adopt “the ABC test” for the purposes of determining whether a worker should
legally be considered an employee.
ABC TEST
Under the ABC test, a worker will be considered an employee, not an independent
contractor, unless the hiring entity can demonstrate that the worker/hiring entity
relationship meets all three of the following requirements:
A: The individual is free from the control and direction of the hiring entity in
connection with the performance of the work, both under the contract for the
services and in fact
B: The individual performs work that is outside the usual course of the hiring
entity’s business
C: The individual is customarily engaged in an independently established trade,
occupation, or business of the same nature as that involved in the work
performed.
BORELLO TEST
Generally, the ABC test will apply for the purposes of evaluating the classification of
most workers. However, some jobs and industries will continue to have the worker’s
classification evaluated by the Borello Test.
Jane Ryder, EA, CPA 18 2020 CA Tax Update
jane@rydergroup.net January 2021Occupations where the Borello test applies instead of the ABC test under Labor
Code section 2750.3:
• Certain licensed insurance agents and brokers
• Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or
veterinarians
• Certain licensed attorneys, architects, engineers, private investigators and
accountants
• Certain registered securities broker-dealers or investment advisers or their
agents and representatives
• Certain direct salespersons
• Certain licensed commercial fishermen (only through December 31, 2022 unless
extended by the Legislature)
• Certain newspaper distributors or carriers (only through December 31, 2020
unless extended by the Legislature)
Occupations or contracting relationships where Labor Code section 2750.3
requires that additional requirements must first be met in order to
use the Borello test instead of the ABC test:
• Certain professional services contracts for marketing; human resources
administration; travel agents; graphic design; grant writers; fine artists; enrolled
agents licensed to practice before the IRS; payment processing agents; still
photographers/ photojournalists; freelance writers, editors, or newspaper
cartoonists; licensed barbers, cosmetologists, electrologists, estheticians, or
manicurists (manicurists only through December 31, 2021). Borello applies to
determine whether the individual is an employee of the hiring entity if initial
requirements are met.
Jane Ryder, EA, CPA 19 2020 CA Tax Update
jane@rydergroup.net January 2021• Certain individuals performing work under a subcontract in the construction
industry, including construction trucking (with certain specific conditions
applicable to construction trucking only through December 31, 2021). Borello and
Labor Code section 2750.5 apply to determine whether the individual is an
employee of the contractor if initial requirements are met.
• Certain service providers who are referred to customers through referral
agencies to provide graphic design, photography, tutoring, event planning, minor
home repair, moving, home cleaning, errands, furniture assembly, animal
services, dog walking, dog grooming, web design, picture hanging, pool cleaning
or yard cleanup. Borello applies to determine whether the service provider is an
employee of the referral agency if initial requirements are met.
• Certain individuals performing services pursuant to a third party’s contract with a
motor club to provide motor club services. Borello applies to determine whether
the individual is an employee of the motor club if initial requirements are met.
• Certain bona fide business-to-business contracting relationships. Borello applies
to determine whether the business providing services is an employee of the
business contracting for the services if initial requirements are met.
For two specific industries, special rules under Labor Code section 2750.3 require
examination under the Business and Professions Code:
• Certain real estate licensees, for whom the test of employee or independent
contractor status is governed by section 10032(b) of the Business and
Professions Code. (If that section is not applicable, then Borello is the applicable
test for purposes of the Labor Code, except ABC will be the applicable test for
purposes of workers’ compensation as of July 1, 2020.)
• Certain repossession agencies, for which the determination of employee or
independent contractor status is governed by Section 7500.2 of the Business and
Professions Code.
Jane Ryder, EA, CPA 20 2020 CA Tax Update
jane@rydergroup.net January 2021Both the Borello test and the ABC test assume that the worker is an employee and the hiring entity must prove that the worker is an independent contractor. However, the ABC test is designed to make it easier for both businesses and workers to determine in advance whether a worker is an independent contractor or an employee. In other words, it is aimed at being more predictable than the multifactor approach used under Borello. Unlike the ABC test — in which the inability of the hiring entity to demonstrate any part of the three-part test means that the worker is not an independent contractor — under the Borello test, no single factor determines whether a worker is an employee or an independent contractor. Courts consider all potentially relevant factors on a case-by- case basis in light of the nature of the work, the overall arrangement between the parties and the purpose of the law. Borello is referred to as a “multifactor” test because it requires consideration of all potentially relevant facts – no single factor controls the determination. Courts have emphasized different factors in the multifactor test depending on the circumstances. Workers Qualifying as Independent Contractors A common source of exposure for hiring entities in payroll audits are groups of employees that perform services similar to or closely aligned with a main business activity of the firm. I have had three separate EDD payroll audits for unrelated firms; A court reporting S-Corp, an event contractor Schedule C who builds temporary stages and sets up audio visual and lighting for specific events, and a mechanical engineer S- Corp. We prevailed in all three audits after spending a great deal of time substantiating each of the independent contractors being paid by these three entities, all of whom were doing the work specifically related to the services the firms were providing to their clients, were all running their own business and providing services to other firms. Both test “C” of the ABC test and certain specific factors of the Borello test support a hiring entity’s right to hire true independent contractors and be free of worry and exposure for liability in the event of an employee classification audit. Jane Ryder, EA, CPA 21 2020 CA Tax Update jane@rydergroup.net January 2021
If the hiring entity is relying on the case that “independent contractor”
relationship actually exists it’s preferable to have the hiring entity consider the
following:
Pay the business entity whenever possible, even if it’s a “dba”, where possible
avoid paying John Smith if you can pay “Smith’s Web Design”. Even better pay
Smith Web Design, LLC.
With some exceptions, the hiring entity should not require a specific person to do
the work. If your “contractor” is truly independent he may have his own employee
do some or all of the work.
In choosing new workers consider hiring the applicant that can substantiate they
are providing similar services for other firms. Do they have a website, a business
card, provide their own tools and supplies?
The hiring entity should consider requiring independent contractors to submit
invoices for payment. A firm may require invoices weekly or bi-monthly and a
contractor may be paid on a straight hourly basis, these payment schedules or
method of calculating the contractor’s compensation do not invalidate the
contractor status simply because the payment dates align with payroll dates.
Penalties for Misclassification
In addition to penalties that may be assessed for wage violations associated with a
worker being misclassified as an independent contractor, there are civil penalties for
willful misclassification. Under Labor Code section 226.8, which prohibits the willful
misclassification of individuals as independent contractors, there are civil penalties of
between $5,000 and $25,000 per violation. Willful misclassification is defined
as voluntarily and knowingly misclassifying an employee as an independent contractor.
Generally, reclassified employees will cause the employer to bare the costs for ALL
payroll taxes, the employer and the employee portions. So at a minimum 15.3% for all
wages under the FICA limit, 1% for all wages under the SDI limit, then SUI, Training Tax
and FUTA for the first $7,000 per employee per calendar year plus 6% California PIT for
any reclassified employees found not to have filed their taxes for any years under the
payroll audit.
Shareholder Reasonable Comp Audit Exposure
Be aware, EDD, not just IRS is raising shareholder reasonable comp issues in
payroll/1099 audits. I recently pointed out to one auditor that raising the shareholder’s
salary above the $36,000 he reported for the years under audit would actually cost
California money because it would lower the $236,000 net profit subject to the 1.5%
Franchise Tax and would only increase the shareholder SDI tax for California which is
only 1%. The auditor said he would not consider that issue if he felt the shareholder
under reported the wages he should have taken. I spent 2 ½ hours that weekend writing
the strongest reasonable comp support letter I could dream up and the auditor and his
manager agreed we could keep shareholder wages at $36,000 but it was a close call.
Jane Ryder, EA, CPA 22 2020 CA Tax Update
jane@rydergroup.net January 2021Payroll/1099 Audits Can be IRS or EDD Whether the EDD holds the payroll audit or the IRS holds the audit the other tax agency will follow up and will bill the employer for their agency’s taxes. These turn in to huge assessments and can be devastating for many businesses. EDD AB 5 Letters Mailed to California Businesses beginning December 2019 The California EDD began mailing letters advising businesses that AB5 is officially in effect as of January 1, 2020. The letters describe a summary of how AB5 evolved into law and describes the 3 requirements for the ABC test. The letter also provides a link to a new website Labor.ca.gov/employmentstatus. This website is very helpful and contains valuable FAQs. Tax Practitioner Caution We all have clients asking us about AB5 and perhaps trying to get us to agree with or approve of some work around or exception they’re hoping to fall back on to support their classification of some independent contractors. Try to find the name of a couple of good employment lawyers you can pass on to your clients and it’s best to avoid “helping” clients circumvent these rules or giving them the nod for their work arounds. Consider following up a meeting or phone call with an email confirming the advice you gave them so you have a record in writing of the conversation and can limit your exposure if there is a misunderstanding in the future of exactly what was said. Sample section for engagement letters: There are several compliance matters of consequence to S-Corporations including, but not limited to; Shareholder Loans, Shareholder Salary, Shareholder Health Insurance, Employee Health Insurance, Workman's Compensation Insurance, Employee Payroll Reporting, Automobile Expenses, Travel Expenses, Meals and Entertainment Expenses, Classification of Employees vs. Independent Contractors, Issuing Form 1099, Form 571-L Unsecured Property Tax on Business Furniture and Equipment, Sales Tax Reporting obligations, and filing the annual Statement of Information with the Secretary of State. You agree that your compliance in these areas is your responsibility and agree to contact my office if you have any questions or require our services regarding compliance in these or other areas. Jane Ryder, EA, CPA 23 2020 CA Tax Update jane@rydergroup.net January 2021
ABOUT THE AUTHOR Jane Ryder, EA, CPA is the owner of Brass Tax Ryder Professional Group, Inc., a full service tax and accounting firm. Brass Tax (not affiliated with Brass Tax Presentations) has been providing tax and accounting services since 1980. Jane received a BS in Business Administration (Accounting) from SDSU and is currently licensed with the California State Board of Accountancy and with the Internal Revenue Service as an Enrolled Agent. Brass Tax is a business centric practice, preparing and consulting on the preparation of Corporations, S-corporations, LLC’s, Partnerships, and Trusts. She also specializes in IRS and state agencies collection problems, payment plans, audit appeals, offers in compromise, and other compliance related issues. Jane Ryder, EA, CPA 24 2020 CA Tax Update jane@rydergroup.net January 2021
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