By Robert Steiger - Tax Counsel, Chevron Corporation
The author, Robert Steiger, is writing in his capacity as a private attorney, and not as an employee of Chevron Corporation. Accordingly, nothing contained in this Practice Insight should be construed as the official or unofficial position of Chevron Corporation or any of its affiliates.
Most states in modeling their state income tax laws conform to the Internal Revenue Code ("IRC"), subject to minor adjustments. California on the other hand has a much different tax structure with fewer deductions and credits, less amortization and depreciation in earlier years, and generally more income subject to taxation than that permitted under the federal tax system. As such, practitioners should fully understand the nuances of the California franchise/income tax system and how the state laws differ from the IRC prior to embarking on any corporate tax planning projects.ANALYSIS California only selectively conforms to the IRC.California only selectively conforms to the IRC. As such, California either directly incorporates a section from the IRC, will not explicitly incorporate the IRC section but will restate it in a manner in which it is nearly identical, will apply a completely different law, or will disregard it completely. As such, practitioners cannot necessarily rely on basic rules set forth in the IRC to determine a taxpayer's taxable income for California franchise tax purposes.
Example: The IRC provides for specific tax benefits for Foreign Sales Corporations (FSCs), Domestic International Sales Corporations (DISCs), foreign investment, or personal holding companies, foreign income tax deductions or foreign tax credits available to domestic corporations. As set forth in Cal. Rev. & Tax. Code Section 23051.5(b) California explicitly does not conform to these tax benefits and thus there may be significant differences between federal and California tax liability depending upon the facts and circumstances of the taxpayer.
Practitioners should fully understand the differences between federal and California law prior to engaging in any federal tax planning to avoid triggering a potential significant California tax liability.Some major differences between the IRC and California tax law are in the area of depreciation and amortization, consolidated returns, and elections.
Other notable differences between the IRC and California Franchise tax law are:
1) Depreciation and amortization - California does not conform to MACRs, ACRs or bonus depreciation under the IRC. California only permits straight line, declining balance, sum of the year digits or any other depreciation method prescribed under the law. See Cal. Rev. & Tax. Code Section 24349.2) Consolidated return rules - California does not conform to IRC Section 1502, et. al., permitting certain corporations to file a consolidated federal tax return. Alternatively, California corporations must file as part of a unitary group if certain requirements are met. The rules for filing a combined unitary return are much different than the consolidated return rules under the IRC (California Revenue and Taxation Code Section 25105).3) Elections - Generally, an election filed with the IRS will be deemed to be a proper election for California purposes. However, in certain circumstances (e.g., IRC Section 338), taxpayers can disregard the federal election or make a separate state election when filing their California Franchise tax return. See Cal. Rev. & Tax. Code Section 23051.5(e).
There may be a timing issue when making an election for California tax purposes that is different from the federal election.
Practitioners should be aware that there may be a timing issue when making an election for California tax purposes that is different from its federal election. For instance, a taxpayer under automatic extension making an election under IRC Section 338 for federal tax purposes is entitled to the same extension for California corporation franchise tax purposes. This is because California law expressly provides that a federal election filed with the IRS is also deemed a proper election for California purposes. However, if a taxpayer chooses to make an IRC Section 338 election for California tax purposes that is different from its federal election, it is required to make a separate election under California law. Because California does not conform to IRC Section 7805, the extension thereby provided, as interpreted by Rev. Proc. 2003-33, does not apply to extend the time for filing the separate California election. See FTB NOTICE No. 2003-9, 2003 Cal. FTB LEXIS 12 (October 24, 2003).All elections made for federal income tax purposes prior to the taxpayer becoming subject to tax in the state will apply retroactively to the taxpayer. As such, the taxpayer must abide by the prior federal election and cannot elect a different California election at the time it enters the state. Likewise, a taxpayer can not make a separate California election at the time it enters the state even if it failed to make such election for federal income tax purposes at the time of filing its originally federal return as set forth in Section 23051.5(e)(3)(B). Furthermore, there has been a movement in California to disallow retroactive elections on state amended returns particularly in those situations where the California election will differ from that reported to the IRS on its originally filed federal return.These materials are published solely as reference materials for use by attorneys and other tax professionals. They do not constitute an opinion or written advice concerning federal or state tax issues and are not written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or other applicable tax laws.
RELATED LINKS: For further information about franchise/income taxation, see:
Water's-Edge Election: Look Before You Leap and Calculate Before You Elect - A California Tax Practice Insight Commentary (Additional fees may apply / Approx. 6 pages)
For further insight into state income tax conformity with federal tax laws, LEXIS users can view:
1-3 Bender's State Taxation: Principles and Practice 3.06 - State Adjustments to Federal Taxable Income
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