2012 Tax Update for the California Professional...on the California Employment Development Department's (EDD) Small Business Employer’s Advisory Committee (SBEAC). In 2010, Vicki

2012 Tax Update for the California Professional

1/15/2013

Vicki L Mulak, EA, CFP®

2012 Tax Update for the CA Professional©

Vicki L Mulak, EA, CFP® i

Vicki is an Enrolled Agent and Certified Financial Planner (CFP®). She is

also insurance and securities licensed. Vicki is the owner of American

Financial and Tax, a tax preparation, planning and representation firm,

which was founded in Tustin, California in 1985, when Vicki became both

a resident and a business owner. Vicki assists small businesses and

individuals in a variety of tax and financial matters.

Vicki is a well-known presenter on federal and California tax law and

business entity topics. She frequently testifies before the Franchise Tax Board meetings in

Sacramento, CA and stays involved in state tax legislation sponsored by the California Society of

Enrolled Agents (CSEA), attending Assembly and Senate committee hearings as necessary. In

2010, Vicki testified with Senator Mimi Walters before the California Labor Committee assisting

in the passage of SB1244, a bill to conform California labor law affecting LLCs to federal. In

addition to her private practice, Vicki has represented the tax practitioner community since 1997

on the California Employment Development Department's (EDD) Small Business Employer’s

Advisory Committee (SBEAC). In 2010, Vicki also started serving on the California Franchise

Tax Board (FTB) Advisory Board.

Vicki regularly speaks on tax topics at CSEA continuing education events, as well as others

hosted by California Society of Tax Consultants (CSTC) and various state affiliates of the

National Association of Enrolled Agents (NAEA). She continues as faculty for CSEA’s annual

Super Seminar, and the Nevada Society of Enrolled Agents’ “Best in the West” seminar.

Vicki was honored in August 2012 with NAEA’s Bill Payne Advocacy Award in recognition of

her commitment to advocacy on behalf of Enrolled Agents. In 2011, Vicki was awarded the

“Distinguished Service Award” for enhancement of CSEA’s reputation. In 2006, she received

CSEA’s prestigious “Thomas P Hess Award” in recognition of her contributions to CSEA’s

educational goals. She appeared in December 2004 on the IRS’ web cast Tax Talk Today.

Since 1993, Vicki has worked to prepare students for the partnership and corporation section of

the Special Enrollment Exam Class through classroom instruction for the Orange County

Chapter of CSEA. She has been an Extended Education instructor for California State

University at Fullerton for their Financial Planning Certificate Program from 1997-1998. Vicki

was honored for her excellent support of the local business community in 1996 as the recipient of

the U.S. Small Business Administration’s “Accountant Advocate of the Year” award.

Vicki remains active with Practitioner Publishing Company, providing editorial services for each

annual edition of the Accounting Quickfinder desk reference book.

She received her Bachelor of Science in Business Administration degree from

Thomas Edison State College in Camden, New Jersey and resides with her husband, George, in

Tustin.


Vicki L Mulak, EA, CFP® ii

Table of Contents Partial Resolution of Fiscal Cliff .................................................................................................... 1

2010 Federal Expired Tax Provisions ............................................................................................. 2

2010 Individual Provisions ......................................................................................................... 2

2010 Business Provisions ........................................................................................................... 2

The American Taxpayer Relief Act of 2012 (ATRA 2012) ........................................................... 3

Individual Provisions with 2-Year Extensions (2012-2013) ...................................................... 3

Educator Expense $ 250 above-the-line adjustment to income .............................................. 3

State and local sales tax deduction .......................................................................................... 3

Tuition and Fees Deduction .................................................................................................... 3

Tax-free charitable distributions from IRAs ........................................................................... 4

Mortgage Insurance Premiums ............................................................................................... 4

Expanded credits for nonbusiness energy property ................................................................ 4

Individual Provisions Made Permanent (No Scheduled Expiration) .......................................... 4

Bush-Era Tax Rates ................................................................................................................ 4

AMT “patch” (including allowance of nonrefundable personal credits) ................................ 5

Marriage Penalty Relief .......................................................................................................... 5

Child Tax Credit ..................................................................................................................... 5

Expanded student loan interest deduction............................................................................... 5

Refundable adoption credit ..................................................................................................... 5

Educational Savings Accounts (ESAs) ................................................................................... 6

Business Provisions with 2-Year Extensions (2012-2013) ......................................................... 6

Research Credit [IRC § 41(h)(1)] ........................................................................................... 6

Work Opportunity Tax Credit (WOTC) [IRC § 51(c)(4)] ...................................................... 7

Differential Wage Payment Credit [IRC § 45P] ..................................................................... 7

15-year Write-off for Specialty Realty Assets [IRC § 168(e)(3) ............................................ 7

Section 179 Expensing [IRC §§ 179(b), 179(f)(1)-(f)(3)] ...................................................... 7

Enhanced Charitable Contributions [IRC § 170(e)(3)] ........................................................... 8

S Corporation Shareholder Lower Stock Basis Adjustment for Charitable Contributions

[IRC § 1367(a)(2)] .................................................................................................................. 8

S corporation Built-in Gain Recognition Period ..................................................................... 9

Expensing of Film and TV Production [IRC § 181(f)] ........................................................... 9

Domestic Production Activities for Puerto Rico [IRC § 199(d)(8)(C)] ................................. 9

Empowerment Zones [IRC § 1391(d)] ................................................................................. 10

Miscellaneous 2011 Federal Expired Provisions Extended through 2013 ........................... 10


Vicki L Mulak, EA, CFP® iii

Energy Incentives—Renewable Resources .......................................................................... 11

Federal 100% Exclusion on Small Business Stock [IRC § 1202] ........................................ 11

Business Provisions with One-Year Extensions (2013) ........................................................... 14

Bonus Depreciation [IRC §§ 168(k)(1) and 168(k)(5)] ........................................................ 14

First Year Depreciation Cap for Autos and Trucks .............................................................. 14

Section 179 for Off-the-Shelf Software ................................................................................ 15

Business Provisions Not Extended ........................................................................................... 15

2013 Filing Season Delay ............................................................................................................. 15

FTB Filing Update .................................................................................................................... 16

2012/2013 Tax Rates and Indexing .............................................................................................. 16

Federal Inflation Rate ............................................................................................................... 16

2013 Inflation-Adjustments Released (IR 2013-4, Rev-Proc 2013-15, 1/14/13) ................. 17

California Inflation Rate ....................................................................................................... 17

2012 Federal Estate and Gift Tax ............................................................................................. 17

Portability .............................................................................................................................. 17

Estate State Tax Deduction ................................................................................................... 17

GST Tax ................................................................................................................................ 17

Other Federal Items................................................................................................................... 18

Federal Individual Tax Rates .................................................................................................... 18

2012 Federal Tax Tables ....................................................................................................... 18

2013 Projected Tax Tables .................................................................................................... 20

Federal Capital Gains Rates .................................................................................................. 20

2012 California Personal Tax Rates ..................................................................................... 21

2012 Federal Corporate Tax Rates ........................................................................................... 22

2012 California Corporate Tax Rate ..................................................................................... 22

2012 Federal AMT .................................................................................................................... 23

2012 California AMT ........................................................................................................... 23

2012/2013 Federal Standard Deductions .................................................................................. 24

Federal Marriage Penalty Relief ........................................................................................... 25

2012 California Standard Deduction .................................................................................... 25

2012 Joint Custody Head of Household Credit .................................................................... 25

2012/2013 Federal Personal Exemptions.................................................................................. 25

PEP Limitation ...................................................................................................................... 26

2012 California Personal/Dependent Exemption Credit....................................................... 26


Vicki L Mulak, EA, CFP® iv

2012 California Personal Exemption Phase-Outs ................................................................. 26

2012 Federal Itemized Deductions ........................................................................................... 26

“Pease” Limitation ................................................................................................................ 26

2012 California itemized Deductions ................................................................................... 27

Other 2012 Federal Credits, Deductions, and Phase-outs ......................................................... 27

2012 California Renter’s Credit ............................................................................................ 28

2012 Federal Child and Dependent Care Credit ....................................................................... 28

2012 California Child and Dependent Care Credit ............................................................... 29

2012 California Filing Requirements........................................................................................ 29

2012 California Cost Recovery Fees ........................................................................................ 30

2012 Federal Adoption Credit .................................................................................................. 30

California Adoption Credit ................................................................................................... 30

2012 Federal Mileage Rates...................................................................................................... 31

2012 Kiddie Tax ....................................................................................................................... 31

2012 Nonbusiness Energy Property Credit (Tax Tip 2011-49) ................................................ 32

Other Federal Updates .................................................................................................................. 32

Over-the-Counter Medical ........................................................................................................ 32

FSA Medical Deferral Decreases in 2013 ................................................................................ 32

Medical Savings Accounts ........................................................................................................ 33

Health Savings Accounts (Rev-Proc 2011-32, May 13, 2011) ................................................. 33

HSA and MSA Penalties ....................................................................................................... 33

Federal ITIN Policy Change in 2013 ........................................................................................ 34

2012 Federal Long-Term Care Premium Table ........................................................................ 34

2013 Federal Pension Cost-of-Living Amounts (Notice 2012-67)........................................... 34

Tax-Exempt Organizations Update........................................................................................... 35

Additional Time for Victims of Hurricane Sandy (IRS Notice 2012-71) ............................ 35

New FBAR Filing Compliance Procedure (IR 2012-65) ......................................................... 35

Election to Treat Secured Home Mortgage Debt as Unsecured ............................................... 35

How to Make the Election CCA 201201017 ........................................................................ 36

Section 105 Medical Reimbursement Plan Update .................................................................. 36

Federal K-1 Penalties (IRC § 6698).......................................................................................... 36

California K-1 Penalties 9R&TC § § 19172, 19172.5) ........................................................ 37

Federal Education Incentives ........................................................................................................ 37

2012 American Opportunity Tax Credit ................................................................................... 37


Vicki L Mulak, EA, CFP® v

2012/2013 Federal Lifetime Learning Credit ........................................................................... 37

Student Loan Interest Deduction .............................................................................................. 37

California Student Loan Interest Deduction ............................................................................. 38

Coverdell Education Saving Accounts (ESA) .......................................................................... 38

Employer-Provided Education Assistance ................................................................................ 38

Federal Scholarships ................................................................................................................. 38

Federal Health Care Reform Update............................................................................................. 38

Federal Health Care Reform Constitutionality Upheld (June 28, 2012) .................................. 39

2009: Tax Relief for Health Care Workers in Underserved Areas .......................................... 39

2010 and 2011: Federal Adoption Credit Enhancements ......................................................... 39

2010 and Future: Health Coverage for Children under Age 27 ................................................ 39

California Conformed Late ................................................................................................... 40

After 3/23/2010 and Future: Indian Tribal Health Benefits ..................................................... 40

7/1/2010 and Future: Federal Tanning Excise Tax .................................................................. 40

2011 and Future: New Federal Rules for Workplace Health Plans ......................................... 40

2013: Two Extra Federal Medicare Taxes ................................................................................ 40

3.8% Federal Medicare Contribution Tax ............................................................................ 40

.9% Medicare Tax on Wages and SE Income....................................................................... 45

2013 and Future: Federal Schedule A Medical Expense Floor Increases to 10% ................... 46

2013: Federal Medical Device Excise Tax .............................................................................. 47

2014 and Future: Federal Penalty for Failure to Carry Health Insurance ................................ 47

State Exchanges .................................................................................................................... 47

2014 and Future: Federal Premium Assistance Refundable Credit ......................................... 47

2010 through 2015: Federal Small Business Health Insurance Credit .................................... 48

2011 and Future: Simple Cafeteria Plans................................................................................. 48

2011 and Future: W-2 Reporting of Employer-provided Health Insurance Coverage ............ 49

2012 and Future: Information Reporting –REPEALED .......................................................... 49

2013 and Future: FSA Limitation ............................................................................................ 49

2018 and Future: Excise Tax Applies to “Cadillac Plans” ...................................................... 49

2012 Employment Development Department (EDD) Update ...................................................... 50

EDD Automated Collection Enhancement System (ACES)-DIR Accounts ............................ 50

EDD Coordination with FTB Financial Institution Record Match (FIRM) ............................. 51

EDD e-Services for Business .................................................................................................... 51

California Payroll Tax Deposits................................................................................................ 51


Vicki L Mulak, EA, CFP® vi

EDD coordination with FTB re: New Jobs Credit .................................................................... 52

Joint Offer-in-Compromise Form ............................................................................................. 54

EDD Using Debit Cards for UI Benefits .................................................................................. 54

2012 Board of Equalization (BOE) Update .................................................................................. 54

Sales Tax Rates ......................................................................................................................... 54

New Tax on Sales of Wood and Lumber Products ................................................................... 55

New Lumber Products Assessment Schedule ....................................................................... 55

BOE Coordination with FTB Financial Institution Record Match (FIRM) ............................. 55

BOE Offers-in-Compromise (OIC) for Active Businesses ...................................................... 55

California Use Tax .................................................................................................................... 55

Qualified Purchasers Update................................................................................................. 56

Use Tax Look-Up Table ....................................................................................................... 56

Online Retailers ........................................................................................................................ 57

New Law ............................................................................................................................... 58

Loophole Still Exists ............................................................................................................. 59

BOE Tax Practitioner Web Page .............................................................................................. 59

Same Day Check Processing .................................................................................................... 59

2012 Franchise Tax Board (FTB) Update .................................................................................... 60

FTB Earning Withholding Order for Taxes (EWOT)............................................................... 60

Taxpayers’ Rights Advocate Authority-Erroneous Assessments ............................................. 60

California E-File ....................................................................................................................... 60

Fiduciary Return ................................................................................................................... 61

Amended Returns.................................................................................................................. 61

Prior Year Returns ................................................................................................................ 61

Electronic Deposits ................................................................................................................... 61

District of Columbia Holidays .............................................................................................. 61

California Holidays ............................................................................................................... 62

Conformity to Federal Tax Return Due Date ........................................................................... 62

California Mandatory e-Pay for Individuals ............................................................................. 62

Relief for Disabled Taxpayers .............................................................................................. 63

FTB e-Services.......................................................................................................................... 63

FTB Subscription Services ................................................................................................... 63

Refund Status ........................................................................................................................ 64

Installment Agreements ........................................................................................................ 64


Vicki L Mulak, EA, CFP® vii

FTB Web Pay ............................................................................................................................ 64

FTB Online Live Chat .............................................................................................................. 64

Systemic Issues Management Systems (SIMS) ........................................................................ 65

EDR Release 1.0.1 to Implement on December 31, 2012 ........................................................ 65

Information Return Update (1099s) .............................................................................................. 65

1099 Law Update ...................................................................................................................... 65

Repealed 1099 Law............................................................................................................... 65

1099 Law-Not Repealed ....................................................................................................... 66

TIN Solicitations ....................................................................................................................... 66

Sole Proprietor TIN............................................................................................................... 66

2012 Information Return Filing Change ............................................................................... 66

Payments to Corporations ......................................................................................................... 67

Payments to Partnerships and LLCs ......................................................................................... 67

IRS Information Reporting Publications .................................................................................. 68

Electronic Filing........................................................................................................................ 68

Testing No Longer Required ................................................................................................ 68

Best Practice Comments ....................................................................................................... 69

Recipient Copies ................................................................................................................... 69

Combined Federal/State Filing Program .................................................................................. 70

Information Return Extensions ................................................................................................. 71

Recipient Extension .............................................................................................................. 71

IRS Extension ....................................................................................................................... 72

1099 Penalties ........................................................................................................................... 73

Increased Federal Penalties ................................................................................................... 73

Federal Penalty Exceptions ................................................................................................... 74

California Penalties for Failure to File 1099s/W-2s ............................................................. 74

Backup Withholding ..................................................................................................................... 75

Federal Backup Withholding Rates .......................................................................................... 76

California Backup Withholding Rates ...................................................................................... 76

CP2100 and CP2100A Notices ................................................................................................. 76

Procedure for Missing TINs.................................................................................................. 76

Procedure for Incorrect TINs ................................................................................................ 77

First B Notice ............................................................................................................................ 77

Second B Notice ....................................................................................................................... 78


Vicki L Mulak, EA, CFP® viii

Remitting Federal Backup Withholding ................................................................................... 78

Remitting California Backup Withholding ............................................................................... 78

Affidavit of Filing Forms 1099—DE 6028P ............................................................................ 85

To Receive Credit for Backup Withholding on FTB Return .................................................... 86

California Nonresident Withholding............................................................................................. 86

Withholding Rates ................................................................................................................ 87

Payments not Subject to Withholding................................................................................... 87

California Real Estate Withholding Update ................................................................................. 87

FTB Gives Up on Property Tax Reporting ................................................................................... 88

FTB Ruling Request ................................................................................................................. 88

Is Everything Deductible (Post-Ruling)? .................................................................................. 88

IRS Fresh Start Initiative .............................................................................................................. 89

Penalty Relief ............................................................................................................................ 89

Installment Agreements ............................................................................................................ 89

Offer-in-Compromise ............................................................................................................... 89

California Relief........................................................................................................................ 89

2011-2012 California Legislation ................................................................................................. 89

LLC/LLP Update ...................................................................................................................... 90

Contractors Eligible to Form LLCs in California (SB 392) ................................................. 90

California Revised Uniform Limited Liability Company Act .............................................. 90

EDD Compliance Concern re: Contractors/ New CA LLC Act ........................................... 91

California LLC Payroll Conformity (SB 1244) .................................................................... 91

Engineers/ Land Surveyors Eligible to Form LLPs (SB 1008) ............................................ 93

AB 560 (CH 2011-291, 9/20/2011): Architect LLP Extension ............................................ 93

AB 289 (CH 2011-289, 9/20/2011): Charitable Thrift Store Sales/Use Tax Exemption ......... 93

AB 1090 (CH 2011-369, 9/30/2011): Property Tax Deferment ............................................... 93

AB 1424 (CH 2011-455, 10/4/2011) Delinquent Taxpayer Accountability Act ...................... 94

License Suspension Process Begins October 2012 ............................................................... 94

AB 397 (CH 2011-546, 10/7/2011): Worker’s Comp Re-Certification .................................. 95

AB 878 (CH 2011-686, 10/9/2011): Contractor’s Work Comp Insurance ............................... 95

AB 242 (CH 2011-727, 10/9/2011): Conformity and Other Provisions ................................... 95

AB 361 (CH 2011-728, 10/9/2011): Benefit Corporations ...................................................... 96

Flexible Purpose Corporation (California Corp Code §§ 2500-3503) .................................. 96

Benefit Corporation (California Corp Code §§ 14600-14631) ............................................. 96


Vicki L Mulak, EA, CFP® ix

AB 1307 (CH 2011-734, 10/9/2011): Seller’s Permits and Tax Delinquencies ....................... 97

SB 459 (CH 2011-706) 10/9/2011: New Penalties for Worker Misclassifications .................. 97

SB 1015 (CH 2012-37, 6/27/2012) Doctrine of Election ......................................................... 97

AB 2332 (CH 2012-203, 8/27/2012) Santa Cruz County Disaster ........................................... 98

SB 1544 (CH 2012-284, 9/7/2012) Disaster: LA/San Bernardino Counties ............................ 98

2012 Federal Disasters .......................................................................................................... 98

SB 1158 (CH 2012-382, 9/19/2012) More Disaster Assistance ............................................... 99

Federal and California Disaster Losses................................................................................. 99

2012 Volycons (Voluntary Contributions on the Tax Return) ............................................... 101

AB 233 (CH 2012-228, 9/7/2012) ...................................................................................... 101

SB 803 (CH 2012-379, 9/19/2012) ..................................................................................... 101

SB 1571 (CH 2012-459, 9/22/2012) ................................................................................... 102

SB 1359 (CH 2012-456, 9/22/2012) ................................................................................... 102

AB 1589 (CH 2012-533, 9/25/2012) .................................................................................. 102

SB 1186 (CH 2012-383), 9/19/12) New Disability Access and Education Fund Fee ............ 102

AB 318 (CH 2012-313, 9/14/2012) Corporation/LLC Equality ............................................. 102

AB 1775 (CH 2012-474) Wage Garnishment Exempt Earnings Increases ............................ 102

SB 1234 (CH 2012-734, 9/28/2012) California Secure Choice Retirement Savings Trust Act

................................................................................................................................................. 102

AB 1845 (CH 2012-783, September 29, 2012) CUIC Amendments ..................................... 103

AB 1677 (CH 2012-858, September 30, 2012) Small Tax-Exempt Threshold Conforms to

Federal Threshold ................................................................................................................... 104

2012 Form Changes .................................................................................................................... 104

2012 Federal Form Changes ................................................................................................... 104

Form 1099-B Reporting Changed for S Corporations ........................................................ 104

Form 8867 Paid Preparer’s Earned Income Credit Checklist ............................................. 104

Form 1099-K Merchant Reporting ..................................................................................... 104

Requirement for Business Reconciliation of Gross Receipts Removed ............................. 105

Backup Withholding on Merchant Reporting begins 2013 ................................................ 105

2012 Form 1099-C Changes ............................................................................................... 105

2012 California Form Changes ............................................................................................... 106

FTB 3520 Power of Attorney ............................................................................................. 106

FTB Form 3541 Motion Picture Credit .............................................................................. 107

Form 3551 Sale of Credit Attributable to an Independent Film ......................................... 107

Schedule EO Pass-Through Entity Ownership ................................................................... 108


Vicki L Mulak, EA, CFP® x

Table 3 Partner’s Share of Cost of Goods Sold, Deductions, Rental Income .................... 109

Form 592-A Payment Voucher for Foreign Partner or Member Withholding ................... 109

Form 589 Reduced Withholding Request ........................................................................... 109

FUTA Tax Complicated by Expired Surtax ........................................................................... 110

Other Conformity Items .............................................................................................................. 110

Interest Income........................................................................................................................ 110

California Interest Income Adjustments ............................................................................. 110

Principal Residence Exclusion for COD Income .................................................................... 111

Federal Legislation Alert .................................................................................................... 111

California Legislation Alert ................................................................................................ 111

QPRI Limitation.................................................................................................................. 112

California Limited Conformity ........................................................................................... 112

Insolvency Exclusion .......................................................................................................... 113

Theft Loss from Ponzi scheme ............................................................................................... 114

Community Property Rules Affect RDP Federal Returns in 2010 ......................................... 114

Federal Definition of Community Property ............................................................................ 115

Other Business Updates .............................................................................................................. 115

California Charitable Contribution Deduction for Food ......................................................... 115

California NOLs...................................................................................................................... 115

2008 NOL Legislation ........................................................................................................ 116

2010 NOL Legislation ........................................................................................................ 116

Legal Ruling 2011-04: Suspension of Net Operating Loss Deductions ............................ 117

Definition of “Doing Business” .............................................................................................. 117

California’s “Bright-Line” Tests ......................................................................................... 118

California’s Franchise Tax ...................................................................................................... 120

Rev-Proc 2011-14: Timing of Federal Deduction for State Taxes ..................................... 120

2011 California Corporation Tax Law Changes ..................................................................... 120

Single Sales Factor Election Available for 2011 ................................................................ 121

Legislative Alert.................................................................................................................. 121

Without the election ............................................................................................................ 121

With the election ................................................................................................................. 122

Public Law 86-272 and Nexus Issues ................................................................................. 122

Secretary of State Office Update ................................................................................................ 123

Secretary of State Procedure Change ...................................................................................... 123


Vicki L Mulak, EA, CFP® xi

SB 1532 (CH 2012-494) Initial Street and Mailing Address .................................................. 124

Practitioner Update ..................................................................................................................... 124

PTIN Renewal Update ............................................................................................................ 124

Consents to Disclose and Consents to Use Tax Return Information (Rev-Proc 2013-14,

December 26, 2012) ................................................................................................................ 125

Appendix ..................................................................................................................................... 126

2012 Tax Update for the CA Professional


1


Partial Resolution of Fiscal Cliff The term, “fiscal cliff” really referred to 4 items:

1. Scheduled expiration of some or all of the Bush-era tax cuts after 2012 (also

referred to as “EGTRRA Sunset”);

2. Imposition of new Medicare tax on investments and wages;

3. Inaction on the part of Congress to renew many tax extenders; and

4. Massive across-the-board federal spending cuts mandated by the Budget

Control Act of 2011.

Everything hinged on who was elected President, and what action, if any, the lame-duck

session of Congress (final days of 112th

Congress) would take after the November

election, or would it be deferred to the work of the 113th

Congress that opened session on

1/3/13.

Before the end of session in August 2012, and prior to the elections, the House and the

Senate had both passed tax-cut extension bills, but there was nothing that passed both

houses and was on to the President:

Job Protection and Recession Prevention Act of 2012 (HR 8). This House bill

extended all of the Bush-era tax cuts through 2013 along with increased

exemption amounts for the AMT. As a GOP-bill, this bill was supported by

presidential candidate Romney.

The Middle Class Tax Cut Bill (Sen. 3412). This bill also extended the Bush-era

tax cuts, but not for higher-income taxpayers, and provided increased AMT

exemption amounts. As a Democratic Party bill, this bill is supported by Obama.

What was at stake?

1. What would be the final outcome of the expiring Bush-era marginal income tax

rates on ordinary income as well as the rates on capital gains and qualified

dividends? Would they:

a. Sunset for ALL taxpayers?

b. Be extended for ALL taxpayers?

c. Sunset for higher-income taxpayers? or

d. Sunset for millionaires only?

2. Would 2013 really bring the imposition of the 3.8% Medicare tax in the

investment income of investors in higher tax brackets?



2

3. Would 2013 really bring the imposition of the .9% additional Medicare tax on

high-income wage earners and self-employed persons? And

4. Would the 2% payroll tax holiday sunset on December 31, 2012?

HR 8, The American Taxpayer Relief Act of 2012 (earlier version had been title Job

Protection and Recession Prevention Act of 2012), finalized on January 1, 2013,

answered many of the questions above. It was the final product of the 112th

Congress,

who worked over the New Year’s holiday.

The Bush-era tax cuts would be extended, except for the wealthy, which were determined

to be those at levels of $ 400,000, $ 450,000 (joint) and $ 425,000 (head of household).

The 2013 Medicare taxes would be moving forward, and the 2012 payroll tax holiday

would expire.

Additionally Medicare reimbursements to doctors would not be reduced (the “doc fix”),

milk would continue to be subsidized (“dairy cliff”) and spending cuts (mandatory

sequestration) would be postponed 60 days.

In addition, there was no reinstatement of the following provisions that expired at the end

of 2010.

2010 Federal Expired Tax Provisions The following provisions expired at the end of 2010:

2010 Individual Provisions Making Work Pay Credit (Schedule M is obsolete);

Exclusion from income for certain benefits provided to volunteer firefighters and

emergency medical responders;

Expenses for the purchase of computer technology and equipment are not allowed

as a qualified higher education expense for any qualified tuition program;

The exemption from AMT for the interest on certain tax-exempt bonds; and

The advanced Earned Income Credit.

2010 Business Provisions The increased amount for Startup expenditures; and

The Alternative Motor Vehicle Credit is not available for the following vehicles

purchased after 2010:

o Advanced lean burn technology;

o Qualified hybrid vehicles weighing 8,500 pounds or less; and

o Qualified alternative fuel vehicles.



3

The American Taxpayer Relief Act of 2012 (ATRA 2012) The following provisions were set to expire at the end of 2011, but were temporarily

reinstated or made permanent. California’s last significant conformity bill was SB 401

(CH 2010-14). SB 401 updated California’s conformity to the Internal Revenue Code as

of 1/1/09, with numerous exceptions.

Signed into law on April 12, 2010, SB 401 updated the specified date of conformity with

the Internal Revenue Code from January 1, 2005 to January 1, 2009, effective

retroactively to January 1, 2010. Although there were 100 or more conformity provisions

in SB 401, the following describes California’s general conformity at the current time:

1. California does not generally conform to any of the changes from the 2009 federal

acts that were retroactive to January 1, 2009 for federal purposes;

2. California does not conform to any 2010 federal acts (HIRE, Health Care Reform,

The Small Business Jobs Act and the Tax Relief Act of 2010);

3. California does not conform to the American Taxpayer Relief Act of 2012; and

4. There are still numerous exceptions to federal conformity.

Individual Provisions with 2-Year Extensions (2012-2013)

Educator Expense $ 250 above-the-line adjustment to income Eligible elementary and secondary school teachers may claim an above-the-line

deduction for up to $ 250 per year of expenses paid or incurred for books, certain

supplies, computer and other equipment, and supplementary materials used in the

classroom. ATRA 2012 extended the deduction for 2 years (2012 and 2013).

California has never conformed to this above-the-line deduction.

State and local sales tax deduction Taxpayers who itemize deductions may elect to deduct state and local general sales and

use taxes instead of state and local income taxes. ATRA 2012 extended this provision for

2 years (2012 and 2013).

California does not allow a deduction for state taxes.

Tuition and Fees Deduction ATRA 2012 extends this above-the-line deduction for years 2012 and 2013. The

maximum deduction has been $ 4,000 for taxpayers with AGIs up to $ 65,000

(or $130,000 for joint filers), and $ 2,000 for taxpayers with AGIs up to $ 80,000

(or $ 160,000 for joint filers).



4

Note: Taxpayers cannot claim the tuition and fees deduction in the same year that they

claim the American Opportunity Tax credit (AOTC) or the Lifetime Learning credit

(LLC). A taxpayer also cannot use the tuition and fees deduction if anyone else claims

the AOTC or LLC for the student in the same year.

California has never conformed to the tuition and fees deduction.

Tax-free charitable distributions from IRAs ATRA 2012 allows for a two-year extension (through December 31, 2013) the provision

allowing tax-free distributions from IRAs to public charities by individuals age 70 ½ or

older, up to $ 100,000 per taxpayer per year. ATRA 2012 allows:

Taxpayers to recharacterize distributions made in January 2013 as made on

December 31, 2012; and

Taxpayers to treat an IRA distribution made in December 2012 as a charitable

distribution, if transferred to charity before February 1, 2013.

California conforms to this provision since it is related to a retirement plan account.

Mortgage Insurance Premiums ATRA 2012 extends the deduction for mortgage insurance premiums as deductible

mortgage interest through 2013.

California has never conformed to the deduction for mortgage insurance premiums.

Expanded credits for nonbusiness energy property ATRA 2012 extends several energy tax incentives, primarily business-related incentives.

ATRA 2012 extends the $ 500 lifetime credit for energy efficiency improvements to an

existing residence (IRC § 25C) through December 31, 2013.

California does not conform to federal nonbusiness energy property incentives.

Individual Provisions Made Permanent (No Scheduled Expiration)

Bush-Era Tax Rates The 2012 individual rates are 10%, 15%, 25%, 28%, 33% and 35%.

The scheduled rates for 2013 were 15%, 28%, 31%, 36% and 39.6%. ATRA 2012 makes

permanent for 2013 and beyond the lower Bush-era tax rates for all taxpayers, except for

taxpayers with taxable income above $400,000, $ 450,000 (joint) and $ 425,000 (head of

household). Income above these levels will be taxed at 39.6%. The 2013 rates will be

10%, 15%, 25%, 28%, 33%, 35% and 39.6%.



5

The 2012 taxpayer-favorable rates for long-term capital gains and qualified dividends are

0% for taxpayers in the 10% and 15% brackets, and 15% for all other taxpayers.

The scheduled rate for 2013 rates were the pre-2003 rates of 10% for taxpayers in the

15% bracket and a maximum 20% for all other taxpayers. ATRA 2012 only raises the

top rate for capital gains and dividends to 20% for individuals in the 39.6% bracket.

California has its own unique tax rates, which were increased retroactively for 2012.

AMT “patch” (including allowance of nonrefundable personal credits) ATRA 2012 increases the individual AMT exemption to $ 50,600 for unmarried filers

and $ 78,750 for married filers for 2012. It permanently indexes the exemption amounts

for tax years after 2011 and allows nonrefundable personal credits to reduce both regular

tax and the AMT.

California has always indexed its AMT exemptions and has never needed a “patch”.

Marriage Penalty Relief The 2010 Tax Relief Act extended the provisions that mitigate the marriage penalty for

2011 and 2012 with respect to the federal standard deduction and the 15% tax bracket.

The standard deduction for joint filers was twice the inflation-adjusted standard

deduction for single and married filing separate. ATRA 2012 extends marriage penalty

relief to the standard deduction and to the tax brackets.

California has never had a marriage penalty.

Child Tax Credit The child tax credit had been scheduled to revert after 2012 to $ 500 per qualifying child

(dependent under age 17 at the close of the year). ATRA 2012 extends permanently the

$ 1,000 child tax credit.

California has never conformed to the child tax credit.

Expanded student loan interest deduction ATRA 2012 permanently extends the suspension of the 60-monh rule for the $ 2,500

above-the-line student loan interest deduction. It also permanently expands the MAGI

range for phase-out of the deduction and permanently repeals the restriction that makes

voluntary payments of interest nondeductible.

California conforms to federal law except for a spouse/RDP of a non-California

domiciled military taxpayer residing in a community property state.

Refundable adoption credit ATRA 2012 permanently extends the Bush-era enhancements to the adoption credit and

the exclusion for employer-paid or reimbursed adoption expenses up to $ 10,000 as



6

indexed for both regular and special needs adoptions. It did not extend the Health Care

Reform enhancements for 2010 and 2011 that allowed for a refundable adoption credit.

California has its own adoption credit.

Educational Savings Accounts (ESAs) The 2012 maximum contribution is $ 2,000. The 2013 maximum contribution was

scheduled for $ 500. Further, elementary and secondary school expenses were no longer

going be qualified ESA expenses in 2013 and later.

ATRA 2012 permanently extends the $ 2,000 maximum contribution and the ability to

use the funds for elementary, secondary and post-secondary education expenses.

California conforms to federal contribution limits for ESAs.

Business Provisions with 2-Year Extensions (2012-2013) The following business provisions expired at the end of 2011 and have extended for two

years:

Research Credit [IRC § 41(h)(1)] In general, the research credit equals the sum of:

1. 20% of the excess (if any) of the qualified research expenses for the tax year over

a base amount (unless the taxpayer elected an alternative simplified research

credit);

2. The university basic research credit (20% of the basic research payments); and

3. 20% of the taxpayer’s expenditures on qualified research undertaken by an energy

research consortium.

ATRA 2012 retroactively extended the research credit for two years (2012 and 2013).

ATRA 2012 liberalizes the rules for persons that acquire the major portion of either a

trade or business of another person. For purposes of calculating the credit, the amount of

expenses paid or incurred by the acquiring person during the measurement period is

increased by certain expenses of the predecessor, and the gross receipts of the acquiring

person for such period is increased by certain gross receipts of the predecessor. The

measurement period is, with respect to the tax year of the acquiring person, any period of

the acquiring person preceding such tax year which is taken into account for purposes of

determining the credit for such year [IRC §§ 41(f)(3)(A) and 41(f)(3)(B)].

ATRA also revised the rules for allocating research credit amount members of a

controlled group (IRC § 41(F)(1)(a)(ii)].

California has its own research credit, with different rules than federal.



7

Work Opportunity Tax Credit (WOTC) [IRC § 51(c)(4)] This credit allows employers who hire members of certain targeted groups to take a credit

against income tax of a percentage of first-year wages up to $ 6,000 per employee

($ 12,000 for qualified veterans; and $ 3,000 for qualified summer youth employees).

When the employee is a long-term family assistance recipient, the WOTC was a

percentage of first and second year wages, up to $ 10,000 per employee.

ATRA extended the WOTC so that it applies to eligible veterans and nonveterans who

begin work for the employer before January 1, 2014 (2012 and 2013).

California does not conform to the WOTC. California does have certain hiring

credits in Enterprise Zones.

Differential Wage Payment Credit [IRC § 45P] Eligible small business employers that paid differential wages could claim a 20% credit

up to $ 20,000 of differential pay paid to an employee during the year. Differential

wages were payments to employees for periods that they were called to activity duty with

the US uniformed services (more than 30 days), that represented all or part of the wages

they would have otherwise received from the employer.

ATRA 2012 extended this credit for two years for differential wages paid through

December 31, 2013 [IRC § 45P(f)].

California does not conform to this credit.

15-year Write-off for Specialty Realty Assets [IRC § 168(e)(3) Qualified leasehold improvement property, qualified restaurant property and qualified

retail improvement property placed in service after December 31, 2011 was scheduled to

no longer eligible for 15-year depreciation write-off under MACRS, but would have been

depreciated over 39 years.

ATRA 2012 retroactively extends the 15-year MACRS life for two years (2012 and

2013) for qualified leasehold improvement property, qualified restaurant property and

qualified retail improvement property.

California never conformed to this provision.

Section 179 Expensing [IRC §§ 179(b), 179(f)(1)-(f)(3)] The maximum amount that could be expensed under IRC § 179 for tax years beginning in

2010 and 2011 was $ 500,000, with a $ 2,000,000 investment ceiling.

For tax years beginning in 2012, the maximum amount was scheduled for $ 139,000,

with a $ 560,000 investment ceiling on the purchase of qualifying property. Off-the-

shelf computer software was qualifying property if placed in service on or before

December 31, 2012.



8

The maximum IRC § 179 deduction was scheduled to drop to $ 25,000 for 2013 with a

$ 200,000 investment ceiling.

Additionally, if qualified leasehold improvement property, qualified restaurant property

or qualified retail improvement property was placed in service during 2010 and 2011, the

property was eligible for Section 179 expensing up to $ 250,000 per year.

ATRA 2012 Extensions ATRA 2012 retroactively increased Section 179 deductions for years beginning in 2012

from $ 139,000 to $ 500,000. Effective for years beginning in 2013, ATRA 2012

increases the scheduled maximum Section 179 deduction from $ 25,000 to $ 500,000.

The investment limit for both 2012 and 2013 for phase-out is restored to $ 2,000,000.

ATRA 2012 extends the expensing of up to $ 250,000 for the costs of qualified leasehold

improvement, qualified restaurant property, and qualified retail improvement property for

2012 and 2013. Off-the-shelf software continues as qualifying property through 2013.

For tax years beginning in 2014, the maximum Section 179 will drop to $ 25,000 with an

investment limit of $ 200,000.

The California maximum Section 179 deduction remains at $ 25,000 and the limit

for qualifying property for Section 179 continues, with no change, at $ 200,000.

Enhanced Charitable Contributions [IRC § 170(e)(3)] The following enhanced charitable contribution rules were scheduled to not apply to

contributions made after December 31, 2011:

C corporation’s enhanced charitable contribution of food inventory that is

wholesome food;

C corporation’s enhanced charitable contribution of book inventory to certain

public schools; and

C corporation’s enhanced charitable contribution of computer technology or

equipment to schools or libraries for educational purposes.

ATRA 2012 retroactively extends the wholesome food contribution rules for two years,

for contributions made before January 1, 2014. It did not extend the enhanced deduction

for contributions of books or computer technology. These provisions have expired.

California never conformed to this provision.

S Corporation Shareholder Lower Stock Basis Adjustment for Charitable Contributions [IRC § 1367(a)(2)] A temporary incentive (PPA 2006) allowed shareholders to reduce their basis in their S

corporation stock by their pro-rata share of the basis of the property the S corporation

contributed to a charity, rather than the FMV of the charitable contribution that flowed



9

through the K-1 for deduction on Form 1040. For example, if in 2011 an S corporation

with one shareholder made a charitable contribution of stock with a basis of $ 100 and a

FMV of $ 500, the shareholder would be able to deduct $ 500 on his/her tax return, but

only reduce basis in his/her stock by $ 100.

This provision had expired at the end of 2011, but ATRA 2012 extends this provision for

two years, so that it applies for contributions made in tax years beginning before

January 1, 2014.

California conformed to this special basis adjustment rule (SB 401-Conformity Act

of 2010).

S corporation Built-in Gain Recognition Period A C corporation that converts to an S corporation generally must hold any appreciated

assets for 10 years following the conversion or, if disposed of earlier, pay tax on the

appreciation at the highest corporate rate (currently 35%). ARRA 2009 and SBJA 2010

temporarily shortened the usual 10-year holding period as follows:

If the 5th

anniversary of the S election date occurred prior to the 2011 tax year, the

built-in gains tax does not apply in 2011; and

If the 7th

anniversary of the S election date occurred prior to either the 2009 or

2010 tax year, the built-in gains tax does not apply in 2009 or 2010.

ATRA 2012 extends the 5-year recognition period for tax years beginning in 2012 or

2013. Effectively, an S corporation is no longer liable for a built-in gains tax if their

S election incurred prior to 1/1/07 for gains realized in 2012 or prior to 1/1/08 for gains

realized in 2013.

California maintains the 10-year recognition period.

Expensing of Film and TV Production [IRC § 181(f)] Taxpayers could elect to expense production costs of qualified film and TV productions

in the US (expenses not exceeding $ 15 million or $ 20 million in certain cases), but only

for productions commencing before January 1, 2012.

ATRA 2012 extended this provision for two years (2012 and 2013).

California has its own Motion Picture Credit.

Domestic Production Activities for Puerto Rico [IRC § 199(d)(8)(C)] The domestic production activities deduction (DPAD) was available for six years (2006-

2011) for qualifying activities in Puerto Rico, if all of the taxpayer’s Puerto Rico-sourced

gross receipts were taxable under the federal income tax for individuals or corporations.



10

The domestic production activities deduction for Puerto Rico expired at the end of 2011.

ATRA 2012 extends this provision for two years through 2013.

California does not conform to IRC § 199 deduction.

Empowerment Zones [IRC § 1391(d)] Empowerment Zone designations had expired on December 31, 201, which had included

the following special tax provisions for Empowerment Zones:

1. 20% wage credit under IRC § 1396;

2. Liberalized Section 179 expensing provisions in contrast to other taxpayers re:

amounts and limitations;

3. Tax-exempt bond financing under IRC § 1394; and

4. Deferral under IRC § 1397B of capital gains on sale of qualified assets sold and

replaced.

ATRA 2012 extends the empowerment zone designation for two years, through

December 31, 2013. Additionally, ATRA 2012 extends for two years, though

December 31, 2018, the period for which a higher percentage exclusion applies for

certain qualified small business stock of empowerment zone businesses

(IRC § 1202(a)(2)].

California does not conform to empowerment zones, but rather has special

incentives for Enterprise Zones.

Miscellaneous 2011 Federal Expired Provisions Extended through 2013 The following provisions (not exhaustive list) were also extended:

New Markets Tax Credit;

The 7-year straight-line cost recovery period for motorsports entertainment

complexes [IRC § 168(i)(15)(D)];

The Indian Employment Credit [IRC § 45(A)(f)];

The Railroad Track Maintenance Credit [IRC § 45G(f)];

The Mine Rescue Team Training Credit [IRC § 45N(e)];

Election to expense advanced mine safety equipment [IRC § 179E(g)];

New York Liberty Zone tax-exempt bond financing;

Increase in the limit on cover over of rum excise taxes to Puerto Rico and the

Virgin Islands [IRC § 7652(f)];

Accelerated depreciation for qualified Indian reservation property [IRC § 168(j);

and

American Samoa Economic Development Credit [Sec 119 of P.L. 109-432 as

amended by Sec 756 of P.L. 111-312].

California does not conform to these expired provisions, but has unique business

credits.



11

Energy Incentives—Renewable Resources ATRA 2012 extends through 2013 the IRC § 45 production tax credit for facilities that

produce energy from wind facilities. ATRA 2012 excluded recycled paper from the

definition of municipal solid waste.

Other energy tax incentives that were extended through the end of 2013 are:

Credits for alternative fuel vehicle refueling property;

Credits for cellulosic biofuel production;

Credits for biodiesel and renewable diesel;

Production credits for Indian coal facilities;

Credit for energy-efficient new homes;

Credit for energy-efficient appliances;

Allowance for cellulosic biofuel plant property;

Special rules for sales of electric transmission property; and

Tax credits and outlay payments for ethanol.

ATRA 2012 did not extend:

Credits for refined coal facilities;

Percentage depletion for oil and gas from marginal wells; and

Grants for certain energy property in lieu of tax credits (from ARRA 2009).

Federal 100% Exclusion on Small Business Stock [IRC § 1202] IRC §§ 1202 and 1045 provides for the exclusion or deferral of gain from the sale or

exchange of qualified small business stock (QSBS). IRC § 1202 provides that taxpayers

(other than corporations) can exclude 50% of any gain from the sale or exchange of

qualified small business stock (QSBS) issued after August 10, 1993, and held for more

than five years. When the 50% exclusion applies, the remaining 50% of the gain is taxed

at a 28% capital gain rate [IRC § 1(h)(5) and (8)]. Thus, the entire gain is taxed at an

effective rate of 14% (50% of gain taxed × 28% rate). Since 7% of the excluded gain is

an AMT preference item, the QSBS exclusion is less attractive while the regular 15%

capital gains rate is currently about the same as the QSBS rate.

QSB stock is domestic C corporation stock, acquired by the taxpayer at its original issue

in exchange for money or property. The domestic C corporation’s aggregate gross assets

cannot exceed $ 50 million and at least 80% of assets are used in the active conduct of

one or more qualified businesses, which is any business except businesses in the fields of

health, law, engineering, architecture, accounting, actuarial science, performing arts,

consulting, athletics, financial services, brokerage services, or any business where the

principal asset of the business is the reputation or skill of one or more of its employees.

Additional disqualified businesses include ones involved in banking, insurance,

financing, leasing, investing, farming (including raising or harvesting of trees), business



12

extracting or producing natural resources eligible for percentage depletion, hotels, motels

and restaurants.

Temporary Increases in the Federal Exclusion The 2010 Small Business Jobs Act enhanced the exclusion of gain from qualified small

business stock to non-corporate taxpayers. For stock acquired after September 27, 2010

and before January 1, 2011, and held for at least five years, the 2010 Small Business Jobs

Act provided an exclusion of 100 percent. The 2010 Tax Relief Act extended the 100%

exclusion for one more year, for stock acquired before January 1, 2012. On

January 1, 2013, the American Taxpayer Relief Act of 2012 extended the 100%

exclusion through the end of 2013. In addition, none of the excluded gain is treated as a

tax preference item for AMT purposes, so stock gains qualifying for the 100% exclusion

will be received completely tax free! Since the investor must hold the stock for 5 years,

stock purchased in 2011 must be held until 2016 before it is eligible for the enhanced

exclusion.

For qualified small business stock acquired after February 17, 2009 and before

January 1, 2011, the American Recovery and Reinvestment Act of 2009 increased the

50% gain exclusion to 75%. As a result of the increased exclusion, gain from the sale of

qualified small business stock acquired during the applicable time period is taxed at a

maximum effective rate of 7% under the regular tax (25% of the gain taxable at 28%

yields the equivalent of 100% of the gain taxable at 7%).

In addition to exclusion provisions, both federal and California law allow for deferral of

gains through re-purchase of more eligible small business stock within 60 days.

California Exclusion Beginning in 1993, California adopted its own stand-alone QSBS provisions (R&TC

18152.5) dealing with exclusions, which generally mirrored existing federal law. The

California exclusion is 50% of the gain on the sale of qualifying small business stock

originally issued after August 10, 1993 that was held for more than 5 years. California

has required corporations to file Form FTB 3565 Small Business Stock Questionnaire, if

the corporation qualified as a “qualified small business” and issued stock during the

current taxable year. In 1998, California adopted its own standalone QSBS provision

dealing with deferrals.

California also did not conform to the federal increase in exclusion to 75% for stock

acquired after February 17, 2009 or to the 100% exclusion for stock acquired after

September 27, 2010 and before January 1, 2011.

California’s Two 80% Rules However, California’s R&TC §§ 18152.5 and 18038.5 required that at least 80 percent of

the company's payroll at the time the stock was purchased must be within California and



13

80 percent of assets and payroll must be within California during the taxpayer's holding

period for the stock in order to qualify for a QSBS gain exclusion or deferral.

Unconstitutionality Upheld in Court of Appeals In August 2012, these provisions in California law regarding the 80 percent asset and

payroll requirements were found to be unconstitutional by the California Second District

Court of Appeal in Cutler v. Franchise Tax Board (FTB). The Appeal Court held that

because the purpose and effect of California’s qualified small business stock statutes is to

favor California corporations—those with property and payroll primarily within

California—over their foreign competitors in raising capital among California residents,

the statutes are discriminatory and cannot stand under the commerce clause of the US

Constitution.

The Franchise Tax Board determined that because the Court of Appeal held that R&TC

§§ 18152.5 and 18038.5 are unconstitutional, these sections are now invalid and

unenforceable and the appropriate remedy is to deny the exclusions and deferrals to

taxpayers who benefited from either. It is important to note that the court's decision in

Cutler did not change the federal treatment of QSBS.

FTB Notice 2012-03 On December 21, 2012, FTB released their legal decision based on the outcome of the

Cutler decision. In FTB Notice 2012-03, FTB states that ALL taxpayers will be denied

the small business stock exclusion for all years still open under the statute of limitations

beginning with 2008.

Taxpayers, who used the small business stock exclusion, can either:

1. Wait for a correspondence from Franchise Tax Board, increasing their tax balance

from the denied code sections; or

2. Voluntarily amend their returns.

Although R&TC § 19142(b)(1) allows an exception to the estimated tax penalty when a

change is due to a provision of the law that is chaptered during the year, it does not apply

to changes due to the application of court decisions. Interest will apply on amounts due.

Important Caution for 2008 Returns Under R&TC § 19116, interest may be suspended where a proposed deficiency notice is

not issued within 36 months of the original due date of the return or the date the original

or amended return was filed, whichever is later. Since the due date of the 2008 return is

more than 36 months ago, taxpayers should wait for FTB to make the adjustment by

issuing a Notice of Proposed Assessment (NPA) rather than voluntarily filing an

amended return. If a taxpayer voluntarily files an amended return to include the



14

previously excluded QSBS gain when more than 36 months have elapsed since they filed

their 2008 return, no interest suspension would be allowed by law.

FTB will automatically compute any applicable interest suspension amount on a

proposed deficiency assessment. To qualify for interest suspension for 2008, taxpayers

should compute the additional tax and pay this amount as a tax deposit without filing an

amended return. The amount paid will be applied against the tax liability shown on the

FTB’s NPA. Interest suspension will then apply to the periods after the expiration of 36

months from the date the original return was filed and the date that the FTB issues its

NPA.

FTB has posted FAQs on their website at:

https://www.ftb.ca.gov/law/Qualified_Small_Business_Stock_and_Cutler_Decision.shtml

Business Provisions with One-Year Extensions (2013) ATRA 2012 creates an extension through 2013 for the following business provisions:

Bonus Depreciation [IRC §§ 168(k)(1) and 168(k)(5)] 100% bonus depreciation, previous to ATRA 2012, applied only for qualified property

acquired and placed in service after September 8, 2010 and before January 1, 2012

(placed in service before January 1, 2013 for certain aircraft and long-production-period

property).

For property acquired and placed in service after December 31, 2011 and before

January 1, 2013 (placed in service after December 31, 2012 and before January 1, 2014

for certain aircraft and long-production-period property), a 50% bonus depreciation

allowance only applies.

ATRA 2012 Extensions ATRA 2012 did not extend 100% bonus depreciation. Instead, ATRA 2012 extends 50%

bonus depreciation to qualified property acquired and placed in service before

January 1, 2014 (before January 1, 2015 for certain property).

Additionally, ATRA 2012 retroactively revives and extends 50% bonus depreciation for

qualified leasehold improvement property [IRC § 168(e)(3)(E)(iv)], qualified restaurant

property (IRC § 168(e)(3)(E)(v)] or qualified retail improvement property

[IRC § (e)(3)(E)(ix)], if placed in service before January 1, 2014.

California never conformed to federal bonus depreciation.

First Year Depreciation Cap for Autos and Trucks The $ 8,000 boost in first-year depreciation (bonus) wasn’t available for cars and trucks

purchased after 2012.

https://www.ftb.ca.gov/law/Qualified_Small_Business_Stock_and_Cutler_Decision.shtml



15

ATRA 2012 extends the placed-in-service deadline for qualified property to

December 31, 2013 (December 31, 2014 for aircraft and long-production-period

property).

For qualifying vehicles the 2013 maximum first-year depreciation is $ 11,160 ($ 3,160

plus $ 8,000). For light trucks or vans, the 2013 maximum first-year depreciation is

$ 11,360 ($ 3,360 plus $ 8,000).

California does not conform to federal additional first-year depreciation.

Section 179 for Off-the-Shelf Software Previous to ATRA 2012, off-the-shelf computer software was qualifying property if

placed in service on or before December 31, 2012. Due to the passage of ATRA 2012,

off-the-shelf software continues as qualifying property through 2013.

Business Provisions Not Extended The following provisions were not extended:

100% bonus depreciation; and

C corporation contributions of:

o Book inventory

o Computer technology.

2013 Filing Season Delay Internal Revenue Service issued IR 2013-2 on January 8, 2013 informing the public that

late legislation (ATRA 2012) will delay the start of filing season. There are two types of

taxpayers who can file as follows:



16

FTB Filing Update Franchise Tax Board is in the process of updating their forms instructions for ATRA

2012 differences.

2012/2013 Tax Rates and Indexing

Federal Inflation Rate The 2012 federal inflation rate that has adjusted the 2012 standard deductions, etc. is

2.58%, which was less than had been expected (3.8%).

The US Tax Code has required inflation adjustments to federal income tax brackets since

the late 1980s, with an increasing number of inflation adjustments to other tax items until

over 650 other inflation-driven computations to determine deduction, exemption and

exclusion amounts in addition to the tax brackets exist in the IRC. Health-related

indexing begins in 2013.



17

2013 Inflation-Adjustments Released (IR 2013-4, Rev-Proc 2013-15, 1/14/13) The IRS recently released inflation-adjusted amounts for 2013. These amounts will be

included as appropriate throughout this material. Rev-Proc 2013-15 is expected to be

available in the Federal Register on January 28, 2013.

California Inflation Rate The inflation rate, as measured by the California Consumer Price Index (CCPI) for all

urban consumers from July 1, 2011 to June 30, 2012 was 1.9% (down from 2.7%). The

2012 personal income tax brackets are indexed by this amount.

2012 Federal Estate and Gift Tax Notable for 2012 is that the estate tax exemption will be inflation adjusted. Set at

$ 5 million for 2011 and 2012 under a temporary compromise at the end of 2010 (TRA

2010), the $ 5 million amount is adjusted 2.4% for inflation in 2012, and is $ 5,120,000,

which is the portion of an estate exempt from the current 35% estate tax.

Also, if the executor chooses to use the special use valuation method for qualified real

property, the aggregate decrease in the value of the property resulting from the choice

cannot exceed $1,040,000, up from $1,020,000 for 2011.

The annual gift exclusion remains at $13,000 for 2012, increasing to $ 14,000 for 2013.

For 2013 and later, ATRA 2012 permanently extends the unified estate and gift regime

that was in effect in 2012, with the exception that a rate of 40%, rather than the 35% rate

in effect for 2012, applies. The 2013 estate and gift tax exemption is $ 5,250,000 million.

ATRA 2012 averted a return to pre-Bush era rate of 55% with a $ 1 million exemption.

Portability ATRA 2012 makes permanent portability provisions between spouses. Portability had

previously expired at the end of 2012. Portability allows the estate of a decedent who is

survived by a spouse to make an election to permit the surviving spouse to apply the

decedent’s unused exclusion to the surviving spouse’s own transfers during life and

death.

Estate State Tax Deduction Before 2005, a credit was allowed against the federal estate tax for state estate

inheritance, legacy, or succession taxes. EGTRRA repealed the state death tax credit for

decedents dying after 2004 and replaced the credit with a deduction. ATRA extends the

deduction for state estate taxes.

GST Tax ATRA 2012 extends the current generation-skipping transfer tax for decedents dying and

transfers made after December 31, 2012. The 2013 GST exemption will also be $ 5

million (indexed), with a 40% rate.



18

Other Federal Items The monthly limit on the value of qualified transportation benefits exclusion for

qualified parking provided by an employer to its employees for 2012 rises to $240,

up $10 from the limit in 2011. However, the temporary increase in the monthly limit

on the value of the qualified transportation benefits exclusion for transportation in a

commuter highway vehicle and transit pass provided by an employer to its

employees decreased to $125 for 2012. ATRA 2012 retroactively extends the

employer-provided exclusion for 2012 and 2013. It is unclear how anyone could

take advantage of the 2012 increase. The 2013 exclusion is $ 245 per month;

The child tax credit is $ 1,000 for 2012, and phases-out for taxpayers with incomes

exceeding $ 110,000 (joint filers) and $ 75,000 (single filers). ATRA 2012

permanently extends the Bush-era enhancements to the dependent care credit. The

current 35% credit rate is made permanent along with the $ 3,000/$ 6,000 cap on

expenses.

Details on 2012 inflation adjustments can be found in Revenue Procedure 2011-52,

which was published in Internal Revenue Bulletin 2011-45 on November 7, 2011.

Federal Individual Tax Rates Unless the Bush-era tax cuts are extended, the reduced individual income tax rates were

scheduled were scheduled to be replaced with higher rates. The 2012 individual rates are

10%, 15%, 25%, 28%, 33% and 35%.

The scheduled rates for 2013 were 15%, 28%, 31%, 36% and 39.6%. ATRA 2012 makes

permanent for 2013 and beyond the lower Bush-era tax rates for all taxpayers, except for

taxpayers with taxable income above $400,000, $ 450,000 (joint) and $ 425,000 (head of

household). Income above these levels will be taxed at 39.6%. The 2013 rates will be

10%, 15%, 25%, 28%, 33%, 35% and 39.6%. IRS updated 2013 withholding tables on

1/3/2013 (IR 2013-1).

2012 Federal Tax Tables

http://www.irs.gov/file_source/pub/irs-drop/rp-11-52.pdf



19



20

2013 Projected Tax Tables

Federal Capital Gains Rates The 2012 taxpayer-favorable rates for long-term gains are 0% for taxpayers in the 10%

and 15% brackets, and 15% for all other taxpayers.

The scheduled rate for 2013 rates were the pre-2003 rates of 10% for taxpayers in the

15% bracket and a maximum 20% for all other taxpayers. ATRA 2012 only raises the

top rate for capital gains and dividends to 20% for individuals in the 39.6% bracket. All

other taxpayers will continue to enjoy a capital gain and dividend rate at a maximum of

15%, when income is in a bracket of 25% or greater, but less than the thresholds where

the 39.6% rate applies. A 0% rate will also continue to apply to the extent income falls

below the top of the 15% bracket.

As such, the concept of “qualified” dividends, scheduled to end in 2012, continues and

qualified dividends will not be subject to ordinary income tax rates beginning in 2013.



21

The 28% rate for collectibles and the 25% rate for 1250 gains continue unchanged after

2012.

2012 California Personal Tax Rates The previous California tax rates of 2%, 4%, 6%, 8% and 9.3% still apply, but three new

brackets have been added by ballot measure (Proposition 30) to apply retroactively to

January 1, 2012. The three new rates are 10.3%, 11.3% and 12.3%. (See revised table

below). The higher rates are scheduled to be in effect for seven years.

2012 CA Underpayment Penalty Waived Taxpayers are not required to “catch-up” for the Proposition 30 tax increase in the first 3

quarters by increasing the fourth quarter estimate. Taxpayers will not receive an

underpayment penalty to the extent the underpayment was created or increased by

Proposition 30 [R&TC §§ 19136(2)(g)(1) and 19142(b)(1)]. Taxpayers may pay the

balance due with the filing of their tax return. Only the portion of the underpayment due

to the tax increase will be eligible for the penalty waiver.



22

The 1% mental health tax continues to apply for taxpayers with taxable incomes of more

than $ 1 million. California has never had a preferential rate for capital gain income or

qualified dividend income.

2012 Federal Corporate Tax Rates The federal tax rates for 2012 remain unchanged from 2011:

2012 California Corporate Tax Rate

Mandatory Single Sales Factor (SSF) Begins in 2013 Proposition 39 requires that taxpayers use a single sales factor apportionment formula to

apportion income from multistate tax activities to California, beginning with tax years

beginning on or after January 1, 2013. Since 2011, taxpayers have been able make an

annual election to use the SSF apportionment formula rather than the standard double-

weighted sales apportionment formula based on property, payroll and sales factors.

Apportioning trades or businesses that derive more than 50% of their gross business

receipts from one or more qualified business activities (agricultural, extractive, savings

and loan, and banking or financial business activities) will continue to apportion their

business income to California by multiplying such income by the equally-weighted three-

factor model.



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Taxpayers are required to use the market-based sourcing rules for purposes of sourcing

sales of other than tangible personal property. Special sourcing rules are also adopted for

cable companies that are part of a qualified combined reporting group that makes an

investment of at least $ 250 million in qualified expenditures in California.

Special Rules for Special Industries There are special rules for certain industries regulated by R&TC §§ 25137-25137-14

(agricultural, extractive, savings and loan, banking or financial business) when making an

SSF election.

Note: See detail on market-based vs. cost of performance sourcing rules under the

heading 2011 California Corporation Tax Law Changes.

2012 Federal AMT ATRA 2012 provides permanent AMT relief by increasing the exemption mounts and

allowing nonrefundable personal credits to offset a taxpayer’s regular and AMT tax.

ATRA 2012 provides for an annual inflation adjustment to the exemption amount for

years beginning after 2012.

The 2012 federal AMT exemption amounts are:

Married exemption: $ 78,750 (Phase-out $ 150,000)

Single/HOH exemption: $ 50,600 (Phase-out $ 115,000)

MFS: $ 39,375 (Phase-out: $ 75,000)

Estates and trusts $ 22,500 (Phase-out: $ 75,000)

The recently announced 2013 federal AMT exemption amounts are below. ATRA 2012

begins the indexing of the phase-outs:

Married exemption: $ 80,800 (Phase-out: $ 153,900)

Single/HOH exemption: $ 51,900 (Phase-out: $ 115,400)

MFS: $ 40,000 (Phase-out: $ 76,950)

Estates and trusts: $ 23,100 (Phase-out: $ 76,950)

2012 California AMT California’s AMT rate for individuals is 7%. Unlike the federal AMT, which needs a

“patch” each year, California has indexed their AMT since 1999, so the California AMT

does not affect middle class taxpayers like the federal AMT.



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The 2012 California AMT exemption amounts are:

The 2012 AMT exemption phase outs are:

Note: California does not conform to IRS § 26(a), but instead allows all nonrefundable

personal credits to reduce regular tax below the tentative minimum tax. California’s

provision has no sunset date (R&TC § 17039).

2012/2013 Federal Standard Deductions

The additional standard deduction for blind people and senior citizens remains

unchanged for 2012, and is $1,150 for married individuals and $1,450 for singles and

heads of household.

Federal government statistics report that nearly two out of three taxpayers take the

federal standard deduction, rather than itemizing deductions, such as mortgage interest,

charitable contributions and state and local taxes.



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The 2013 standard deductions are:

Single: $ 6,100

Head-of-Household: $ 8,950

Married filing Joint $ 12,200

Married filing separately: $ 6,100

Qualifying Widow/Widower: $ 12,200

Dependent: $ 1,000

Federal Marriage Penalty Relief The 2010 Tax Relief Act extended the provisions that mitigate the marriage penalty for

2011 and 2012 with respect to the federal standard deduction, the 15% tax bracket and

the Earned Income Credit. The standard deduction for joint filers was twice the inflation-

adjusted standard deduction for single and married filing separate. ATRA 2012 extends

marriage penalty relief to the standard deduction and to tax brackets. Without relief, the

standard deduction for married couples would have been 167% of the deduction for

single individuals rather than 200% beginning in 2013.

2012 California Standard Deduction

2012 Joint Custody Head of Household Credit Joint custody head of household was a filing status for pre-1987 tax years. It has been

replaced as a tax credit for post-1986 tax years. This provision was further amended to

add the dependent parent credit for tax years beginning on or after January 1, 1988. The

original 1987 taxable year credit was $200 or less, computed by multiplying the net tax

by 30%. Indexing last year's credit of $401 yields a 2012 credit of the lesser of $409 or

30% of net tax.

2012/2013 Federal Personal Exemptions The 2012 personal exemption increases to $ 3,800. The 2013 personal exemption will be

$ 3,900. 2012 was scheduled to be the last year that there was no phase-out of federal

personal exemptions (PEP).



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PEP Limitation For years beginning after 2012, the PEP, which had been previously suspended, is

reinstated with a starting threshold of $ 300,000 for joint filers and surviving spouse,

$ 275,000 for heads of household, $ 250,000 for single filers and $ 150,000 for married

separate filers.

2012 California Personal/Dependent Exemption Credit

2012 California Personal Exemption Phase-Outs Although, there is no phase-out of federal personal exemptions in 2012, California

continues to phase out personal exemptions:

2012 Federal Itemized Deductions There is no phase-out of federal itemized deductions through 2012 (known as the “Pease

Limitation”). Itemized deductions were scheduled to return to phase-outs for certain

income thresholds in 2013.

“Pease” Limitation For years beginning after 2012, ATRA 2012 provides that the phase-out of itemized

deductions, which had been previously suspended, is reinstated with a starting threshold

of $ 300,000 for joint filers and surviving spouse, $ 275,000 for heads of household,



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$ 250,000 for single filers and $ 150,000 for married separate filers. These amounts will

be inflation-adjusted after 2013.

2012 California itemized Deductions Although the phase-out of federal itemized deductions is temporarily suspended,

California continues to phase-out itemized deductions.

Other 2012 Federal Credits, Deductions, and Phase-outs For tax year 2012, the maximum earned income tax credit (EITC) for low- and

moderate- income workers and working families rises to $5,891, up from $5,751 in

2011. The maximum income limit for the EITC rises to $50,270, up from $49,078

in 2011. The credit varies by family size, filing status and other factors, with the

maximum credit going to joint filers with three or more qualifying children.

Earned Income Credit Number of Qualifying Children

Item One Two Three or

More None

Earned Income Amount $9,320 $13,090 $13,090 $6,210

Maximum Amount of Credit $3,169 $5,236 $5,891 $475

Threshold Phase-out Amount (Single, Surviving Spouse, or

Head of Household) $17,090 $17,090 $17,090 $7,770

Completed Phase-out Amount (Single, Surviving Spouse, or

Head of Household) $36,920 $41,952 $45,060 $13,980

Threshold Phase-out Amount (Married Filing Jointly) $22,300 $22,300 $22,300 $12,980

Completed Phase-out Amount (Married Filing Jointly) $42,130 $47,162 $50,270 $19,190

In 2013, the maximum EITC is $ 6,044 for taxpayers with more than two qualifying

children, $ 5,372 for taxpayers with two qualifying children, $ 3,250 for taxpayers with

one qualifying child, and $ 487 for taxpayers with no qualifying children. The credit

amount begins to phase-out at an income level of $ 17,530 ($ 7,979 for taxpayers with no

qualifying children). The credit is not allowed if the aggregate amount of certain

investment income exceeds $ 3,300.

California does not conform to the EITC.



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The foreign earned income exclusion rises to $95,100, an increase of $2,200 from

the maximum deduction for tax year 2011.

California does not conform to the foreign earned income exclusion.

The modified adjusted gross income threshold at which the lifetime learning credit

begins to phase out is $104,000 for joint filers, up from $102,000, and $52,000 for

singles and heads of household, up from $51,000.

The $2,500 maximum deduction for interest paid on student loans begins to phase

out for a married taxpayers filing a joint returns at $125,000 and phases out

completely at $155,000, an increase of $5,000 from the phase out limits for tax year

2011. For single taxpayers, the phase-out ranges remain at the 2011 levels.

2012 California Renter’s Credit The California renter’s credit was reinstated in 1998 by SB 94 (98-931) as a

nonrefundable $60 credit for single filers with an AGI $25,000 or less and a $120 credit

for joint filers with an AGI $50,000 or less. Indexing was restarted for taxable year 1999.

The new 2012 indexed year AGI amounts are $36,337 or less for single filers and

$72,674 or less for joint filers.

2012 Federal Child and Dependent Care Credit 2012 was scheduled to be the final year for the enhanced child and dependent care credit.

The dependent care credit is a percentage of employment-related expenses up to $3,000

for one qualifying individual ($6,000 for two or more qualifying individuals). The credit

is limited by the taxpayer's AGI, by a downward reduction in the credit percentage (to not

less than a 20% credit).

The child and dependent care expense credit was scheduled to decrease for tax years

beginning after December 31, 2012. Under the “EGTRRA Sunset”, for tax years

beginning on or after January 1, 2013, the maximum credit allowed was scheduled to

return to the pre-EGTRRA level of 30 percent of qualifying child or dependent care

expenses. The maximum amount of qualifying expenses to which the credit applied

would have been $2,400 for individuals with one qualifying child or dependent (for a

maximum credit of $720), or $4,800 for individuals with two or more qualifying children

or dependents (for a maximum credit of $1,440.

ATRA 2012 permanently extends the Bush-era enhancements to the dependent care

credit. The current 35% credit rate is made permanent along with the $ 3,000/$ 6,000

cap on expenses.



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2012 California Child and Dependent Care Credit Beginning in 2011, the California Child and Dependent Care credit is no longer a

refundable credit.

If the EGTRRA sunset for the federal credit had occurred, the California credit, which is

based on a percentage of the federal credit would have also been reduced accordingly.

The AGI limitation on the California credit is $ 100,000. The credit is not available at all

when the AGI threshold is reached.

2012 California Filing Requirements



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2012 California Cost Recovery Fees

2012 Federal Adoption Credit For tax years beginning in 2012, the maximum federal credit amount is $12,650, and the

phase-out range begins at $189,710, with no credit allowed for taxpayers with a modified

AGI of $229,710 or more (See Rev. Proc. 2011-52). The 2013 maximum credit is

$ 12,970, phasing out for taxpayers with MAGI in excess of $ 194,580, with no credit

allowed for taxpayers with MAGI of $ 234,580 or more (Rev-Proc 2013-15). The credit

is no longer refundable.

For tax years beginning in 2010 and 2011 only, the credit amount was increased to

$ 13,360 and was refundable.

For tax years other than 2010 and 2011, taxpayer claimed a nonrefundable credit on Form

8839 for a set amount of qualified adoption expenses incurred for adopting an eligible

child (IRC § 23). The credit was phased out ratably for taxpayers with a modified

adjusted gross income (MAGI) over a threshold amount.

Both the nonrefundable and refundable credits use the same definitions for qualifying

expenses and eligible children, and the same rules for claiming the credit.

ATRA 2012 permanently extends the Bush-era enhancements to the adoption credit and

the exclusion for employer-paid or reimbursed adoption expenses up to $ 10,000 as

indexed for both regular and special needs adoptions. It did not extend the Health Care

Reform enhancements for 2010 and 2011 that allowed for a refundable adoption credit.

California Adoption Credit California allows a personal income tax credit for a portion of the costs paid or incurred

by a taxpayer for the adoption of any minor child who is a citizen or legal resident of the

US and was in the custody of a state or county public agency (R&TC § 17052.25).

The California credit is allowed in an amount equal to 50% of the eligible costs paid or

incurred by the taxpayer for the adoption, up to a maximum of $2,500 per child.

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The California credit is similar to the federal tax credit provided by IRC § 23. However,

California's requirements concerning the adoptive child's citizenship, residency, and

custodial status do not apply for purposes of the federal credit.

The "costs" eligible for the California credit include:

Fees for services required by the Department of Social Services or a licensed

adoption agency;

Travel and associated expenses incurred by the adoptive family in direct relation

to the adoption process; and

Medical fees and expenses not reimbursed by insurance that are directly related to

the adoption process.

Unlike the federal credit, the California credit does not include any reasonable and

necessary adoption fees, court costs, attorney fees, and other expenses that are directly

related to the adoption proceedings. Additionally, although the federal credit is phased

out on the basis of the taxpayer's adjusted gross income, there is no such limitation on the

California credit.

2012 Federal Mileage Rates

Purpose 1/1/12-12/31/12 1/1/13-12/31/13

Business 55.5 56.5

Medical/Moving 23.0 24.0

Charitable 14.0 14.0

Depreciation Component 23.0 23.0

Note: Beginning in 2011, the business standard mileage rate may be used for a vehicle

used for hire, such as a taxicab.

California conforms to the federal mileage rates.

2012 Kiddie Tax The kiddie tax applies to a child if:

The child has not reached the age of 19 or is a full-time student over age 18 but

under age 24;

Either of the child’s parents are alive at such time; and

The child’s unearned income exceeds $ 1,900 (2011 and 2012); and

The child does not file a joint return.

AMT: The kiddie tax is also aggravated if the absence of a 2012 AMT patch. The

current AMT exemption is the lesser of $ 6,950 plus the child’s earned income or

$33,750.

California conforms to the federal kiddie tax beginning in 2010.



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Note: The kiddie tax does not apply to a child whose earned income exceeds one-half

of their support. Scholarships are not counted in the support test.

2012 Nonbusiness Energy Property Credit (Tax Tip 2011-49) Form 5695 filers have basically two energy credits available:

1. Residential Energy Efficient Property Credit. This credit is available for

individual taxpayers who install solar hot water heaters, solar electricity

equipment and wind turbines, as well as geothermal heat pumps in their main

homes. The credit is 30% of qualified property regardless of the amount. The

credit is set to expire in 2017.

2. Plug-in Electric Drive Vehicle Credit. ARRA 2009 modified this credit for

vehicles purchased after December 31, 2009. The minimum amount of the credit

is $ 2,500 and the maximum credit is $ 7,500, depending on battery power ($ 417

per kilowatt hour exceeding 5 kilowatt hour capacity, not to exceed $ 5,000).

Other Federal Updates The following items are adjusted as follows:

Over-the-Counter Medical Beginning in 2011, a medicine or drug is a qualified medical expense only if it is a

prescribed drug or insulin. Distributions for over-the-counter medicines or drugs from

HSAs no longer qualify for exclusion from income without a prescription. California

does not conform to HSAs.

This limitation on medicines also applies to Archer MSAs (California does conform to

MSAs). Although California does not conform to the federal limitation on excludable

distributions for medicines, MSAs are expected to comply with federal rules, so

California practically conforms.

A requirement for a prescription for over-the-counter medicines or drugs also applies to

FSAs and Health Reimbursement Arrangements (HRA), including IRC § 105 plans

utilized by small businesses.

FSA Medical Deferral Decreases in 2013 Beginning January 2013, medical Flexible Spending Account (FSA) contributions will be

capped at $ 2,500 per year, as set forth by the Patient Protection and Affordable Care Act.

Currently most employers cap FSAs at $ 5,000, even though there is no mandated limit.

Meanwhile, over 85% of all medical FSA participants fund less than $ 2,500 annually.

The average amount is between $ 1,300 and $ 1,400.



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Fiscal year businesses, which complete their 2013 enrollment elections in 2012, will not

be subject to the new cap until the following plan year. The new $ 2,500 mandate will

only apply to a plan year beginning February 1, 2013 or later.

Medical Savings Accounts

Health Savings Accounts (Rev-Proc 2011-32, May 13, 2011) For calendar year 2012, the annual limitation on deductions under IRC § 223(b)(2)(A) for

an individual with self-only coverage under a high deductible health plan is $3,100. For

calendar year 2012, the annual limitation on deductions under IRC § 223(b)(2)(B) for an

individual with family coverage under a high deductible health plan is $6,250.

For calendar year 2012, a “high deductible health plan” is defined under

IRC § 223(c)(2)(A) as a health plan with an annual deductible that is not less than $1,200

(no change from calendar year 2011) for self-only coverage or $2,400 (no change from

calendar year 2011) for family coverage, and the annual out-of-pocket expenses

(deductibles, co-payments, and other amounts, but not premiums) do not exceed $6,050

for self-only coverage or $12,100 for family coverage.

HSA and MSA Penalties For distributions made after December 31, 2010, the federal penalty for nonqualified

distributions from HSAs has increased from 10% to 20%.

California does not conform to HSAs. The following result from California’s

nonconformity:

Difference in federal and state wages on Form W-2, in cases where employers are

funding HSAs;

Employment taxes on employer contributions;

Taxable events when providers discontinue MSAs and convert accounts to HSA,

including a 10% California penalty;

A Schedule CA adjustment to increase income where taxpayers make federally-

deductible contributions to their HSAs;

The need to increase the California medical expense deduction for any expenses

paid from the HSA;

Taxability of income on HSA accounts; and

A requirement to track basis in the HSA for California purposes.

The federal penalty for nonqualified distributions from an Archer MSA also increases

from 15% to 20%. The federal penalty does not apply if the taxpayer is disabled or over

age 65.

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California’s penalty remains at 10%.

Federal ITIN Policy Change in 2013 New ITINs will now be issued for a 5-year period rather than an indefinite period. This

change is to help ensure that ITINs are being used for legitimate purposes. Additionally,

IRS will only accept original ID documents or certified copies of these documents from

the issuing agency, along with the completed Form W-7 and Federal tax return.

2012 Federal Long-Term Care Premium Table For taxable years beginning in 2012, the limitations under § 213(d)(10), regarding

eligible long-term care premiums includible in the term “medical care,” are as follows:

Attained Age Before the Close of the Taxable Year Limitation on Premiums

40 or less $350

More than 40 but not more than 50 $660

More than 50 but not more than 60 $1,310

More than 60 but not more than 70 $3,500

More than 70 $4,370

2013 Federal Pension Cost-of-Living Amounts (Notice 2012-67) The 2013 elective deferral limit increases from $ 17,000 to $ 17,500.

Catch-up contributions for age 50 or older remain at $ 5,500, so the maximum

deferral limit for age 50 or older is $ 23,000;

The limit on IRA contributions increases from $ 5,000 to $ 5,500. The catch-up

contribution for age 50 or older remains at $ 1,000, resulting in a maximum

contribution of $ 6,500;

Traditional IRA deductions are phased-out for singles and heads-of-household

covered by a workplace retirement plan at MAGI of $ 59,000-$ 69,000. For

married joint returns (in which the spouse who makes the IRA contribution is

covered by a workplace retirement plan) at MAGI of $ 95,000-$ 115,000. For an

IRA contributor who is not covered by a workplace retirement plan, and is

married to someone who is covered, the deduction phases out when MAGI is

between $ 178,000-$ 188,000;

The AGI phase-out range for taxpayers making contributions to a Roth IRA is

$ 178,000 to $ 188,000, and for singles and heads-of-household from $ 112,000-

$ 127,000 and for married separate filers from $ 0-$ 10,000;

The limitation on the annual benefit under a defined benefit plan under

§415(b)(1)(A) is increased from $200,000 to $205,000;

The limitation for defined contribution plans under §415(c)(1)(A) is increased

from $50,000 to $51,000;

The limitation under §408(p)(2)(E) regarding SIMPLE retirement accounts is

increased from $11,500 to $12,000; and

The annual compensation limit under §§401(a)(17), 404(1), 408(k)(3)(C), and

408(k)(6)(D)(ii) is increased from $250,000 to $255,000.



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Tax-Exempt Organizations Update Organizations that did not file required information returns or electronic notices

(e-Postcard 990-N) for their taxable years beginning in 2007, 2008 and 2009,

automatically lost their tax-exempt status, and must apply if they want to be reinstated.

In IRS Notice 2011-43, the IRS provided transitional relief for certain small

organizations that met the following:

Were not required to file annual information returns for taxable years beginning

before 2007;

Were eligible to file Form 990-N for their taxable years beginning in 2007, 2008,

and 2009; and

Applied for reinstatement of tax-exempt status on or before December 31, 2012.

These organizations may file an application for tax exemption, and, if approved, will

have their tax-exempt status reinstated retroactively to the date the status was revoked,

paying a reduced application fee of $ 100.

Reinstatement requires filing:

Form 1023 Application for Recognition of Exemption under Section 501(c)(3) of

the Internal Revenue Code; or

Form 1024 Application for Recognition of Exemption under Section 501(a).

Additional Time for Victims of Hurricane Sandy (IRS Notice 2012-71) The IRS is postponing the filing date until February 1, 2013 for small tax-exempt

organizations affected by Hurricane Sandy to take advantage of the transitional relief. To

be eligible for the extended deadline of February 1st, the organization’s principal place of

business must be located in the covered disaster area, or records necessary to meet the

application deadline must be maintained in the covered disaster area.

New FBAR Filing Compliance Procedure (IR 2012-65) IRS released a new procedure for filing delinquent returns for non-resident US taxpayers

(including dual citizens), who have resided outside the US since January 1, 2009, and

who were required (but didn’t) to file FBAR forms (TD F 90-22.1) during that same time

period. This procedure is available only to “low compliance risk” taxpayers, and went

into effect on September 1, 2012.

Election to Treat Secured Home Mortgage Debt as Unsecured To secure a more favorable outcome when deducting mortgage interests, taxpayers can

elect to treat any secured debt as unsecured [Temp Reg § 1.163-10T(o)(5)]. The election

is irrevocable without IRS consent. Once the election is made, the use of the proceeds

follows the general tracing rules. If the election is made, the debt is no longer treated as

secured by the home. No portion of the debt can be allocated back to the home.



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How to Make the Election CCA 201201017 The temporary regulations § 1.163-10T(o)(5) are not very specific about how to make the

election. CCA 201201017 clarifies that the election does in fact apply to the entire

proceeds of a refinance, which must be traced to and treated as business, rental, or other

deductible interest, rather than qualified residence interest, or the proceeds will be treated

as qualified residence interest, until the qualified residence interest thresholds are

exhausted.

Once the election is made, it is binding for all future years, unless the IRS gives

permission for revocation.

Attached a statement to the return.

Some Sample Language: “Per Temp Reg § 1.163-10T(o)(5), Robert and Melinda Smith

elect to treat the loan secured by our residence with Bank of America (Loan # 45678) as

if the loan is not secured by this respective property. As taxpayers, we understand that

this election is binding and may only be revoked by the IRS Commissioner.”

Section 105 Medical Reimbursement Plan Update The 10

th Circuit Court of Appeals unanimously reversed the Tax Court decision in

Milo L. and Sharlyn K. Shellito v Comm. (TCM 2010-41). This was a strong win for

small business. Milo Shellito had followed his accountant’s advice, and issued separate

payroll checks and reimbursement checks to his spousal employee, Sharlyn. All

employment tax forms including W-2s were filed:

Wages Medical Reimbursements

2001 $ 754 $ 15,593

2002 $ 1,292 $ 20,987

The Appeals Court emphasized that there was no minimum wage requirement.

Compensation payments include amounts paid for “sickness, accident, hospitalization,

medical expense or similar benefit plan”, even when it is paid to the owner’s wife under a

bona fide employment arrangement. The Appeals Court determined the Tax Court

should have first determined if a bona fide employee arrangement existed by looking to

the “right to direct and control the means and manner in which work is done”.

Relying on the outcome of this case, third-party administrators (TPAs) like the one the

Milo Shellito used, TASC (AgriPlan-BizPlan), feel more confident about recommending

a relaxation in previous guidance given as to how much regular payroll should be in

relationship to the benefits.

Federal K-1 Penalties (IRC § 6698) The penalty for a late-filed LLC or S corporation is $ 195 per K-1 participant per month

for a maximum of 12 months or $ 2,340 per participant.



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California K-1 Penalties 9R&TC § § 19172, 19172.5) California has its own penalty that mirrors the federal penalty of $ 18 per K-1 participant

per month for a maximum of 12 months or $ 216 per participant.

Federal Education Incentives Two credits are available for higher education expenses, the Hope scholarship (American

Opportunity) credit and the Lifetime Learning Credit. The American Recovery and

Reinvestment Act of 2009 (ARRA 2009) enhanced and renamed the Hope scholarship

credit as the American Opportunity Tax Credit (AOTC). The 2010 Tax Relief Act

extended the AOTC through 2012.

Unlike the Hope credit, which was limited to the first two years of post-secondary

education (before 2009), the American Opportunity Credit (AOTC) may be claimed for

all four years of post-secondary education, and is partly refundable since 2009. The

AOTC enhancements to the Hope scholarship credit were scheduled to expired at the end

of 2012.

ATRA 2012 extends the AOTC for five years, through 2017.

The Lifetime Learning credit is available for 20 percent of education expenses up to

$10,000. The AOTC is a per student credit, whereas the Lifetime Learning Credit is a

per taxpayer credit.

The Lifetime Learning credit is nonrefundable.

Both credits are phased out as income increases.

2012 American Opportunity Tax Credit The maximum AOTC is $ 2,500 for the costs of tuition, fees and course materials paid

during the year, based on 100% of the first $ 2,000, plus 25% of the next $ 2,000 with

AGI phase-outs starting at $ 80,000 for singles and $ 160,000 for joint filers.

2012/2013 Federal Lifetime Learning Credit The modified adjusted gross income threshold at which the lifetime learning credit begins

to phase out is $104,000 for joint filers, up from $102,000, and $52,000 for singles and

head of household, up from $51,000. The 2013 income threshold will be $ 107,000 for

joint filers and $ 53,000 for singles and head of household filers.

Student Loan Interest Deduction The $2,500 maximum deduction for interest paid on student loans begins to phase out for

a married taxpayers filing a joint returns at $125,000 and phases out completely at

$155,000, an increase of $5,000 from the phase out limits for tax year 2011. For single

taxpayers, the phase-out ranges remain at the 2011 levels or $ 60,000.



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ATRA 2012 permanently extends the suspension of the 60-month rule for the $ 2,500

above-the-line student loan interest deduction. It also permanently expands the MAGI

range for phase-out of the deduction and permanently repeals the restriction that makes

voluntary payments of interest nondeductible. The 2012 and 2013 phase-outs are the

same.

California Student Loan Interest Deduction California conforms to the federal student loan interest deduction. There is a

requirement for non-California domiciled military taxpayers to add back excluded

military wages and California has its own phase-out amounts [R&TC §§

17024.5(a)(2)(B), 17201].

Coverdell Education Saving Accounts (ESA) The 2012 maximum contribution is $ 2,000. The 2013 maximum contribution was

scheduled for $ 500. Further, elementary and secondary school expenses were no longer

going be qualified ESA expenses in 2013 and later.

ATRA 2012 permanently extends the $ 2,000 maximum contribution and the ability to

use the funds for elementary, secondary and post-secondary education expenses.

Employer-Provided Education Assistance The exclusion from income and employment taxes of up to $ 5,250 in annual employer-

provided education assistance lasts only through 2012. After the scheduled sunset,

employer-provided educational assistance would have been excludable only if it qualified

under the more stringent working condition fringe benefit rules.

ATRA 2012 permanently extends the exclusion.

Federal Scholarships ATRA 2012 makes permanent the exclusion from income for the National Health

Service Corps Scholarship Program and the Armed Forces Scholarship Program.

Federal Health Care Reform Update Health Care Reform refers to two March 2010 tax bills:

Patient Protection and Affordable Care Act (PPACA); and

Health Care and Education Reconciliation Act (HCERA).

The PPACA includes 459 provisions and the reconciliation bill (HCERA that made

amendments to the PPACA includes another 55 provisions—514 in all. It is by far, the

largest set of tax law changes in more than 20 years, amending numerous section of the

Internal Revenue Code. Some experts believe that IRS is significantly underfunded at



39

current levels to handle its expected multi-faceted role in implementing the health care

law over the 2013-2018 period.

Federal Health Care Reform Constitutionality Upheld (June 28, 2012) The US Supreme Court upheld the constitutionality of the 2010 health care reform bills,

including the individual mandate that requires individuals to pay a penalty if they fail to

carry minimum essential health insurance (National Federal of Independent Business, et.

Al. v. Sebelius, SCt, 2012-2 USTC 50,423).

In a 5-4 decision, the Court cleared the path for the PPACA and HCERA to move

forward as planned.

These two bills phase in Health Care Reform over a nine year period beginning in 2009

and ending in 2018 as follows:

2009: Tax Relief for Health Care Workers in Underserved Areas Health care professionals whose student loans were repaid or forgiven under various state

programs that reward those who work in underserved communities could exclude the

repayment or forgiveness amounts from income. To take advantage of this benefit

requires amending 2009 federal returns.

2010 and 2011: Federal Adoption Credit Enhancements As discussed previously, the maximum adoption credit increased to $13,170. This

increased tax credit amount applied to adoptions in 2010 and 2011. Additionally, the

adoption credit was refundable for 2010 and 2011.

Carryovers from prior years were refundable in 2010. An amount of an adoption credit

claimed in an earlier taxable year that was carried forward was allowable as a refundable

tax credit. Any adoption credit in the year 2009 or earlier that was in excess of the tax

liability could be carried forward to the subsequent tax year. Excess adoption credits can

be carried-forward for five years and is used up on a first-in, first-out basis. The IRS

provided a Credit Carry forward Worksheet in the Instructions for Form 8839 Qualified

Adoption Expenses.

Due to the mandatory documentation requirements, these returns could not be e-filed.

2010 and Future: Health Coverage for Children under Age 27 Health insurance costs for a non-dependent child under age 27 were excluded from

taxable wages. The new law applies to reimbursements for medical care expenses under

an employer-provided accident or health plan, benefit provided under a VEBA, and a

deductible medical care insurance expenses of self-employed individuals, and applies to

expenses incurred and benefits provided on or after March 30, 2010.



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California Conformed Late California conformed to this provision with the passage of AB 36 (2011-17, 4/6/11).

Unfortunately, California conformed after 2010 W-2s had been filed, and many

employers were required to file corrected W-2s for California, as their original W-2s only

excluded the costs from federal wages and not California wages, since California’s

conformity occurred after the W-2 filing deadline (2/28/11 for paper W-2s, and 3/31 for

e-filed W-2s). Additionally many taxpayers received a W-2c, and needed to amend their

Form 540 to take advantage of the conformity.

After 3/23/2010 and Future: Indian Tribal Health Benefits The value of certain health benefits received from the Indian Health Service is excluded

from income.

7/1/2010 and Future: Federal Tanning Excise Tax Beginning July 1, 2010, businesses offering ultraviolet tanning services were required to

begin collecting a 10-percent excise tax. Businesses must collect the tax at the time the

customer pays for the tanning services. If the customer does not pay the excise tax, the

tanning service provider must pay it.

Tanning service providers must report and pay the excise tax (Form 720) in full on a

quarterly basis. The first quarterly return and payment was due Nov. 1, 2010, covering

taxes collected during July, August and September of 2010.

The tax does not apply to spray tans or topical creams and lotions. The tax also does not

apply to phototherapy services performed by licensed medical professionals like

dermatologists, psychologists, and registered nurses. Under certain circumstances,

federal regulations provide an exception for physical fitness facilities that offer tanning as

an incidental service to members without a separately identifiable fee. Indoor tanning

services provided by organizations that are usually considered tax exempt, such as

universities or private clubs, are subject to this tax.

2011 and Future: New Federal Rules for Workplace Health Plans As previously discussed, over-the-counter medicine requires a prescription, and new

penalties began on nonqualified distributions from MSAs and HSAs.

2013: Two Extra Federal Medicare Taxes Unless repealed, the Medicare tax takes effect in 2013, and effects high-income taxpayers

with investment income, and high-income wage earners.

3.8% Federal Medicare Contribution Tax This Medicare surtax will be imposed on a taxpayer’s “net investment income” (NII) and

generally, is to apply to passive income. It will also apply to capital gain from

disposition of property. It will not apply to income derived from a trade or business, or



41

from the sale of property used in a trade or business. For individuals, the surtax will

apply to:

The lesser of the taxpayer’s NII; or

The amount of MAGI (AGI with foreign income added back) that exceeds:

o $ 250,000 for joint filers and surviving spouse filers;

o $ 125,000 for married separate filers; and

o $ 200,000 for single and head of household filers.

Comment: This surtax may cause an investor “paradigm shift”. For years, taxpayers

have been desirous of income to be passive, so as to avoid employment taxes, and want

losses to be non-passive, so they can offset other non-passive income. With the

imposition of the surtax, taxpayers with higher incomes may prefer active business

income over passive investment income.

Additionally, taxpayers may re-allocate their portfolios to minimize the tax:

Change investments to tax-free investments; or

Invest in real estate generating losses.

Another strategy for new retirees could include taking their first RMD earlier rather than

later. For instance, a taxpayers who turns 70 ½ in 2012 has the option of deferring their

first RMD until 3 ½ months into the second year. However, it causes two RMDs to be

taxed in one year, and could increase their MAGI to an amount exceeding the surtax

threshold.

Additionally, when this 3.8% surtax is combined with the scheduled highest 2013

marginal tax rate of 39.6%, certain taxpayers could be paying 43.4% on investment

income.

EXAMPLE

Joe files single, and has MAGI of $ 230,000, which includes NII of $ 40,000. The

Medicare surtax applies to the lesser of $ 40,000 (NII) or the excess of MAGI over

$ 200,000 ($ 230,000 - $ 200,000) or $ 30,000. The tax applies to $ 30,000.

EXAMPLE

Lucy files single, and has MAGI of $ 175,000, including $ 70,000 of NII. Because

Lucy’s income is below the threshold of $ 200,000, she does not owe the Medicare

surtax, in spite of the fact that she has substantial NII.



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EXAMPLE

William and Mary file jointly, and have MAGI of $ 350,000, including $ 75,000 in NII.

The Medicare surtax applies to the lesser of $ 75,000 (NII) or the excess of MAGI over

$ 250,000 ($ 350,000 - $ $ 250,000) or $ 100,000. The tax applies to $ 75,000.

Individual Federal Medicare Surtax Planning Caution will need to be exercised when taxpayers have unusual spikes in income such as:

Principal residences with gains in excess of the IRC § 121 exclusion;

Taxable inheritance received (income in respect of a decedent); or

Roth conversions.

Application of Federal Medicare Surtax to Estates and Trusts The Medicare surtax applies to the lesser of:

Undistributed NII for the year; or

The amount of AGI that exceeds the dollar amount at which the highest tax

bracket begins for estates and trusts (estimated to be $ 11,950 for 2013).

Estate and Trust Federal Medicare Surtax Planning Within the confines of governing instruments, fiduciaries of trusts and estates might

evaluate whether it is optimal to distribute NII to beneficiaries, or allow NII to be taxed

to the estate or trust, depending on how much surtax would be paid under each scenario.

If the beneficiaries have incomes under the individual thresholds of $ 200,000 or

$ 250,000, it would seem that the income should be distributed. If the beneficiaries have

incomes exceeding the individual thresholds, possibly the trust or estate should plan to

pay the tax, if less. Administrative trusts (living trusts that became irrevocable at death)

could evaluate whether an IRC § 645 (trust election to be treated as an estate) would be

strategic.

EXAMPLE

The Smith Trust has undistributed NII of $ 5,000, and AGI of $ 20,000. The Medicare

surtax applies to the lesser of $ 5,000 or $ 8,050 ($ 20,000 - $ 11,950). The 3.8% surtax

would apply to $ 5,000. If the trust had distributed its NII to beneficiaries with incomes

under $ 200,000, the Medicare surtax does not apply.



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What is Included in Net Investment Income (NII)? NII includes:

Gross income from interest, dividends, annuities, royalties, and rents, provided

this income is not derived in the ordinary course of an active trade or business;

Gross income from a trade or business that is a passive activity under IRC § 469;

Gross income from a trade or business of trading in financial instruments and

commodities [IRC § 475(e)(2)]; and

Net gain (taken into account in computing taxable income) from the disposition of

property, other than property held in an active trade or business.

In order to exclude trade or business income, the taxpayer must materially participate in

the trade or business. If the taxpayer does not materially participate, the income,

including disposition gains are counted as NII. Income, gain, or loss on working capital

is not treated as derived from a trade or business.

Comment: The material participation standard also applies to a trade or business held by

an estate or trust, but it remains to be seen how the IRS will address material participation

in an estate or trust. It seems reasonable the IRS will look at whether the trustee is

operating/managing the trade or business, or whether the trustee has hired others to run

the business. Neither the proposed regulations issued on December 5, 2012 (see next)

nor the current regulations on passive activities (IRC § 469) address this issue with trusts.

It is concerning, since trusts and estates have struggled with how to determine whether

their activities rise to the level of material participation.

Note: Rental income is reduced by deductions “properly allocable” to the gross rental

income in the calculation of NII.

Federal Medicare Surtax Exclusions The 3.8% Medicare surtax does not apply to the following taxpayers:

Nonresident aliens;

Corporations;

Trusts whose interests are devoted to charitable purposes; and

Charitable Remainder Trusts (IRC § 664).

The Medicare surtax does not apply to the following types of income:

Traditional IRA distributions;

Roth IRA distributions;

Pension distributions;

401(k) distributions;

Tax-sheltered annuity (TSA) distributions;

Section 457 distributions;



44

Amounts subject to SE tax;

Excluded income, such as veteran’s benefits;

Excluded principal residence gains; and

Interest on tax-exempt bonds.

Note: Although pension/IRA distributions are not NII, these items of income do increase

AGI and any increase in AGI can trigger the 3.8% tax.

Comment: Currently, there is no exception for distributions from nonqualified deferred

compensation plans. This may be an area addressed in technical corrections, if the

scheduled tax actually applies in 2013.

Planning for Minimization of 3.8% Medicare Tax Modified AGI may be reduced below the filing status thresholds by using:

Installment sales;

Deferred annuities;

Municipal bonds;

Pension contributions;

Deferred compensation;

Charitable remainder trusts; and

Roth Conversions.

EXAMPLE

Tom and Mary have wages of $ 200,000, investment income of $ 50,000 and an annual

traditional IRA distribution of $ 65,000. Although the IRA distribution is excluded from

the Medicare surtax, it is included in MAGI, causing $ 50,000 of investment income to be

subject to the 3.8% tax. Consider whether Tom and Mary should make a Roth

conversion (most optimal if made in 2012), as Roth distributions are not included in

MAGI.

Proposed Regulations NPRM REG-130507-11 (Dec 5, 2012) Section 1411(c)(1) provides that net investment income means the excess (if any) of

The sum of:

o gross income from interest, dividends, annuities, royalties, and rents, other

than such income derived in the ordinary course of a trade or business to

which the tax does not apply,

o other gross income derived from a trade or business to which the tax

applies, and



45

o net gain (to the extent taken into account in computing taxable income)

attributable to the disposition of property other than property held in a

trade or business to which the tax does not apply; over

The deductions which are properly allocable to such gross income or net gain.

The threshold amount is not indexed for inflation. Under the proposed regulations, the

threshold amount is generally not prorated in the case of a short taxable year of an

individual. However, the proposed regulations provide a special rule in the case of an

individual who has a short taxable year resulting from a change of annual accounting

period. Under IRC § 443(b)(1), a taxpayer that undergoes a change in annual accounting

period under IRC 442 and has a short period must annualize its taxable income. The

taxpayer's Federal income tax is the tax computed on the annualized taxable income by

multiplying the taxable income for the short period by twelve and dividing the result by

the number of months in the short period. Proposed §1.1411-2(d)(2)(ii) provides that an

individual taxpayer that has a short period resulting from a change of annual accounting

period shall reduce the applicable threshold amount to an amount that bears the same

ratio to the full threshold amount provided under section 1411(b) as the number of

months in the short period bears to twelve.

Because Congress did not provide a rule specifying the particular trusts subject to IRC

§ 1411, the Treasury Department and the IRS have determined that IRC § 1411 applies to

ordinary trusts described in §301.7701-4(a). The general rule set forth in proposed

§1.1411-3(a)(1)(i) (that IRC §1411 applies to all estates and trusts that are subject to the

provisions of part I of subchapter J of chapter 1 of subtitle A of the Code) implements

this approach. This rule excludes from the application of IRC § 1411 business trusts

described in §301.7701-4(b), which are treated as business entities under §301.7701-2

and as eligible entities for purposes of entity classification in §301.7701-3. Accordingly,

such trusts are not subject to section 1411 at the entity level.

.9% Medicare Tax on Wages and SE Income Effective January 1, 2013, higher income individuals will be subject to an additional .9%

Medicare tax on wages. Wages received in excess of $ 200,000 ($ 250,000 for married

couples filing a joint return and $ 125,000 for married couples filing separately) will be

subject to a 2.35% Medicare rate (1.45% + .9%).

Planning for the Medicare tax on wages is complicated by the fact that it is imposed on

the combined wages of employee and spouse. Married couples, who have filed joint

returns in past years, may want to explore the benefits, if any, of filing separate returns

for 2013 and future years, if combined incomes make them liable for the additional

Medicare tax.



46

The Affordable Care Act added IRC § 1401(b)(2). IRC §1401(b)(2)(A) increases the

Medicare tax on self-employment income for any taxable year beginning after December

31, 2012, by an additional 0.9 percent of self-employment income which is in excess of

certain threshold amounts. As with Additional Medicare Tax under the FICA, the

threshold amounts for an individual to be subject to Additional Medicare Tax under the

Self-Employment Contributions Act (SECA) are determined by the individual's filing

status. The threshold amounts enumerated under IRC §1401(b)(2)(A), are $250,000 in the

case of a joint return, $125,000 in the case of a married taxpayer filing a separate return,

and $200,000 in any other case.

Note: This tax should not be confused with the 3.8% surtax, but, in essence mimics the

3.8% tax since the normal Medicare rate is 1.45% for employee and 1.45% for employer

or 2.9% total. When the .9% additional tax is added the total Medicare rate on wages and

self-employment is 3.8% (2.9 + .9).

Employer Withholding Requirements The statute requires an employer to withhold additional Medicare tax on wages or

compensation it pays to an employee in excess of $200,000 in a calendar year. An

employer has this withholding obligation even though an employee may not be liable for

the Additional Medicare Tax because, for example, the employee’s wages or other

compensation together with that of his or her spouse (when filing a joint return) does not

exceed the $250,000 liability threshold. Any withheld Additional Medicare Tax will be

credited against the total tax liability shown on the individual’s income tax return (Form

1040).

Proposed Regulations NPRM REG-130074-11 (Dec 5, 2012) IRC 3102(f)(3) provides that if an employer fails to withhold the Additional Medicare

Tax, and the tax is subsequently paid by the employee, the IRS will not collect the tax

from the employer. IRC § 3102(f)(3) specifies, however, that the employer would remain

subject to any applicable penalties or additions to tax for failure to withhold Additional

Medicare Tax as required. The proposed regulations under IRC § 3102(f) provide that to

the extent Additional Medicare Tax is not withheld by the employer, the employee is

liable for the tax.

Under IRC § 6654(m), which was added by the Affordable Care Act, the Additional

Medicare Tax is treated as a tax subject to estimated tax payment requirements.

2013 and Future: Federal Schedule A Medical Expense Floor Increases to 10% Deductible medical expenses must exceed 10% of AGI, instead of 7.5%. This is same

floor as AMT currently. The new 10% floor does not apply for taxpayers age 65 or older.



47

2013: Federal Medical Device Excise Tax Final Regulations (TD 9604-Dec 6, 2012) discuss this 2.3% excise tax on medical

devices. Most important is the application of a retail exemption for contact lenses,

eyeglasses, hearing aids and other medical devices. “Other Medical Devices” are subject

to a facts and circumstances approach.

2014 and Future: Federal Penalty for Failure to Carry Health Insurance US citizens and legal residents will be required to maintain “minimum essential health

coverage” or pay a penalty. Grandfathered coverage must comply with certain

provisions. Certain individuals are exempt from penalty. The penalty will be phased in

from $ 95 in 2014 to $ 695 in 2016.

Employers, employing an average of 50 or more full-time equivalents (FTEs) working an

average of 30 hours per week will be required to participate in the “shared responsibility”

provisions of offering enrollment in an employer-sponsored plan providing essential

coverage that is affordable relative to an employee’s household income.

State Exchanges The PPCA requires each state to establish an American Health Benefit Exchange and

Small Business Health Options Program (SHOP) to provide qualified individuals and

qualified small business employers access to health plans. Exchanges will have four

levels of coverage: bronze, silver, gold, or platinum. In early 2012, at least 34 states and

D.C., had received grants to fund their progress toward building Exchanges. If a state

decides not to operate an Exchange for its residents, there will be a federally-facilitated

Exchange (FFE) available for participation.

2014 and Future: Federal Premium Assistance Refundable Credit Health care reform provides for a federal subsidy for eligible individuals who purchase

from Exchanges. The subsidy will be based on a percent of federal poverty level (FPL).

Participants will confirm eligibility for the premium assistance providing their last 2

years tax information to the Exchange.

If at least one employee is certified to the employer as having enrolled in health insurance

coverage purchased through a state Exchange, with respect to which a premium

assistance tax credit is allowed or paid, and the employer failed to offer its full-time

employees and their dependents the opportunity to enroll in minimum essential coverage

under an employer-sponsored plan, a non-deductible penalty of $ 166.67 per month/

$ 2,000 per year per employee over a 30-employee threshold applies.



48

EXAMPLE

ABC Corporation fails to offer essential minimum coverage to its 150 full-time

employees, one of who receives a tax credit for enrolling in a state exchange-offered

plan. ABC Corporation will be assessed a penalty of $ 240,000 [(150-30) x $ 2,000]

annually, payable monthly.

2010 through 2015: Federal Small Business Health Insurance Credit The PPACA created a temporary IRC code section 45R. For tax years 2010 through

2013, the maximum credit is 35% of health insurance premiums paid by small business

employers (25% for tax-exempt employers). The credit is scheduled to increase to 50%

for small business employers after 2013, but will terminate after 2015.

For tax years after 2013, an employer must participate in an insurance exchange in order

to claim the credit, and certain other modifications and restrictions apply.

In order to qualify for the credit, the employer must have:

Fewer than 25 FTEs;

Average annual wages of less than $ 50,000 per FTE; and

A “qualifying arrangement” that is maintained.

The maximum credit is for employers of 10 or fewer employees.

Excluded employees include:

Sole-proprietors and their family members;

Partners in a partnership, including their family members;

Shareholders owning more than 2% of stock in an S corp; and

5% or more owners in any business.

2011 and Future: Simple Cafeteria Plans Beginning in 2011, the Simple Cafeteria plan provides an excellent way to establish a

vehicle for providing health benefits for owners of businesses with employees.

Up to now, most small business owners find they can’t participate in a classic IRC § 125

cafeteria plan due to nondiscrimination requirements. In this new simple cafeteria plan,

the employer can retain potentially discriminatory benefits for highly compensated and

key employees subject to some restriction relating to contributions.

All eligible employees must be allowed to participate. The eligibility requirement is met

if:



49

All employees (other than excludable employees) are eligible to participate; and

Each eligible employee is able to elect any benefit available under the plan.

Employees who can be excluded are:

Have not attained age 21 before the close of a plan year;

Have fewer than 1,000 hours of service for the preceding plan year;

Have not completed one year of service with the employer;

Are covered under an agreement that the Secretary of Labor finds to be a

collective bargaining agreement; or

Are nonresident aliens working outside the US.

An employer may choose between two methods of employer contributions to the plan:

1. The non-elective contribution method; or

2. The matching contribution method.

The non-elective contribution under the non-elective contribution method is an amount

equal to a uniform percentage (not less than 2%) of each eligible employee’s

compensation for the plan year, regardless to whether the employee makes a salary

reduction contribution or not.

The matching contribution is the lesser of 100% or the amount of the salary reduction

contribution elected to be made by the employee for the plan year or 6% of the

employee’s compensation for the plan year.

2011 and Future: W-2 Reporting of Employer-provided Health Insurance Coverage The required reporting is informational only. In Notice 2010-69, IRS made reporting

optional for all employers for 2011. In Notice 2012-9, the IRS provided transitional

relief for small employers. For 2012 Forms W-2 (and later years unless further guidance

is issued), an employer is not subject to reporting if they file fewer than 250 Forms W-2

for the preceding year.

2012 and Future: Information Reporting –REPEALED This repealed law would have required issuance of 1099s for purchases of goods as well

as services, and services provided by corporations.

2013 and Future: FSA Limitation As mentioned previously, the maximum deferral decreases to $ 2,500 in 2013.

2018 and Future: Excise Tax Applies to “Cadillac Plans” A 40% excise tax will apply when premiums for employer-sponsored plans exceed:

$ 10,200 for individual coverage; or

$ 27,500 for family coverage.



50

2012 Employment Development Department (EDD) Update The 2012 withholding tables were released on October 17, 2011, and then, later revised

in November for the effect of Proposition 30. The tables are available online at

www.edd.ca.gov.

The 2012 SDI rate is 1.0% with a taxable wage limit of $ 95,585. The maximum SDI

per employee is $ 955.85. UI Rate schedule in effect for 2012 and 2013 is the “F+”

schedule, with a maximum wage limit of $ 7,000. The EFT rate is 0.1%. The 2012

withholding rate on supplemental payments is 6.6%. The withholding rate on stock

options and bonus payments is 10.23%.

The 2013 SDI rate was released on November 6, 2012. The rate remains at 1.0% with a

maximum wage base of $ 100,880 and a maximum payment amount of $ 1008.80.

EDD Automated Collection Enhancement System (ACES)-DIR Accounts With the enactment of SB 1006 (CH 2012-36, 6/27/12), EDD is collecting delinquencies

for the Department of Industrial Relations (DIR), rather than FTB since January 1, 2012.

EDD will not be using the existing employer account number for employment tax, if the

employer has a balance due the DIR. EDD will assign a new account number for these

accounts that are 6 digits in length, with the first two digits beginning with “DR”.

http://www.edd.ca.gov/



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EDD Coordination with FTB Financial Institution Record Match (FIRM) Budget trailer bill SB 1015 (CH 2012-37, 6/27/2012) authorizes the EDD to provide the

FTB with information relating to delinquent tax debtors for collection purposes. FTB

will work to match EDD delinquent tax debtors to financial institution accountholder

records. The FTB follows-up by providing the EDD with any “matches” for purposes of

collection. EDD is required to reimburse FTB for its costs in the implementation and

administration of FIRM.

EDD e-Services for Business The Employment Development Department (EDD) offers employers the ability to

manage their payroll tax accounts online. Payroll agents can access their clients’

accounts through a third party access, which will allow the agent to maintain their clients’

accounts.

Advantages

Fast, easy, and secure way to manage your payroll taxes;

Simple one-time online enrollment;

Ability to view and print returns/reports and payments previously submitted

online; and

Most of e-Services for Business is available 24 hours a day, 7 days a week.

Features

Register for an employer payroll tax account number;

Request your current and past three years payroll tax rates;

Submit most returns/reports online (including previous quarters back to 1/1/11);

View and print returns/reports and payments previously submitted online;

Make payroll tax deposits and pay past liabilities by Electronic Funds Transfer

(EFT) or credit card;

Update account information, including changing your address; and

Inactivate or close your account

For a more detailed description of any of the services and features, select e-Services for

Business FAQs at www.edd.ca.gov.

In order to use the e-Services for Business programs, users need to establish a username

and password. Payroll agents can establish their own username and password to file

returns/reports and make payments for their clients.

To begin the enrollment process, go to e-Services for Business and select “e-Services for

Business Login. There are currently 150,000 businesses using EDD e-services.

California Payroll Tax Deposits It is important to understand that the frequency of California payroll tax deposits could be

required more frequently than federal payroll tax deposits. This is because California

looks at the amount of accumulated personal income tax (PIT) withheld that has not been

http://www.edd.ca.gov/Payroll_Taxes/FAQ_-_e-Services_for_Business.htm

http://www.edd.ca.gov/Payroll_Taxes/FAQ_-_e-Services_for_Business.htm

https://eddservices.edd.ca.gov/index.html



52

remitted. If the amount is less than $ 350, the PIT, as well as the State Disability

Insurance (SDI) is due quarterly. If PIT is $ 350-$ 500, then the PIT and SDI are due by

the 15th

of the month following.

Employer contributions of Unemployment Insurance (UI) and Employment Training Tax

(ETT) are due quarterly.

Note: Since implementation of the Automated Collection Enhancement System (ACES)

project, EDD has improved computer systems to track when PIT thresholds are reached.

Employers are notified to exercise more caution with the $ 350 threshold, in order to

avoid receiving unexpected penalty notices.

Note: Although the IRS has discontinued the use of payroll coupons to make payments

at banks (Form 8109), EDD does not have plans at the current time to discontinue use of

its DE 88 coupons, and the ability to pay by check through the mail.

EDD coordination with FTB re: New Jobs Credit SBX3-15 (CH 09-17) created the New Jobs Credit, a nonrefundable credit for small

employers (20 employees or less) who create new jobs.

For taxable years beginning on or after January 1, 2009, a small business is allowed a

credit of up to $ 3,000 for each net increase in qualified full-time employees hired during

the taxable year. Unlike other credits, there is no requirement to hire from targeted

groups, but the credit is available for hiring general employees. A qualified full-time

employee is paid wages for at least 35 hours per week, or is a salaried employee who was

paid compensation during the year for full-time employment.

A qualified employee does not include an employee who is:

Certified as a qualified employee in an enterprise zone or targeted tax area (TTA);

Certified as a qualified disadvantaged individual in a manufacturing enhancement

area (MEA);

Certified as a qualified disadvantaged individual or qualified displaced employee

in a local agency military base recovery area (LAMBRA); or

An employee whose wages are included in calculating any other credit allowed.

One interesting aspect of the credit, is that it appears a business that has seasonal

employees may qualify if the number of weeks worked by a full-time individual

increases.

The credit is not subject to the 50% limitation for business, but it is subject to a $ 400

million cap for all taxpayers, for all taxable years. As of 12/1/12, there is still credit

available of approx. $ 261 million.



53

Wage deductions do not have to be reduced by the amount of the credit claimed. Unused

credits may be carried over for eight taxable years.

Important: The new jobs credit must be requested as a result of a timely-filed tax return

(no amended returns). The FTB will send a notice if the credit is disallowed.

The credit is based on the business’ taxable year, not a payroll calendar year. For

example, a business with a fiscal year end of October 31, 2011 computes the credit based

on the increase in employees from November 1, 2010 through October 31, 2011 as

compared to November 1, 2009 through October 31, 2010.

Unused credits can be carried forward for seven years and are not allowed to reduce

regular tax below the tentative minimum tax (or AMT limits the credit).

Note: According to EDD, information regarding new hires is communicated by request

to FTB for purposes of compliance in use of this credit.

EXAMPLE

Sally left her job at a consulting firm, and formed her own corporation to provide

consulting services in January 2012. She is hired by her closely-held corporation as the

sole full-time employee and is paid a salary. Her corporation is entitled to a $ 3,000

credit on its 2011 return because:

The increase in employees from 2011 to 2012 is one employee;

The corporation has less than 21 employees at the end of 2011; and

The corporation has one, full-time employee in 2012.

Note: When an S corporation qualifies for the credit, the S corporation is granted 1/3 of

the credit against CA S Corp tax (1.5%) AND 100% of the credit passes through on the

K-1s to the shareholders.

Note: A failed bill in the 2011-2012 legislative session, AB 643, would have capped the

New Jobs Tax Credit at $ 100 million, and instead, created a new credit similar to the



54

federal New Market Tax Credit, which allows for a “qualified equity investment credit”

of 39% under California’s personal income tax (PIT) and Corporation Tax Law (CTL).

Joint Offer-in-Compromise Form Although EDD joins with FTB and BOE for multi-agency OICs since 2008, there has not

been any uptick in frequency of use Form 999CA Multi-Agency Form for Offer in

Compromise. Each agency also maintains its own distinct OIC form as well:

Franchise Tax Board: FTB 4905 PIT

Employment Development Dept: DE 999A

Board of Equalization: BOE-490

EDD Using Debit Cards for UI Benefits The EDD Debit Card from Bank of

America is California’s new and

efficient way of delivering State

Disability Insurance, Unemployment

Insurance and Paid Family leave. It

also provides customers with a direct

deposit transfer option once they

receive the card. The card is valid for

three years from the date of issue. In

July 2011, the EDD began

transitioning its over one million UI

customers to the new EDD Debit Card. As of September 2011, 731,000 UI customers

have received their cards. The rollout of debit cards for SDI recipients is complete. EDD

has suggested that customers that use automatic bill payments in their personal banking

should schedule a few extra days for such payments. Certain fees apply to the cards use,

but careful use of the card can result in completely avoiding fees.

2012 Board of Equalization (BOE) Update

Sales Tax Rates Effective July 1, 2011, the combined statewide sales and use tax rate decreased from

8.25% to 7.25%, due to the expiration of the temporary 1% increase implemented in

April 2009, which expired on June 30, 2011. District taxes add to the statewide rate to

yield the total rate applicable.

Proposition 30, which passed on November 6, 2012, temporarily increases the statewide

sales tax rate by .25% for the next four years—from January 1, 2013 through the end of

2016.



55

The most updated list of sales tax rates is available at:

http://www.boe.ca.gov/sutax/pdf/districtratelist.pdf

New Tax on Sales of Wood and Lumber Products Effective January 1, 2013, a 1% assessment is imposed on “persons” who purchase

lumber products or engineered wood products. The new law imposed as a result of AB

1492 (CH 2012-289, 9/11/2012), includes sales of lumber, plywood particle board,

fiberboard, poles, posts, structural panels, decking, railings and fencing. It does not

include “secondary” wood products such as furniture, paper products, indoor finished

flooring products, paneling, shutters, blinds, frames, window, doors and cabinets.

New Lumber Products Assessment Schedule Retailers, who sell lumber products and engineered wood products, are required to collect

the new assessment and remit to BOE. Retailers will be required to e-file a lumber

products assessment schedule with their sales and use tax returns.

An emergency regulation is being implemented to allow reimbursable implementation

costs for retailers.

BOE Coordination with FTB Financial Institution Record Match (FIRM) Budget trailer bill SB 1015 (CH 2012-37, 6/27/2012) authorizes the BOE to provide the

FTB with information relating to delinquent tax debtors for collection purposes. FTB

will work to match BOE delinquent tax debtors to financial institution accountholder

records. The FTB follows-up by providing the BOE with any “matches” for purposes of

collection. BOE is required to reimburse FTB for its costs in the implementation and

administration of FIRM.

BOE Offers-in-Compromise (OIC) for Active Businesses SB 1548 (CH 2012-285, 9/7/2012) extends the sunset date for program provisions that

allow the BOE to accept Offers in Compromise (OIC) for businesses that are open and

active from January 1, 2013 to January 1, 2018.

BOE contends that the bill will result in approx. $ 400,000 additional revenue. In fiscal

year 2009-2010 and 2010-2011, the BOE accepted 8 offers from open and active

businesses. The amount offered totaled to $ 532,668. 7 of the 8 businesses continue to

be in business.

California Use Tax AB 2270 (CH 2012-200, 8/27/2012) liberalized the due date for individual use tax filers

(that file and pay directly to the BOE rather than add the tax and report on FTB return).

For taxpayers who file directly to BOE, the due date of January 31st is permanently

extended to coincide with the due date of Form 540 (April 15th

).

http://www.boe.ca.gov/sutax/pdf/districtratelist.pdf



56

Qualified Purchasers Update The QP program has generated approx. $ 121 million since implementation. A qualified

purchaser is a person (as defined by R&TC § 6005) who:

1. Receives at least $ 100,000 in gross receipts from business operations per

calendar year;

2. Is not required to hold a seller’s permit or certificate of registration for use tax;

3. Does not hold a use tax direct payment permit; and

4. Is not otherwise registered with BOE to report use tax.

Although these “persons” were previously automatically registered by BOE when the QP

program began a few years ago, BOE has discontinued its automatic registration of QPs.

Taxpayers, who meet the QP threshold of income ($ 100,000), should apply for an

account number online, since they will not be automatically registered as in the past.

Registration can be accomplished through e-Reg, which is BOE’s online account

application.

The BOE now allows taxpayers to close a QP account if their gross receipts drop below

$ 100,000 for two consecutive years. Additionally, the BOE closed-out over 360,000 QP

accounts, where the QPs filed returns reporting zero use tax liability for 3 consecutive

years. On July 31, 2012, 156,000 active QPs remain “on the rolls”.

AB 2059, a bill that never made it out of the 2011-2012 legislation session would have

made friendly modifications to the Qualified Purchasers (QP) program. If the bill had

been successful, it would have:

1. Increased the $ 100,000 gross income threshold to $ 500,000 for mandatory

participation in the program; and

2. Allowed QPs to use a look-up table similar to regular taxpayers.

In October 2012, BOE released its new tri-fold brochure Publication 126 Mandatory Use

Tax Registration for Service Enterprises. The brochure explains the program and the

requirement to register if qualified.

Use Tax Look-Up Table SB 86 (CH 2011-14, 3/24/2011) amended R&TC § 6452.1 to make it more convenient

for taxpayers to comply with their use tax obligations by giving them the option to report

their “estimated use tax liabilities” based upon their AGI (purchase price < $ 1,000).



57

In addition to its outreach to tax practitioners, in August 2012, BOE sent out 27,000

letters to Form 540 filers with incomes greater than $ 1 million re: their use tax reporting

requirements.

Online Retailers Sales tax applies when a California consumer purchases merchandise in California. Use

tax applies when a California consumer purchases merchandise without tax from a

business located outside the state. Although use tax is typically paid by the purchaser,

sales tax collected by an out-of-state retailer is also called use tax.



58

AB X1 28 (2011-7, 6/28/2011), referred to as the “Amazon Bill” and later AB 155 (CH

2011-313, 9/23/2011) referred to as the “Amazon Compromise” bill, expanded the types

of out-of-state retailers that are “engaged in business in this state”.

The compromise reached in AB 155 was a one-year delay in the implementation of use

tax collection by internet retailers from their California customers as authorized by

AB X1 28 (2011-7, 6/28/2011). Out-of-state retailers were required to begin collecting

use tax in California by September 15, 2012, but only if Congress failed to act on a

federal online use tax measure. Because no federal legislation was enacted in this area,

California’s Amazon law became effective on September 15, 2012.

New Law The California Department of Finance issued a certification letter on August 15, 2012

confirming that federal legislation on the issue of online use tax collection had not been

enacted. The BOE issued a Special Notice to retailers, notifying them that for sales on

and after September 15, 2012, an out-of-state retailer will be considered engaged in

business in California and required to register with BOE to collect and remit use tax if the

retailer has a substantial nexus in California.

Under AB 155, an out-of-state retailer is engaged in business in this state if the out-of-

state retailer has a substantial nexus with California for purposes of the commerce clause

of the United States Constitution or federal law permits California to impose a use tax

collection duty on the retailer. Online and other retailers that do not have a direct

physical presence in California are now required to register with BOE and report and

collect use tax if the retailer has:

More than $10,000 in sales to California customers through referral from

California-based affiliates; and

Sold more than $1 million in tangible personal property to California consumers

in the past 12 months.

Specifically, AB 155 amended R & TC § 6203 to provide that the term “retailer engaged

in business in this state” means “any retailer that has substantial nexus with this state for

purposes of the commerce clause of the United States Constitution and any retailer upon

whom federal law permits this state to impose a use tax collection duty” and that the term

now includes:

1. Any retailer that is a member of a commonly controlled group, as defined in

Section 25105, and is a member of a combined reporting group, as defined in

paragraph (3) of subdivision (b) of Section 25106.5 of Title 18 of the California

Code of Regulations, that includes another member of the retailer’s commonly

controlled group that, pursuant to an agreement with or in cooperation with the

retailer, performs services in the state in connection with tangible personal



59

property to be sold by the retailer, including, but not limited to design and

development of tangible personal property sold by the retailer, or the solicitation

of sales of tangible personal property on behalf of the retailer (e.g., a “sister”

corporation); and

2. Any retailer entering into an agreement or agreements under which a person or

persons in this state, for a commission or other consideration, directly or

indirectly refer potential purchasers of tangible personal property to the retailer,

whether by an Internet-based link or an Internet Web site, or otherwise (referred

to as a “Click-Through Affiliate”), provided that both of the following conditions

are met:

First: The total cumulative sales price from all of the retailer's sales, within the

preceding 12 months, of tangible personal property to purchasers in this state that are

referred pursuant to all of those agreements with a person or persons in this state, is in

excess of ten thousand dollars ($10,000); and

Second: The retailer, within the preceding 12 months, has total cumulative sales of

tangible personal property to purchasers in this state in excess of one million dollars

($1,000,000).”

These requirements are met at the website retailer level, not the affiliate level.

Loophole Still Exists The new law will be difficult to manage for third-party sellers who use Amazon to sell

their goods. In these circumstances, Amazon is passing the order to the third-party seller,

who fills the order and ships the product. However, the third-party seller must remit sales

tax if it is doing business in CA, even if Amazon is not collecting it.

BOE Tax Practitioner Web Page The BOE has decided to have a special wage page for tax practitioners, similar to FTB

and BOE. The BOE is willing to take comments about its design and content from the

practitioner community.

Same Day Check Processing As of September 2012, the BOE scans and deposits paper checks the same day they are

received, which means funds are withdrawn from taxpayer accounts on the same day,

also. As such, there is no advantage gained from not paying electronically.

There are several ways to make electronic payments. For information on electronic

methods, visit www.boe.ca.gov/elecsrv/esrvcont.htm.

http://www.boe.ca.gov/elecsrv/esrvcont.htm



60

2012 Franchise Tax Board (FTB) Update

FTB Earning Withholding Order for Taxes (EWOT) Budget trailer bill SB 1015 (CH 2012-37, 6/27/2012) eliminated the need for the FTB to

record a lien to preserve the ability to issue EWOTs (wage levies) for the entire 20-year

California collection statute.

An EWOT is a continuing wage garnishment based on a percentage of a debtor’s

earnings not to exceed 25% of disposable income. By law, before an EWOT can be

issued, there had to be an enforceable state tax lien in effect, whether recorded or

unrecorded. Under the new law, the FTB can issue an EWOT at any time during the 20-

year SOL.

Taxpayers’ Rights Advocate Authority-Erroneous Assessments AB 2686 (CH 2012-349, 9/17/2012) authorizes the FTB Taxpayers’ Rights Advocate to

waive penalties or additions to tax, fees, and interest that are a result of an FTB error up

to $ 7,500.

The FTB is in the process of creating a form similar to Form FTB 3701 Request for

Abatement of Interest for this purpose. The request for relief as provided by AB 2686

should be either faxed to the Taxpayers’ Rights Advocate at 916.845.6614 or mailed to:

Taxpayer Advocate Bureau

Franchise Tax Board MS A381

PO Box 157

Rancho Cordova, CA 95741-0157

California E-File California business e-file began in January 2006. E-file capability for Form 199

California Exempt Organization Annual Information Return began July 2, 2012.

Currently, business taxpayers may e-file the following forms:

Form 100 Corporation Franchise or Income Tax Return

Form 100S S Corporation Franchise or Income Tax Return

Form 100W Corporation Franchise or Income Tax Return-Water’s Edge

Form 565 Partnership Return of Income

Form 568 Limited Liability Company Return of Income

Form 199N Small Tax-Exempt Organizations (California e-Postcard)

Form 199 California Exempt Organization Annual Information Return

California does not have a mandatory e-file law that applies to the filing of business

returns.



61

Fiduciary Return California does not currently accept Form 541 California Fiduciary Income Tax Return

through their e-file system, but FTB is planning to support e-file of fiduciary returns

beginning in January 2014, for tax year 2013. This is in sync with IRS plans to support

e-file of fiduciaries in MeF format beginning in January 2014. Form 541 must be filed as

a paper return, in spite of the federal mandate to file Federal Form 1041 US Income Tax

Return for Estates and Trusts electronically.

Amended Returns Software providers have indicated to FTB, that they will not support e-file for Form

540X until the IRS begins to allow Form 1040X to be e-filed. As such, FTB plans to

implement e-file for amended returns to coincide with IRS. IRS has not set a definitive

date, but has set an approximate date of January 2015 to accept amended returns.

Prior Year Returns FTB currently supports e-filing of 2 prior tax years in addition to the current year for both

individual and business entity returns. Although FTB supports prior year returns, many

software providers have not programmed their software for e-file of prior year returns.

Practitioners should check with their software providers to verify.

Electronic Deposits Form 8109 became obsolete in 2011. Taxpayers must use electronic funds transfer for

deposits of employment tax, excise tax, corporate income tax, and taxes withheld on

payments to foreign persons. EFTPS is a free service provided by the Department of

Treasury for this purpose. Other methods are available for a fee from banking

institutions.

If a due date for a deposit is Saturday, Sunday, or a legal holiday in the District of

Columbia, the deposit is considered timely if it is deposited on the first business day after

the due date. The deposit must be initiated on the day before the deposits is due.

Previously, if a deposit was due on Tuesday, and Monday was a holiday, the taxpayer

needed to initiate the deposit on the Friday before. This procedure has been modified,

and a taxpayer can now initiate the deposit on Monday.

District of Columbia Holidays 1. January 1 - New Year's Day

2. 3rd Monday in January - Martin Luther King Day

3. 3rd Monday in February - Washington's Birthday

4. April 16 - Emancipation Day

5. Last Monday in May - Memorial Day

6. July 4 - Independence Day

7. 1st Monday in September - Labor Day

8. 2nd Monday in October - Columbus Day

9. November 11 - Veterans' Day

http://en.wikipedia.org/wiki/New_Year%27s_Day

http://en.wikipedia.org/wiki/Martin_Luther_King_Day

http://en.wikipedia.org/wiki/Washington%27s_Birthday

http://en.wikipedia.org/wiki/Emancipation_Day

http://en.wikipedia.org/wiki/Memorial_Day

http://en.wikipedia.org/wiki/Independence_Day_(US)

http://en.wikipedia.org/wiki/Labor_Day

http://en.wikipedia.org/wiki/Columbus_Day

http://en.wikipedia.org/wiki/Veterans%27_Day



62

10. 4th Thursday in November - Thanksgiving

11. December 25 - Christmas Day

California Holidays 1. January 1 - New Year's Day

2. 3rd Monday in January - Martin Luther King, Jr. Day

3. 3rd Monday in February - Presidents Birthday

4. March 31 - César Chávez Day

5. Last Monday in May - Memorial Day

6. July 4 - Independence Day

7. 1st Monday in September - Labor Day

8. November 11 - Veterans' Day

9. 4th Thursday in November - Thanksgiving

10. December 25 - Christmas Day

Note: Some lists include the day after Thanksgiving as a California legal holiday.

Conformity to Federal Tax Return Due Date AB 318 (CH 2012-313, 9/14/2012) expands the legal holiday for California income and

franchise tax purposes to include those legal holidays recognized by the Internal Revenue

Service that extend the due date for federal returns, payments, and other tax-related

documents (e.g., Emancipation Day).

Note: AB 318 permanently sets the due date of the California return to equal the due

date of the federal return.

California Mandatory e-Pay for Individuals Mandatory e-Pay penalty for individuals is currently being assessed. The penalty is equal

to 1% of the amount paid, and may be waived for reasonable cause. The penalty applies

to personal income taxpayers (PIT) whose:

Tax liability is greater than $ 80,000; or

Who make an estimated tax or extension payment that exceeds $ 20,000 for

taxable years beginning on or after January 1, 2009.

Once either condition is met, all future payments must be made electronically.

FTB is currently sending a notice (FTB 4106 MEO) when a taxpayer has triggered the e-

pay requirement. The notice includes information as to how to request a waiver from the

mandatory e-pay requirement. Waivers and request to discontinue e-pay are requested on

FTB 4107 Mandatory e-pay Election to Discontinue or Waiver Request. FTB is giving

high priority to processing FTB 4107’s received. Taxpayers can fax them to

916.845.9300.

http://en.wikipedia.org/wiki/Thanksgiving_(United_States)

http://en.wikipedia.org/wiki/Christmas_Day

http://en.wikipedia.org/wiki/New_Year%27s_Day

http://en.wikipedia.org/wiki/Martin_Luther_King,_Jr._Day

http://en.wikipedia.org/wiki/Washington%27s_Birthday

http://en.wikipedia.org/wiki/C%C3%A9sar_Ch%C3%A1vez_Day

http://en.wikipedia.org/wiki/Memorial_Day

http://en.wikipedia.org/wiki/Independence_Day_(US)

http://en.wikipedia.org/wiki/Labor_Day

http://en.wikipedia.org/wiki/Veterans%27_Day

http://en.wikipedia.org/wiki/Thanksgiving_(United_States)

http://en.wikipedia.org/wiki/Christmas_Day



63

Relief for Disabled Taxpayers The FTB has created a permanent waiver of the mandatory e-pay requirement for

taxpayers who have “a permanent physical or mental impairment that prevents them from

using a computer”. To qualify, a taxpayer must include a physician’s statement attesting

to the impairment. Also, taxpayers can check a box on FTB 4107 and have the FTB

review their account for a possible waiver of a previously imposed mandatory e-pay

penalty.

Available e-Pay methods are:

Web pay online at www.ftb.ca.gov;

Request EFW (electronic funds withdrawal) when a tax return is e-filed;

Pay by credit card (not available for group nonresident/composite filers; and

The pay by phone option (advance registration required).

FTB e-Services In November 2010, FTB dramatically improved information available online through

“My FTB Account”. Practitioners were encouraged to create a login to begin to access

client information. Enrolled Agents create a login using either their PTIN or EFIN

number. This created some consternation as to the lack of recognition of EAs, but FTB

has responded that this is linked to an IRS requirement.

With FTB recent webpage enhancements, the term, ‘My FTB Account”, has been

eliminated altogether. The new website has a place to sign in called “Access Your

Account”. Passwords must be changed every 12 months.

To obtain a taxpayer’s permission, use FTB 743 Online Account View Access

Authorization. This form is kept in the practitioner’s records, and is not required to be

sent to FTB.

In February 2011, FTB added availability to business taxpayer information. Business

entities and their authorized representatives can view payments and verify exact entity

name.

FTB Subscription Services Taxpayers and practitioners may sign up for the following subscriptions:

Tax Information

o Information returns

o Newsroom

Meetings

o FTB Meetings

o Regulation Hearings

o Interested Party Meetings

http://www.ftb.ca.gov/



64

Law and Legislation

o FTB Legislation Information

o Notices and legal Rulings

o Regulation Information

Refund Status Refund status can be checked online with the following information:

SSN

Mailing address

Refund amount shown on tax return.

Installment Agreements FTB has enhanced its electronic installment agreement (eIA) application to pay

outstanding California personal income and corporation franchise and income taxes in

installments. As a result of the enhancements, FTB will be able to verify the taxpayer’s

eligibility to enter into the agreement at the time the application is submitted.

Taxpayers can submit the eIA application during normal business hours, evenings, and

weekends. Those taxpayers who do not qualify to enter into an installment agreement

will be advised to call FTB for further assistance.

Online installment agreements are available online if:

Balance is $ 25,000 or less

IA is for 60 months or less

All required tax returns are filed.

Fee is $ 34 for individuals and $ 50 for businesses.

FTB Web Pay FTB web pay allows for direct electronic payment from checking or savings accounts

using a payment date selected by the taxpayer. Web pay does not require a registration

process to begin processing payments. Business entities may also use web pay to pay:

Current year tax return balance

Extension payment

Any amount owed for prior years

Amended tax return balance

Notice of proposed assessment payment

Tax deposit payment for a pending audit.

FTB Online Live Chat FTB has updated their website to include live chat during business hours of 8am-5pm.

The box to initiate live chat is located in the lower left-hand corner. Taxpayers should

not include social security numbers or bank account numbers in live chat sessions.



65

Systemic Issues Management Systems (SIMS) Systemic issues can be reported online utilizing a user-friendly form. Systemic issues are

issues that affect multiple taxpayers, relate to FTB systems, policies or procedures, and

involve protecting taxpayer rights or reducing or preventing taxpayer burden.

EDR Release 1.0.1 to Implement on December 31, 2012 This release is the second of nine planned. It includes the function of scanning all pages

of paper-filed current year, 2008, and prior year personal income tax form 540 form types

including W-2s, schedules, and checks. It also includes scanning of amended personal

returns (540X), and will electronically deposit any checks received with any of these

returns (called Image Cash Letter).

Information Return Update (1099s) Beginning in 2011, new Items I and J on Schedule C and information return filing

questions have been added to all business returns.

1099 Law Update On April 15, 2011, the president signed H.R. 4, the “Comprehensive 1099 Taxpayer

Protection and Repayment of Exchange Subsidy Overpayments Act of 2011” (1099 Act).

This law retroactively repealed certain unpopular Form 1099 information reporting rules

added by 2010 legislation. Since inception, information reporting is part of a greater IRS

goal to minimize underreporting by all types of taxpayers.

Repealed 1099 Law 1. The requirement under § 9006 of the Patient Protection and Affordable Care Act

(PPACA P.L. 111-148) to report payments of amounts in consideration for any

type of goods or other property, that was to begin with the 2012 tax year;

2. The requirement under IRC § 6041(h) and § 9006 of the Patient Protection and

Affordable Care Act (PPACA P.L. 111-148) to report payments of amounts to

non-tax-exempt corporations that was to begin with the 2012 tax year;

3. The requirement that rental income recipients making payments of $ 600 or more

to a service provider in the course of earning rental income become subject to

information reporting as “engaged in the trade or business of renting property”.

This change was scheduled to be effective for the 2011 tax year as authorized by

the Small Business Jobs Act of 2010 (SBJA P.L. 111-240); and

4. 3% withholding on government payments to persons providing property or

services as authorized by TIPRA 2005 (previously delayed until 2012 and 2013).



66

1099 Law-Not Repealed 1. Beginning in 2011, credit card payment processors were required to make an

annual information report to the merchant and the IRS stating the gross amount

paid to the merchant during a calendar year. Beginning for payments after

December 31, 2010, enactment of IRC § 6050W as authorized by the Housing

Assistance Tax Act of 2008, requires payment settlement organizations to report

payments in settlement of payment card and third-party network transactions each

year.

2. Backup withholding for amounts reportable under IRC § 6050W merchant

reporting applies to amounts paid after December 31, 2011 (2012). But, in

Announcement 2011-88, IRS postponed the effective day to amounts paid after

December 31, 2012 (2013).

3. Significant increase in penalties for failure to file forms or for filing late.

4. Requirement that brokers report cost basis of securities sold in addition to gross

proceeds on Form1099-B Proceeds from Broker and Barter Exchange

Transactions began in 2011.

TIN Solicitations A TIN solicitation is a request for a payee’s correct TIN. A TIN is a Social Security

Number (SSN) or an Employer Identification Number (EIN). A payee must furnish their

TIN on Form W-9 Request for Taxpayer Identification Number and Certification in an

initial solicitation. The initial solicitation should be made when the transaction occurs or

the payee opens an account. If the payee does not provide a TIN in the initial solicitation,

backup withholding should begin immediately.

Note: Businesses, which fail to secure Form W-9 until 1099 filing season, are operating

with “missing TIN”. They should follow procedures for “Missing TIN”. When the payor

is missing the TIN, backup withholding begins immediately.

Sole Proprietor TIN A sole proprietor may have an SSN or an EIN. However, he or she must always furnish

his or her individual name on Line 1 of FormW-9 regardless of whether he or she uses a

SSN or EIN. A sole proprietor may also provide a business name or DBA on Line 2, but

he or she must list his or her individual name first on the account.

2012 Information Return Filing Change Notice 2011-38 allows all filers of Forms 1099 to truncate a recipient’s identification

number (SSN), individual taxpayer identification number (ITIN), adoption taxpayer

identification number (ATIN) on paper payee statements for tax years 2011 and 2012.



67

Payments to Corporations Generally, payments to corporations are not reportable. See IRC Reg § 1.6049-

4(c)(1)(ii). However, certain payments to corporations are required to be reported:

Medical and health care payments on Form 1099-MISC;

Withheld federal income tax or foreign tax;

Barter exchange transactions (Form 1099-B);

Substitute payments in lieu of dividends and tax-exempt interest (Form 1099-A);

Cancellation of debt (Form 1099-C);

Payments of attorneys’ fees and gross proceeds paid to attorneys (Form 1099-

MISC);

Credits for qualified tax credit bonds treated as interest and reported on Form

1099-INT;

Merchant card and third-party network payments (Form 1099-K); and

Federal executive agency payments for services (Form 1099-MISC).

Payments to Partnerships and LLCs Reporting generally is required for all payments to partnerships and LLCs, unless the

LLC is filing as a corporation, as verified on Form W-9, and the payment is not in the

above list.



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IRS Information Reporting Publications There are 3 IRS documents available for assistance with information reporting:

1. General Instructions for Certain Information Returns;

2. Publication 1220 Specifications for Filing Forms 1099 Electronically; and

3. Publication 1281 Backup Withholding for Missing and Incorrect Name/TIN(s)

Electronic Filing Electronically filed return procedures are updated annually in Pub 1220 through the FIRE

system (Filing Information Returns Electronically).

Transmitters are required to submit Form 4419, Application for Filing Information

Returns Electronically (FIRE), to request authorization to file information returns with

IRS/Information Return Branch (IRB). A single Form 4419 should be filed no matter

how many types of returns the transmitter will be submitting electronically. Forms 4419

may be submitted anytime during the year; however, it must be submitted to IRS/IRB at

least 30 days before the due date of the return(s) for current year processing to allow

IRS/IRB the time necessary to process and respond to applications. Form 4419 may be

faxed to IRS/IRB at 877-477-0572.

Form 4419 is subject to review before the approval to transmit electronically is granted

and may require additional documentation at the request of the IRS. Upon approval, a

five-character alpha/numeric Transmitter Control Code (TCC) is assigned and included in

an approval letter. The TCC must be coded in the Transmitter "T" Record. IRS uses the

TCC to identify payers/transmitters and to track their files through the processing system.

Electronically filed returns may not be submitted to IRS until the application has been

processed.

Testing No Longer Required There is no longer any requirement to submit test files; however, IRS higher recommends

first time electronic filers and software companies to participate in testing, especially if

using combined federal/state filing. Electronic test files can be transmitted from

November 1 through February 15 via the FIRE test system at: http://fire.test.irs.gov.

Note: Electronically filing is mandatory when 250 or more information returns of any

type are filed. But, electronic filing is encouraged for all filers. Electronic filing

requirements apply separately to original returns and corrected returns. If corrected

returns are less than 250, corrections can be filed on paper, even though original returns

were filed electronically.



69

Failure to file electronically when required, without an approved waiver, can generate

penalties of up to $ 100 per return, unless reasonable cause is established.

Handwritten forms are still acceptable, if all information is legible and acceptable for

scanning, but it is highly discouraged.

Best Practice Comments Unlike paper Forms 1099-MISC which are due on February 28, electronic filers receive

an additional 30 days to file with the IRS. Electronically-filed Forms 1099-MISC are due

March 31.

One of the biggest values of the additional 30 days affects the Schedule C business,

where the owner typically keeps a tax appointment with his or her practitioner after

February 28. It is during the month of March, that the practitioner will discover “stray”

1099s for Schedule C filers that didn’t recognize they had an information return filing

requirement.

Recipient Copies Recipient copies of information returns may be furnished electronically instead of on

paper, except for Form 1098-C Contributions of Motor Vehicles, Boats and Airplanes.

The recipient must consent, and must not have withdrawn consent before the statement is

furnished.



70

Once the recipient consents, a new consent to receive the statement electronically is

required whenever new hardware or software is put into service.

If the recipient does not consent to receive the statement electronically, a paper copy

should be provided. Refer to IRS General Instructions for Certain Information Returns

for details involved in consents.

Combined Federal/State Filing Program Through the Combined Federal/State Filing (CF/SF) Program, IRS/IRB will forward

original and corrected information returns filed electronically to participating states for

approved filers.

Note: Although filers of paper Forms 1099 are not required to file to California’s

Franchise Tax Board, electronic filers of Forms 1099 ARE required to file to the

Franchise Tax Board.

Under the Combined Federal/State Filing Program, the Form 6847 Consent for Internal

Revenue Service to Release Tax Information is now obsolete. This form was used in

previous years as a type of authorization for IRS to release information to states. IRS no

longer requires this form as part of the Combined Federal/State Filing Program. The

Combined Federal/State Filing (CF/SF) Program was established to simplify information

returns filing for the taxpayer. IRS will forward this information to participating states

free of charge for approved filers.

Separate reporting to those states is not required. For approval to participate in the

Combined Federal/State Filing Program test filing is still required. For approval, the filer

must submit a test file coded for this program. Additionally, the Combined Federal/State

filing indicator in the Payer “A” Record was moved from field position 26 to 6.

If a payee has a reporting requirement for more than one state, separate “B” records must

be created for each state. Payees prorate the amounts to determine what should be

reported to each state. The payee does not report the total amount to each state. This is

duplicate reporting.

Forms 1099-DIV, 1099-G, 1099-INT, 1099-MISC, 1099-OID, 1099-PATR, 1099-R and

5498 may be filed under the Combined Federal/State Filing Program.



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Note: In order to participate in the combined program, information return filers must

also select a vendor that processes under the combined program, as well.

Information Return Extensions Since information returns are sent to both recipient/payees and the IRS, and since the due

date for delivery is different for each party, there is an extension required when additional

time is requested to deliver to either a payee or the IRS.

Recipient Extension Generally, the deadline for delivery of a 1099-MISC to a recipient payee is January 31

st.

(Amounts being reported in Box 8 or 14 are due to recipients on February 15th

).

Electronic delivery is acceptable if required consents are in place. The only information

return that may not be furnished electronically is Form 1098-C Contributions of Motor

Vehicles, Boats and Airplanes.

A filer may request an extension of time to furnish recipient 1099 statements by sending

a letter to: Internal Revenue Service, Information Returns Branch, Attn: Extension of

Time Coordinator, 240 Murall Drive, Mail Stop 4360, Kearneysville, WV 25430.

The extension consists of a letter, postmarked on or before January 31st, that includes the

payer name, payer TIN, payer address, type of return, a statement that extension request

is for prevising timely statements to recipients, reason for delay; and signature of the

payer or authorized agent.

If the extension is approved, a maximum of 30 extra days is allowed for providing

recipient statements.

If a request for an extension of time to furnish recipient statements is for more than 10

payers, it must be submitted electronically. See Publication 1220, Sec. 4.



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IRS Extension



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A filer of information returns can secure an automatic 30-day extension of time to file by

completing Form 8809 Application for Extension of Time to File Information Returns:

If the request is for an extension for 10 or fewer filers, complete Form 8809 and

mail it to the address listed in the instructions; or

If the request is for more than 10 filers, submit the extension request online or

electronically through the FIRE system.

Due to the increased penalties that apply to late Forms 1099-MISC, practitioners should

exercise caution to prevent penalties by notifying their clients of the need to file

extensions, if the 1099 file cannot be submitted on either February 28 (paper forms) or

March 31 (electronic forms).

In addition to preventing and reducing 1099 penalties (discussed later), an added benefit

of an IRS extension of electronically-filed Forms 1099-MISC, is that the extended due

date of April 30, allows for completion of the 1040 filing season first.

1099 Penalties 1099 penalties apply for:

Failure to file timely;

Failure to include all information required to be shown on a return;

Failure to include correct information;

Providing an incorrect TIN (Taxpayer Identification Number);

Failing to report a TIN; and

Filing paper returns when required to file electronically.

Increased Federal Penalties Increased penalties affecting information returns, which began with 2011 forms, are:

$ 30 per information return if correctly filed within 30 days of the due date.

Maximum penalty: $ 250,000 per year or $ 75,000 for a small business;

$ 60 per information return if correctly filed more than 30 days after the due date

but by August 1st. Maximum penalty: $ 500,000 per year or $ 200,000 for a

small business; and

$ 100 per information return if filed after August 1st or for failure to file a return.

Maximum penalty: $ 1,500,000 per year or $ 500,000 for a small business.

A small business is defined as one in which average gross receipts do not exceed $ 5

million.

Caution: If a taxpayer does not file corrected forms and does not meet any exception to

penalties as outlined below, the penalty is $ 100 per information return.



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Penalties do not apply to inconsequential errors or omissions that do not hinder the IRS

from process the return or correlating the information required to be shown on the return

with the information shown on the payee’s tax return. Errors and omissions that are

never inconsequential are those related to a TIN, payee surname and/or the amount.

Federal Penalty Exceptions Exceptions to the penalty:

1. The penalty will not apply to any failure that was due to reasonable cause and not

to willful neglect. In general, the taxpayer must be able to show that he acted in a

responsible manner and took steps to avoid the failure.

2. The error or omission is not considered a failure to include correct information.

3. Even though reasonable cause does not apply, the penalty for failure to file correct

information returns will not apply to a certain number of returns if the taxpayer:

a. Filed the information returns;

b. Either failed to include all the information required on a return or included

incorrect information; and

c. Filed corrections by August 1st.

If a taxpayer meets all the conditions in a, b, and c., above, the penalty for filing incorrect

returns (but not for filing late) will not apply to the greater of 10 information returns of ½

of 1% of the total number of information returns required to be filed for the calendar

year.

California Penalties for Failure to File 1099s/W-2s California penalties for not filing information returns (Forms W-2 or Forms 1099-MISC)

for personal services paid are equally as expensive:

CUIC § 13052 authorizes a $ 50 per form penalty; and

CUIC § 13052.5 authorizes a penalty of the maximum California personal income

tax rate (currently 9.3%) to be applied to the unreported amount. Additionally, if

the payer is under audit by the Franchise Tax Board (FTB), the FTB can deny the

deduction to the business for the personal services paid, which were deducted as

“ordinary and necessary”. FTB’s denial of the expense deduction is no longer an

item eligible for appeal.

Federal/California Difference-Construction Industry For California purposes, if an individual performs services in the construction industry,

and does not hold a valid contractor’s license when required, he/she will be considered an

employee of the licensed or unlicensed contractor who has hired such an individual

(CUIC §§ 621.5 and 13004.5). This same individual may be an Independent Contractor

for federal purposes. In this setting, there will be a “California-only” W-2 issued to the



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worker by the business. Neither a landlord nor a property manager in California must

treat an unlicensed contractor as an employee simply because they are unlicensed.

CUIC § 13004.5 does not apply because the landlord or property manager is not a

contractor.

EXAMPLE

Joe Smith operates a small construction company. He utilizes a haphazard system of TIN

solicitation and 1099 return compliance. For tax year 2012, he paid 75 subcontractors

requiring an information return. Joe failed to receive properly completed Forms W-9

before making payment to 15 of the subcontractors. Joe was unable to secure TINS after

mailing out Forms W-9 and placing several unsuccessful calls to the contractors at his

accountant’s request. He was unsure if he should file the 1099s with TINs missing or just

omit filing the returns altogether. A third option would be to file late and continue to try

to secure the missing TINs. What should Joe do?

Options for Joe Smith:

1. Best: File timely, include the 15 subcontractor 1099s and leave the TIN box

empty. Continue to solicit the missing TINs, and file corrected 1099s for TINs

secured by August 1st. The risk for penalty would be approx. $ 500 (15 incorrect

1099s less 10 exempt 1099s = 5 returns x $ 100).

2. File the 1099s for all but the 15 that are missing information. Continue to try to

secure the missing TINs and file a second information return submission late.

Risk for penalty would be $ 450 (15 x $ 30) if the second submission is within 30

days of the original due date. Risk for penalty on or before August 1st would be

$ 900 (15 x $ 60).

3. Omit the 15 forms altogether from his information return submission. Risk for

penalty would be approx. $ 1,500 (15 x $ 100).

Note: All future payments to the 15 subcontractors are subject to both federal (and

California) backup withholding, due to failure to provide a TIN.

Backup Withholding A TIN solicitation is a request for a payee’s correct TIN. A TIN is a Social Security

Number (SSN) or an Employer Identification Number (EIN). A payee must furnish their

TIN on Form W-9 Request for Taxpayer Identification Number and Certification in an

initial solicitation. The initial solicitation should be made when the transaction occurs or



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the payee opens an account. If the payee does not provide a TIN in the initial solicitation,

backup withholding should begin immediately.

Federal Backup Withholding Rates The 2012 federal backup withholding rate is 28%. The 2013 scheduled federal backup

withholding rate was 31%, but early reports are that ATRA 2012 extended the 28% rate.

California Backup Withholding Rates ABX4-18 (CH 09-16) conformed, with modifications, to IRC §3406, relating to federal

backup withholding rules effective January 1, 2010. California now requires backup

withholding at a rate of 7% whenever federal backup withholding is required.

EXAMPLE

Joe Smith Construction contracts with Ed Jones Plumbing. Joe Smith Construction’s

accounts payable department sends an initial TIN solicitation (W-9) to Ed Jones

Plumbing. Ed Jones Plumbing does not respond. The contract is performed, and

according to contract, payment is due upon completion to Ed Jones Plumbing. Joe Smith

Construction is required to backup withhold at a 28% rate. California backup

withholding at 7% is also required when federal backup withholding requirements are

met.

Payees exempt from backup withholding are:

Tax-exempt organizations;

Government agencies;

Corporations; and

Other entities listed in the “Instructions for the Requester of Form W-9”.

CP2100 and CP2100A Notices These notices are IRS-generated notices sent to payers that may be responsible for

backup withholding. The notice includes a list of missing and/or incorrect TINs from

information return filings (1099 submissions). Large volume filers will receive a CD or

DVD data file CP2100, mid-size filers receive a paper CP2100 and small filers receive a

paper CP2100A.

Procedure for Missing TINs Once the CP2100 or CP2100A is received, backup withholding should begin on missing

TINs. Backup withholding is continuously required until a TIN is received. Up to 3 TIN

solicitations must be made to avoid a penalty for failing to include a TIN on the

information return: The initial solicitation, the first annual solicitation, and the second

annual solicitation.



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The first annual solicitation must be filed by December 31 of the year in which the

account is opened or the transaction occurs, or January 31 of the following year, for

accounts opened in December. If the payee does not provide a TIN after the first annual

solicitation, a second annual solicitation is required by December 31 of the year

following the calendar year in which the account was opened.

Important: Sending and documenting the sending of the 3 solicitations is for the

purpose of protecting the information return filer from information return penalties.

Procedure for Incorrect TINs Compare the accounts on the listing in the CP2100 or CP2100A with records on file. If

the information in the notice disagrees with the information in the filer’s records, it is an

error. The only thing to do is to update records internally for future 1099 submissions.

There is no requirement to call or write to the IRS regarding the error. There is also no

requirement to send a ‘B Notice”.

If the information on the listing in the CP2100 or CP2100A agrees with the filer’s

records, then the first “B Notice” should be sent. “B Notices” are referred to as “B

Notices”, as it is the “B” record in the transmission file that contains the problem. Up to 2

annual solicitations must be made in response to a CP2100 or CP2100A Notice with

incorrect TINs.

First B Notice The first “B Notice” must be sent within 15 business days from receipt of a CP2100 or

CP2100A Notice.

The first B Notice is sent with a FormW-9 enclosure and a reply envelope to a payee after

receipt of the first CP2100 or CP2100A with respect to the account for purposes of

solicitation of a correct Name/TIN combination. The first B Notice is sent within 15 days

of receipt of the first CP2100 or CP2100A. The outside mailing envelope must be clearly

marked: IMPORTANT TAX INFORMATION ENCLOSED or IMPORTANT TAX

RETURN DOCUMENT ENCLOSED.

If a Proposed Penalty Notice (972CG) but not a CP2100 or CP2100A is received, the

annual solicitation must be made by December 31st of the year the notice is received. If a

“B Notice” has already been sent in the calendar year in response to a CP2100 or

CP2100A Notice, there is no requirement to send another solicitation in response to the

proposed penalty notice. If an IRS notice is received in the next calendar year reporting

that a TIN is still incorrect, a second annual solicitation must be sent within 15 business

days of receipt of the second CP2100 or CP2100A.



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If the payee does not return a signed Form W-9 in response to the First B Notice before

the expiration of 30 business days after the date of the CP2100 or CP2100A Notice, then

backup withholding should begin.

Note: Backup withholding regulations require that payers bear the responsibility for

tracking the status of the notices they receive and the “B Notices” they send out in

response. Sending a “B Notice” to a payee in response to a CP2100 or CP2100A satisfies

the annual solicitation requirement in order to avoid a penalty for filing an information

return with an incorrect TIN.

Second B Notice If a second CP2100 or CP2100A Notice is received within 3 calendar years, then the

Second B Notice is required. Again, the envelope should be marked: IMPORTANT

TAX INFORMATION ENCLOSED or IMPORTANT TAX DOCUMENT ENCLOSED.

The Second B Notice is NOT accompanied with a Form W-9. The reason a W-9 is not

enclosed, is that the payee must now certify his correct TIN by submitting within 30 days

either:

A SSN printout (obtained from a local Social Security office); or

A Letter 147C (IRS verification of an EIN).

Backup withholding is required until either of the validations above is received. Backup

withholding may stop anytime within the 30 calendar days after receiving verification.

Remitting Federal Backup Withholding Backup withholding is remitted using Form 945 Annual Return of Withheld Federal

Income Tax. Backup withholding is entered on Line 2 of Form 945.

Like employment tax forms, amounts less than $ 2,500 can be enclosed with the return.

Payments in excess of $ 2,500 must be paid using the EFTPS system beginning in 2011.

Remitting California Backup Withholding The forms used for nonresident withholding (592 Series), are the same forms also used

when backup withholding applies. Although nonresident withholding does not apply on

payments less than $ 1,500 per year, backup withholding applies on the first dollar paid,

once federal backup withholding is required.

Form 592 Resident and Nonresident Withholding Statement is used to report

backup withholding. Similar to Federal Form 945, the 7% backup withholding

collected is entered on line 2.

Form 592-V Payment Voucher for Resident and Nonresident Withholding

Statement is used to remit backup withholding.



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Form 592-B Resident and Nonresident Withholding Tax Statement is used to

report to the recipient the amount of payment subject to backup withholding, and

the amount of the backup withholding.



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Affidavit of Filing Forms 1099—DE 6028P The EDD has developed a new form for use during audit, whereby an employer can file

an affidavit as to the filing of information return forms 1099. The importance of the

affidavit is for purposes of securing PIT (personal income tax) abatements when



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independent contractors are reclassified as employees and for avoiding penalties for

failure to report.

To Receive Credit for Backup Withholding on FTB Return If a payee has backup withholding, the payee must contact the FTB to provide a valid

TIN (SSN or ITIN) before filing their return. Failure to provide the correct SSN or ITIN

would result in denial of the withholding credit.

California Nonresident Withholding Withholding is required on payments to a nonresident payee when payments or

distributions are greater than $ 1,500 for a calendar year, unless the withholding agent

(defined as the person, corporation, partnership, fiduciary, state officer, agency or

political subdivision) receives a waiver or reduced withholding amount approval.

The following California source income is subject to withholding:

Payments made to a nonresident for personal services performed in California;

Payments made to nonresident entertainers for services rendered in California,

including guaranteed payments, overages, royalties and residual payments;

Payments received for a covenant not to compete in California;

Payments releasing a contractual obligation to perform services in California;

Income from options received because of performing personal services in

California;

Bonuses paid for services performed in California;

Rents and royalties from assets located in California; and



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Distributions of California source income (different from foreign partner

withholding under R&TC § 18666) which is based on allocations rather than

distributions of income. (For information on withholding on non-US or foreign

persons, see R&TC § 18666, IRC § 1446, or federal regulations § 1.1446).

Withholding Rates The withholding rate is 7% of:

Gross payments made to nonresident independent contractors for services

performed in California (discussed above);

Gross payments made to nonresident recipients of California rents or royalties;

Distributions of California source income to nonresident beneficiaries of estates

or trusts; and

Distributions of California source income to domestic nonresident S corporation

shareholders and partners (includes LLC members).

Payments not Subject to Withholding The following types of payments are not subject to withholding:

Payments made to nonresident directors of a corporation for attending board

meetings in California; and

Income from intangible personal property such as stocks, bonds, notes, unless the

property has acquired a business situs in California. This can happen when

property is employed as capital in California, and is used in connection with a

business, trade, or profession in California as an asset of a business. Examples

include an intangible asset pledged as security for a loan connected to a California

business or bank account maintained to pay expenses related to business activities

in California.

Note: See FTB Publication 1017 Resident and Nonresident Withholding Guidelines,

which includes 150 FAQs about California backup and nonresident withholding.

California Real Estate Withholding Update Real estate withholding is at a rate of 3 1/3% of the sales price, or an alternative

withholding rate based on tax rates.

For taxable years beginning on or after January 1, 2012, the maximum personal tax rate is

12.3% (instead of 9.3%) due to the passage of Proposition 30 on 11/6/2012. As such, the

alternative withholding rate for individuals and non-California partnerships is now

12.3%.

The alternative withholding rate for the gain on sale of California real property by S

corporations is 13.8% (12.3% personal rate plus 1.5% S corp rate). The alternate

withholding rate for financial S corporations is 15.8%.



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FTB Gives Up on Property Tax Reporting A new section was planned to be added to Schedule CA, page 2 to report parcel number

and address of property for which a real estate tax deduction is taken. The new

requirement was intended to assist the FTB in evaluating taxpayers’ real estate deduction,

which, according to FTB, should not include non-deductible fees such as bond

repayments and Mello Roos levies. There is also no consistency as to what information

is available on county websites, and uniformity needs to be implemented. In response to

multiple contacts from practitioner organizations, FTB announced on 10/31/2011, they

would delay the planned form change, and would only concentrate on education and

outreach in 2012.

FTB Ruling Request The FTB requested a ruling from the IRS to answer this question: “Is a non-ad valorem

tax on real property deductible?” The IRS issued guidance in the form of a letter to the

FTB which stated that an IRS 2003 internal memorandum directly addressing Mello-

Roos taxes was correct, thus disappointing FTB hopes of disallowing deductions of

property tax, especially Mello-Roos taxes.

The IRS stated that IRC § 164(a)(1) permits a deduction for real property taxes and does

not explicitly require that the tax be ad valorem (based on value) to be deductible, only

that it is assessed at a “like rate throughout the jurisdiction”. This is contrary to FTB’s

assertion that none of the Mello-Roos tax paid is deductible because it isn’t ad valorem.

Is Everything Deductible (Post-Ruling)? Amounts assessed only on specific properties for a local benefit (such as for streets,

sidewalks, etc.) cannot be deducted as real property taxes. However, taxpayers are

permitted a deduction for the portion of the local benefit assessments that were imposed

to repair, maintain, or meet interest charges for these local benefits.

An amount paid for a local benefit is not currently deductible, but must be capitalized.

However, determining what a local benefit is can be very difficult. Even when a property

tax bill lists the items that comprise the tax, it is impossible to get a breakdown from the

county or to find someone at the Mello-Roos district office who will provide an annual

breakdown of how the Mello-Roos payment or other assessment was spent.

The federal General Accounting Office (GAO) concluded that taxpayers would have a

great deal of difficulty determining what was deductible, even though there is awareness

that taxpayers are overstating their real property tax deductions. This is because there is

no reporting requirement for counties and local agencies to distinguish which property

taxes are deductible and which ones aren’t.

In response to the IRS letter, the FTB has removed the previous information on its

website that only ad valorem real property taxes are deductible.



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IRS Fresh Start Initiative On March 7, 2012, the IRS announced a major expansion of its Fresh Start Initiative to

help struggling taxpayers. The expanded relief includes:

Penalty Relief This provision gives eligible taxpayers a 6-month extension to fully pay 2011 taxes.

Interest still applies on 2011 taxes from 4/17/2012 until the taxes are paid, but failure-to-

pay penalties won’t apply until October 15, 2012.

Two categories of taxpayers can access this relief:

1. Wage earners who have been unemployed at least 30 consecutive days during

2011 or 2012 up to April 17, 2012; or

2. Self-employed individuals who experienced a 25% or greater reduction in

business income in 2011 due to the economy.

Additionally, AGI must not exceed $ 200,000 if married filing jointly or $ 100,000 if

filing single, married separate, or head of household. The 2011 balance due cannot

exceed $ 50,000. A new federal Form 1127A is available for taxpayers to apply for this

federal penalty relief.

Installment Agreements The threshold for requesting installment agreements with limited financial information

was increased from $ 25,000 to $ 50,000.

Offer-in-Compromise The IRS will take more of a “common-sense” approach to more closely reflect “real

world” situations (according to IRS website).

California Relief California does not have either a system in place to prevent assessment of penalties in

advance or a program that mirrors IRS Fresh Start Initiative. Although California does

not have a similar program, penalty relief is still available in circumstances where the

inability to pay the tax by the due date because of financial circumstances can sometimes

be considered reasonable cause. It is very possible that FTB may abate penalties, if IRS

has abated under this program. When making the FTB request, the taxpayer should

provide copies of the IRS abatement with relevant facts and the reason for the request.

When making the request, the taxpayer will need to contact FTB for the penalty

abatement and a payoff amount. The tax and interest must be paid by October 15, 2012.

2011-2012 California Legislation In addition to new law mentioned elsewhere in these materials, the following recaps other

important legislation for the two-year legislative session that concluded on August 31,

2012. There were no federal conformity bills.



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LLC/LLP Update The state of California passed its LLC statutes in 1994, restricting the types of businesses

that could form as LLCs (restrictions applied to those licensed through the Business &

Professions Code). Recently, California has been relaxing these restrictions.

In 2010, California resolved certain conflicts in the employment tax code (CUIC) that

applied to LLC members, that were in conflict with certain portions of the IRC and the

R&TC (SB 1244, CH 2010-522, 9/29/10). Other legislation in 2010 and 2011 either

allowed or extended the LLC/LLP format to contractors, engineers, land surveyors and

architects.

Contractors Eligible to Form LLCs in California (SB 392) SB 392 (CH 10-698), allowed an individual or business providing services as a contractor

to form and operate as an LLC, effective January 1, 2011.

The contractor must obtain and maintain a $ 1 million insurance policy or place $ 1

million on deposit or in escrow, plus an additional $ 100,000 per license in excess of five

persons employed by the LLC or up to $ 5 million in total insurance, escrow or deposit.

The bill authorized and required the California State License Board to issue contractor’s

license to these LLC no later than July 1, 2011.

California Revised Uniform Limited Liability Company Act In 2012, California enacted the California Revised Uniform Limited Liability Company

Act (CRULLC), which recasts and reorganizes the existing Beverly-Killea Limited

Liability Act of 1994 (SB 323, CH 2012-419, 9/21/12). The CRULLC is effective

January 1, 2014.

The CRULLC:

Repeals California’s Beverly-Killea Limited Liability Company Act of 1994 as of

January 1, 2014;

Distinguishes between a manager-managed LLC and a member-managed LLC for

purposes of defining the scope of a member’s agency, and limiting fiduciary

duties of members who are not in control of an LLC;

Authorizes the CA Secretary of State to issue a certificate of registration with

respect to a foreign LLC. It provides for the filing of specified records and

provides that an individual who signs such a record affirms under penalty of

perjury that the information in the record is accurate;

Allows an LLC to be subject to the nonexclusive jurisdiction of courts in another

state and California or the exclusive jurisdiction of California courts;

Allows a member to consent to arbitration, as specified;

Specifies when a member may be disassociated from an LLC and the effects of

the member’s disassociation from the LLC;



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Revises provisions relating to capital contribution standards and liability of

members, and regulates the allocation of profits and losses, distributions of money

and property, withdrawal of membership, assignment of interests, and dissolution

of the LLC;

Provides that the CRULLC applies to all foreign LLCs registered with the

Secretary of State who registrations have not been cancelled as of

January 1, 2014, to all domestic LLCs existing on and after January 1, 2014, and

to all actions taken by the managers or members of such LLCs on and after that

date;

Provides that except as otherwise expressly provided, any vote or consent by the

managers or members of an LLC prior to the January 1, 2014 effective date, in

accordance with prior law may be filed after January 1, 2014 in accordance with

prior law, such as any certificate or document required to be filed in any public

office of this state ;

Provides that it does not cancel or otherwise affect the status of, or create a new

filing requirement with the Secretary of State or any other agency, board,

commission, or department for, an LLC registered to transact intrastate business

in this state prior to January 1, 2014; and

Provides that it (CRULLC) may be amended or repealed at any time.

EDD Compliance Concern re: Contractors/ New CA LLC Act Since SB 392 (CH 2010-698, 9/30/2010) allowed contractors to form as LLCs effective

1/1/2011, EDD has expressed concern that contractors will avoid employment tax

requirements for individuals performing services in the construction industry, which do

not hold valid contractor’s licenses when required. CA law requires that unlicensed

contractors are treated as employees of either the licensed or unlicensed contractor who

hired them (CUIC §§ 621.5 and 13004.5).

With the passage of SB 392 in 2010 (ability of contractors to form LLCs), EDD’s

concerns focused on a “loophole” created in this bill that would allow unlicensed

contractors to become partners in contractor LLC firms, and so avoid the employment tax

requirements of CUICC §§ 621.5 and 13004.5.

2010 LLC Employment Tax Conformity was Almost Repealed In a late amendment proposed by EDD to SB 323 (CRULLC), which was later amended

out through the eleventh-hour efforts of CSEA, California Taxpayer’s Association

(CalTax) and other like-minded organizations and persons, EDD was almost successful

in overturning SB 1244 (CH 2010-522, 9/29/2010), which had provided for payroll tax

conformity for LLCs under the check-the-box regulations. This amendment was

removed, and SB 323 was enrolled and chaptered without this amendment.

California LLC Payroll Conformity (SB 1244) Longstanding nonconformity in remuneration of LLC members was resolved with the

passage of CSEA-sponsored SB 1244 (CH 10-522, September 29, 2010). Certain



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conflicts had existed for thirteen years in the interpretation and application of various

R&TC and CUIC code sections that require LLCs to treat remuneration to its members

differently for California income tax purposes as compared to California employment tax

purposes.

History California passed its LLC statutes in 1994. The federal check-the-box regulations

followed in 1997, along with California conformity to the federal check-the-box

regulations. It appeared that the intent of the California legislature was to conform to

these regulations with SB 1234 (Alpert) in 1997 (CH 97-608), and AB 1704 (Leach) in

1998 (CH 98-243) and that the conformity should be for all taxes, not just for income and

franchise taxes. Unfortunately, the conformity did not extend to state employment tax

law (CUIC), as well as income tax law (R&TC). The lack of conformity resulted in

rampant misreporting and confusion in the business community, as it was next to

impossible for an LLC to report in the same manner for state as well as for federal in the

following two scenarios:

Scenario 1: Guaranteed payments to a non-managing member of an LLC, where

the LLC files federal and state partnership returns, were treated (prior to SB 1244)

as guaranteed payments for IRC and R&TC purposes, but as wages under CUIC;

and

Scenario 2: Wages paid to a managing member of an LLC filing as either a C

corporation or an S corporation, were treated (prior to SB 1244) as wages for IRC

and R&TC, but as guaranteed payments under CUIC.

SB 1244 made the following changes to the CUIC:

Amended § 621 definition of employee;

Added § 623 which defines that an employee does not include any member of an

LLC that is treated as a partnership;

Added § 928.7 which states that wages include compensation paid to an LLC

filing corporate income tax returns; and

Amended § 13009 which defines wages.

California is now in full conformity with federal regarding remuneration of LLC

members effective January 1, 2011. EDD updated DE 44 Employer Guide will be

updated with information regarding LLC payroll conformity as well as its information

sheet DE 231 LLC.



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Engineers/ Land Surveyors Eligible to Form LLPs (SB 1008) SB 1008 (CH 10-634), authorized licensed engineers and land surveyors to organize and

operate as LLPs and required them to maintain insurance liability coverage. (The LLP is

a California format for certain professional companies not allowed by California to form

as an LLC). The bill was effective immediately upon enactment. It is operative as of that

date and before January 1, 2016, when existing law is scheduled to be reinstated.

Note: Although SB 1008 authorized engineers and land surveyors to operate as LLPs for

five years (2011-2015), most experts feel confident that this authorization will be

extended before it would ever expire.

AB 560 (CH 2011-291, 9/20/2011): Architect LLP Extension This bill extended the sunset date under which licensed architects are allowed to organize

and operate as LLPs from January 1, 2012 to January 1, 2019.

AB 2914 (CH 06-426) had previously extended this provision from 1/1/07 to 1/1/12.

There is no sunset for attorneys and accountants.

AB 289 (CH 2011-289, 9/20/2011): Charitable Thrift Store Sales/Use Tax Exemption This bill extends the sunset date from January 1, 2012 to January 1, 2019 for the current

sales and use tax exemption for retail items sold by thrift stores operated by nonprofit

organizations to assist individuals with human immunodeficiency virus (HIV) or acquired

immune deficiency syndrome (AIDS).

AB 1090 (CH 2011-369, 9/30/2011): Property Tax Deferment Current law establishes the Senior Citizens and Disabled Citizens Property Tax

Postponement law (PTP), which allows the Controller to pay property taxes to county tax

collectors on behalf of individuals over age 62 or disabled persons making less than

$39,000 per year. The claimant must repay the Controller upon sale of the home. The

state’s tax lien is subordinate to the county tax lien. The state has not funded the PTP

since 2007-2008.

This bill enacted the County Deferred Property Tax program for Senior Citizens and

Disabled Citizens. Counties may participate in the program by adopting a resolution

indicating the county’s intention to participate. Eligible claimants can apply for

deferment with participating counties. The bill prohibits counties from charging penalties

or undertaking collection action against taxpayers granted county deferments. Claimants

will file annually in their counties between October 1st and December 10

th. Deferments

will be secured by a lien, and carries an interest rate that counties must disclose, which is

the higher of 7% per year or the effective annual yield earning in the prior fiscal year by

the Pooled Money Investment Account plus 2%. Eligibility requirements are:



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Apply in their county;

Have attained eligibility for social security benefits on the last day of the filing

period for the fiscal year or is blind or disabled’

Own a residential dwelling with at least 20% equity; and

Have household income of less than $ 35,500, using the existing definition, which

does not allow for business losses.

AB 1424 (CH 2011-455, 10/4/2011) Delinquent Taxpayer Accountability Act

Expands the “hall of shame” from the top 250 delinquencies over $ 100,000 to

500;

Increased refreshing of the publication to quarterly for BOE and semi-annually

for FTB;

Requires that the list contains names and title of officers of the business entities

on the list;

Requires the inclusion of the type, status, and number of any

professional/occupational licenses held by taxpayers or business entities on the

list;

Requires suspension of occupational, professional, and DMV licenses for

taxpayers on the list;

Prohibits state agencies from entering into contracts for goods and services from

anyone on the list;

Allows reciprocal agreements with other states for purpose of offsetting tax

refunds; and

Allows the state to enter into reciprocal agreements with other states and the IRS

to collect tax liabilities owed to California and for the BOE or the FTB to collect

liabilities owed to other states.

License Suspension Process Begins October 2012 The FTB will mail a letter to affected taxpayers informing of the above ramifications of

this law, and provide opportunity to resolve their liabilities before publication of the list.

The first letter is followed by a certified letter, stating a 30 day grace period to make

payment. Once the list is published, the FTB provides the list to:

DMV;

Department of Real Estate and Insurance;

Department of Consumer Affairs (includes Medical Board, Dental Board

and Board of Accountancy); and

CA State Bar and Department of Alcohol and Beverage Control.

The above agencies will mail letters to the taxpayers, explaining that their licenses will be

suspended in 90 days, if they do not come into compliance with FTB.



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AB 397 (CH 2011-546, 10/7/2011): Worker’s Comp Re-Certification This bill required an active contractor licensee to recertify at time of renewal of his/her

California contractor’s license an existing exemption from worker’s compensation

insurance or to provide a current and valid Certificate of Worker’s Compensation

insurance or Certificate of Self-insurance. This bill also provides for retroactive license

renewal, except when the applicant provides required documentation within 30 days after

notification by the Contractor’s State License Board of the renewal rejection.

AB 878 (CH 2011-686, 10/9/2011): Contractor’s Work Comp Insurance Currently, worker’s compensation insurers are required to report to the Contractor’s State

License Board regarding a contractor licensee’s worker’s compensation policy.

This bill additionally requires a worker’s compensation insurance carrier to report a

licensee whose worker’s compensation insurance policy is canceled by the insurer if the

insurer has completed a premium audit or investigation, and a material misrepresentation

has been made by the insured that results in financial harm to the insurer, and no

reimbursement has been paid by the insured to the insurer.

AB 242 (CH 2011-727, 10/9/2011): Conformity and Other Provisions This bill conformed to four tax provisions of the 2010 federal health care reform acts

effective January 1, 2012:

1. Health professional’s student loan repayment program exclusion and student loan

forgiveness exclusion effective for taxable years beginning on or after

January 1, 2010;

2. The Indian tribal government health benefits exclusion for benefits/coverage

provided after March 23, 2010;

3. The safe harbor for small employer cafeteria plans (Simple Cafeteria) for

taxable years beginning on or after January 1, 2011; and

4. Small employer cafeteria plans to allow Exchange-participating health plans for

taxable years beginning on or after January 1, 2014.

Other provisions of this bill effective January 1, 2012 are:

Restitution orders due to the Board of Equalization (BOE) may be collected by

the BOE in any manner provided by law for the collection of the Cigarette and

Tobacco Products Tax (CTPT);

Requires the BOE to reimburse the manufacturer of a new motor vehicle for any

use tax the manufacturer pays to or for a buyer or lessee when providing a

replacement vehicle or making restitution under California’s “lemon law”;

Eliminates the requirement for retailers and lenders to file an election with the

BOE designating which party is entitled to claim a “bad debt” deduction or

refund;

Makes technical clarification to the “repair, retrofit, or modification” exception to

the 12-month rebuttable presumption for vessels purchased outside of California;



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Delete superfluous language in Sales and use Tax law (SUT) as a matter of code

maintenance;

Allows a taxpayer to claim a reimbursement of bank charges and third-party

charge fees incurred as the direct result of an erroneous processing action or

erroneous collection action by the BOE; and

Provides that restitution orders that are due to the BOE may be collected by the

BOE in any manner provided by law for collection of a delinquent SUT liability.

AB 361 (CH 2011-728, 10/9/2011): Benefit Corporations This bill created a new type of corporation called a ‘benefit corporation”, which is also

known as a “B” corporation .

As of January 1, 2012, there are two new subtypes of stock corporations in California—a

‘flexible purpose corporation” and a “benefit corporation”. The new corporation

subtypes allow entrepreneurs and investors to organize stock corporations that can pursue

both economic and social objectives. The new stock corporation subtypes differ from

traditional “for profit” corporations that are organized to pursue profit and nonprofit

corporations that must be used solely to promote social benefits.

To form a benefit corporation or a flexible purpose corporation, the persons forming the

corporation draft free-form Articles of Incorporation. This is similar to other stock

corporations that do not fit into the simple Articles of Incorporation form that is available

on the California Secretary of State’s website. The filing fee of $ 100 is the same as

general stock corporations. The free-form Articles of Incorporation must include the

unique purposes for the specific entity type:

Flexible Purpose Corporation (California Corp Code §§ 2500-3503) The Articles of Incorporation must include one of the purpose statements required by

California Corporations Code § 2602(b)(1), as well as a statement that a purpose of the

flexible purpose corporation is to engage in one or more of the specific purposes provided

in California Corporation Code § 2602(b)(2).

Benefit Corporation (California Corp Code §§ 14600-14631) In addition to the statutory stock purpose clause required by Corporations Code § 202(b),

the Articles of Incorporation for a benefit corporation must include the following

additional statement: “This corporation is a benefit corporation.” Additionally, the

Articles of Incorporation of a benefit corporation may identify one or more specific

public benefits that shall be the purpose or purposes of the benefit corporation. Examples

include but are not limited to:

Providing low-income or underserved individuals or communities with beneficial

products or services;

Promoting the arts, sciences, or advancement of knowledge; or



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The accomplishment of any other particular benefit for society or the

environment.

AB 1307 (CH 2011-734, 10/9/2011): Seller’s Permits and Tax Delinquencies This bill authorizes the Board of Equalization (BOE) to refuse to issue a seller’s permit to

any person with an outstanding final liability with the BOE, unless an installment

payment agreement is in place. Failure to comply with installment agreement terms also

requires the BOE to revoke a seller’s permit.

Additionally, this bill authorizes the EDD to provide employer or employee information

to the BOE for the purpose of tax or fee enforcement [New employee registry (NER)

information (DE 34) and/or quarterly return information].

Earlier versions of the bill would have required BOE to participate in FTB’s Financial

Institution Record Match system (FIRM). This provision was removed in

August 31, 2011 amendments.

SB 459 (CH 2011-706) 10/9/2011: New Penalties for Worker Misclassifications This bill makes willful misclassification of employees as independent contractors

“unlawful”, and provides for severe penalties. The higher penalties apply for the

employer and the professionals advising the employer, such as an Enrolled Agent or CPA

(attorneys are exempt). The penalty is a civil penalty of $ 5,000 to $ 15,000 for each

violation. If the labor Commissioner, or court, determines there is a pattern or practice of

these violations, the civil penalty can be as high as $ 10,000-$ 25,000. There are also

fines for requiring willfully misclassified independent contractors to pay their own

expenses.

The new law also requires the labor agency to notify the Contractors’ State License

Board of a licensed contractor who is determined to willfully misclassify workers, and

then requires the registrar of the Contractors’ State License Board to initiate disciplinary

action against a licensee within 30 days of receiving a certified copy of an agency order.

SB 1015 (CH 2012-37, 6/27/2012) Doctrine of Election In addition to previous features of this bill, SB 1015 repealed existing state law that

adopted the Multistate Tax Compact, thereby ending California’s membership in the

Multistate Tax Commission, and makes legislative finds, declaratory of existing law, that

the Doctrine of Election is applicable for any election that effects the computation of

income or franchise tax under the R&TC, unless otherwise provided.

Pending litigation, Gillette v. Franchise Tax Board, Calif. First Dist. Ct. App. Dkt.

No. A-130803, involves the issue of whether taxpayers may elect to utilize a



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single-weighted apportionment formula contained in the Multistate Tax Compact (R&TC

38006, instead of the mandatory double-weighted sales factor methodology contained in

R&TC § 25128. The Court of Appeal reversed the trial court’s judgment of dismissal

and held that such an election was available.

Notice 2012-01 Although the FTB’s position is that a taxpayer cannot elect to utilize the methodology

contained in the Multistate Tax Compact on an amended return, and that such an election

must have been made on the taxpayer’s original return, it is not known if the FTB will

seek review by the California Supreme Court. In the meantime, taxpayers may need to

protect refunds from statute expiration should file protective claims according to the

procedures outlined in Notice 2012-01, issued on October 5, 2012. There is a specific

address to send the return, and the return should be marked in red “COMPACT

METHOD”.

AB 2332 (CH 2012-203, 8/27/2012) Santa Cruz County Disaster This bill authorizes disaster loss treatment for losses sustained as a result of the severe

storms that occurred in March 2011 in Santa Cruz County.

SB 1544 (CH 2012-284, 9/7/2012) Disaster: LA/San Bernardino Counties This bill authorizes disaster loss treatment for losses sustained as a result of the severe

winds that occurred in November 2011 in the counties of Los Angeles and

San Bernardino.

2012 Federal Disasters Federal declarations include:

1. Hurricane Isaac in certain parishes/counties of Louisiana and Mississippi;

2. Tropical storm Debby for certain counties of Florida; and

3. Hurricane Sandy.

2012 Hurricane Sandy On November 9, 2012, FTB issued a news release announcing special tax relief for

California taxpayers in this federally-declared disaster area. IRS postponed due dates

for filing tax returns and paying taxes including 4th

quarter from January 15, 2013 to

February 15, 2013. California will follow this postponed date. If a victim of Hurricane

Sandy has a California filing requirement, the same federal disaster rules and

postponement periods automatically apply to them.

Taxpayers claiming disaster losses should write “Hurricane Sandy” in red ink at the top

of the tax return to alert the FTB to expedite the refund. Taxpayers, who are e-filing,

should follow the software instructions to enter the disaster information.



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BOE Relief

BOE is offering a one-month extension for filing and payment of BOE taxes and fees for

taxpayers located in states affected by Hurricane Sandy as posted by Special Notice on

the BOE website at www.boe.ca.gov/news/pdf/1342.pdf.

SB 1158 (CH 2012-382, 9/19/2012) More Disaster Assistance This bill conforms state law to federal law, by allowing FTB to postpone deadlines for a

period up to one year for governor-declared disasters, and to abate interest to the extent

the interest is attributable to FTB’s delay in mailing a notice or correspondence that

requires a response from the taxpayer affected by a disaster declared by either the

President or the Governor.

The bill provides a process for taxpayers to appeal FTB denials of requests for interest

abatement to BOE. Taxpayers must apply in writing and have 30 days to file an appeal

for unpaid interest, and 90 days for paid interest. The appeal process mirrors existing on

BOE appeals for interest abatement for FTB errors.

Federal and California Disaster Losses A disaster loss is a type of casualty loss that receives special tax treatment. Disaster loss

treatment is allowed for federal purposes after a presidential declaration. Disaster loss

treatment is allowed for California purposes after a governor declaration and subsequent

state legislation. If the disaster receives both a federal declaration and a California

declaration accompanied by legislation, special tax loss treatment is allowed for both

federal and California purposes.

Once a disaster is governor-declared, subsequent state legislation is required in California

to activate the disaster provision for California tax purposes.

Like federal disasters, California personal disaster losses are subsequently reduced by:

$ 100; and

10% of federal AGI.

In order to claim a disaster loss, a taxpayer must itemize deductions. The following rules

apply to claiming a disaster loss on a California tax return:

Personal disaster losses are only claimed as an itemized deduction;

Each personal casualty and disaster loss is reduced by $ 100;

There is a 10% of federal AGI reduction for personal disaster and casualty losses;

If the loss qualifies under IRC § 165(i), the taxpayer may elect to deduct the loss

from the previous year’s income;

The NOL deduction is limited to 90% of AMTI; and

Disaster losses are allowed a 15 year carryover if designated by statute (R&TC

§§17207 and 24347.5).

http://www.boe.ca.gov/news/pdf/1342.pdf



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California Disaster Loss Treatment The election to deduct the loss on the previous year’s tax return must be made by the

later of:

The due date (including extensions) of the return for the taxable year in which the

disaster occurred; or

The due date (including extensions) of the return for the taxable year preceding

the year in which the disaster occurred.

Write the name of the disaster at the top of the original or amended tax return.

California Property Tax Changes for Disaster Victims California disaster victims, who acquire a new property in the same county to replace

damaged/destroyed property, are eligible for base-year value transfers for property tax

purposes under R&TC § 69 for all property types. The requirements before 2010 law

changes were:

The damaged/destroyed property is located in a governor-declared disaster area;

The damage to the appraisal unit (land and improvements) is more than 50% of its

FMV before the disaster (see 2010 law change below);

The replacement property is located in the same county;

The replacement property is comparable to the damaged/destroyed property;

The FMV of the replacement property does not exceed 120% of the FMV of the

damaged/destroyed property before the disaster; and

The replacement property is acquired (or built) within 5 years of the disaster.

When the replacement property exceeds the 120% of FMV rule, only the amount that

exceeds the threshold is assessed for property tax purposes at FMV.

R&TC § 69.3 provides similar disaster base-year value transfer relief to principal

residences only, when the replacement property is purchased in a different county from

the county where the disaster occurred. This provision is also only available if the board

of supervisors of that county makes this benefit available by ordinance. Currently, nine

California counties allow the base-year value transfers for displaced homeowners from

other counties. Additionally, the provisions of R&TC § 69.3 limit the amount of base-

year transfer to various percentages of the FMV of the original property, depending upon

the year the replacement property is purchased in relation to the year of the disaster.

New Law: Beginning January 1, 2010, the 50% damage test under R&TC §§69 and 69.3

is applied separately to land and improvements. This change will benefit taxpayers

whose land comprises more than 50% of a property’s total value. If either component

suffers a loss in value of more than 50%, the property owner will now qualify for a base-

year value transfer.



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For purposes of comparing values of the original and replacement properties’ values,

within the 120% FMV limitation, land and improvements continue to be considered as

one appraisal unit.

To request a base-year value transfer, file Form BOE-65-P Claim for Intracounty

Transfer of Base Year Value for Property Damaged or Destroyed in a Governor-

Declared Disaster to Replacement Property with the county assessor.

Federal and California Disaster Resources For additional information for federal taxpayers, refer to Publications 547, 584A, 584B

and 16000. For additional information for California taxpayers, refer to FTB Publication

1034 Disaster Loss: How to Claim a State Tax Deduction.

FTB Updates Instructions to 3805V and 3805Q Codes 51 and 50 were added to form instructions:

Caution: For all 2011 disasters (Santa Cruz, LA/San Bernardino and Mendocino

County), the last day to deduct a 2011 disaster loss on the previous year’s return (2010),

is October 15, 2012, the due date of the return for the year of the disaster (2011).

2012 Volycons (Voluntary Contributions on the Tax Return) The following are the voluntary contributions added or modified for 2012:

AB 233 (CH 2012-228, 9/7/2012) This bill allows taxpayers to make voluntary contributions to the California YMCA

Youth and Government Fund on their personal tax returns.

SB 803 (CH 2012-379, 9/19/2012) This bill allows taxpayers to make voluntary contributions to the California Youth

Leadership Fund on their personal tax returns.



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SB 1571 (CH 2012-459, 9/22/2012) This bill allows taxpayers to make a voluntary contribution to the School Supplies for

Homeless Children on their personal tax returns.

SB 1359 (CH 2012-456, 9/22/2012) This bill extends the repeal date of the California Breast Cancer Research Fund and the

California Cancer Research Fund until January 1, 2018.

AB 1589 (CH 2012-533, 9/25/2012) This bill allows taxpayers to contribute to the State Parks Protection Fund on their

personal tax returns, and entitles taxpayers to an annual California part day use access

pass if their contribution is an amount equal to or greater than the price of a Parks Pass,

as determined by the Department of Parks and Recreation.

SB 1186 (CH 2012-383), 9/19/12) New Disability Access and Education Fund Fee California Government Code § 4467 now requires that all business license applications or

renewals submitted or paid after December 31, 2012 to be subject to a state-mandated $ 1

Disability Access and Education Fund Fee.

SB 1186 includes multiple modifications to law surrounding the Unruh Civil Rights Act

including statutory damages and litigation protections for defendants for construction-

related accessibility violations.

AB 318 (CH 2012-313, 9/14/2012) Corporation/LLC Equality In addition to conforming California tax return due dates to federal tax return dates, AB

318 expands the imposition of the non-qualified, suspended, or forfeited failure-to-file

penalty of $ 2,000 to limited liability companies (LLCs). Beginning January 1, 2013, the

$ 2,000 penalty applies to LLCs that fail to file a tax return within 60 days after receiving

a formal written demand to file. The penalty may be waived for reasonable cause.

AB 1775 (CH 2012-474) Wage Garnishment Exempt Earnings Increases This bill increases the amount of weekly earnings exempt from an earnings withholding

order for tax (EWOT) from 30 times the federal minimum wage to 40 times the

California minimum wage ($ 217.50 to $ 320.00) effective July 1, 2013.

SB 1234 (CH 2012-734, 9/28/2012) California Secure Choice Retirement Savings Trust Act This bill created the California Secure Choice Retirement Savings Trust to be

administered by the California Secure Choice Retirement Savings Investment Board (also

established by this bill), which consists of the State Treasurer, the Director of Finance the

State Controller, an individual with retirement savings and investment expertise

appointed by the Senate Rules Committee, a small business representative appointed by



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the Governor, a public member appointed by the Governor, and an employee

representative appointed by the Speaker of the Assembly.

This bill creates a statewide program known as the Secure California Retirement Savings

Program (SCRSP), which will provide one or more IRA arrangements, to allow private

workers who do not participate in any other type of employer sponsored retirement

savings plan, an opportunity to save for retirement.

Although motivated by the large amount of private workers without retirement plans

(84% of workers whose employer employs 25 or fewer persons), all employers will be

making this option available. The SCRSP will only become operative if the Board

notifies the Director of Finance that based on market analysis, the SCRSP can be self-

sustaining and only if implementation costs are made available from a nonprofit or

private entity, the federal government or a budget appropriation.

There is a staggered employer enrollment scheduled:

1. Employers of 100 or more will enroll 3 months after enrollment opens;

2. Employers of 50 or more will enroll 6 months after enrollment opens; and

3. Employers of 5 or more will enroll 9 months after enrollment opens.

EDD will be responsible for administering a penalty of $ 250 per employee, when an

employer, who without good cause, fails to allow its employees to participate in the

SCRSP within 90 days after being notified of the failure to comply. The penalty

increases to $ 500 per employee if noncompliance continues 180 days after notice.

Note: According to EDD, there are 235,000 reporting employers with at least 5

employees, who would be required to make the SCRSP available. There are currently

588,000 accounts reporting 0-4 employees, who would not be required to participate.

AB 1845 (CH 2012-783, September 29, 2012) CUIC Amendments This bill is in response to the federal Trade Adjustment Assistance Extension Act of 2011

(PL 112-40), which requires California to make certain amendments to its UI fund

program integrity, and implement them by October 1, 2013, or face losing its

administrative grant funds to operate ($ 340 million in 2012) and CA employers losing a

federal tax credit.

The federal law requires states to impose a monetary penalty on UI claimants whose

fraudulent acts resulted in UI benefit overpayments. It also prohibits states from

providing relief from charges to an employer’s UI reserve account when the actions of

the employer or employer’s agent led to the UI overpayment. Employers will be required

to report rehired employees to EDD within 20 days of their start-of-work date (DE 34-

New Employee Registry). An individual is considered “rehired” if the



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employer/employee relationship has ended and the returning individual is required to

submit a W-4 to the employer.

AB 1845 amends the CUIC to conform the timeliness of state tax deposit requirements to

the timeliness of the federal tax deposits on and after January 1, 2013, by using “business

days’ rather than “banking days” to determine when a payment is complete.

AB 1677 (CH 2012-858, September 30, 2012) Small Tax-Exempt Threshold Conforms to Federal Threshold This bill increases the threshold for filing Form 199 from $ 25,000 to $ 50,000, to

conform to the federal filing threshold for Form 990. Small tax-exempts under the filing

threshold are required to electronically file both the federal e-Postcard (Form 990-N) and

the California e-Postcard (Form 199-N).

2012 Form Changes

2012 Federal Form Changes

Form 1099-B Reporting Changed for S Corporations Beginning with the 2012 tax year, brokers will be required to report gross proceeds and

basis information to S corporations (previously exempt recipients) on Form 1099-B.

Form 8867 Paid Preparer’s Earned Income Credit Checklist A page four has been added to the 2012 version of Form 8867 which asks for certain

checkboxes to be completed concerning documents relied on to determine:

Residency of Qualifying Child(ren);

Disability of Qualifying Child(ren);and

Existence of business reported on Schedule C.

Form 1099-K Merchant Reporting Merchant reporting is accomplished through Form 1099-K Merchant Card and Third

Party Network Payments. IRS issued final regulations relating to merchant reporting on

August 16, 2010. These final regulations amend the existing regulations under IRC §§

6041 and 6041A to provide relief from duplicate reporting for certain transactions.

Additionally:

The final regulations provide for the reporting of the gross amount of the

transaction, unadjusted by fees, etc.;

The final regulations do not provide an exemption for private label cards and mall

cards;

The final regulations do not require reporting of payment by convenience checks.

Because convenience checks are accepted and processed as checks, not as

payment cards, the regulations provide an example to clarify that the use of a

convenience check is not a payment card transaction; and



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IRC § 6050W(f) provides that payee statements may be furnished electronically,

if consented to, which includes previously having consented to receive federal tax

statements in electronic format.

Caution: Since Form 1099-K is new, both clients and practitioners will need to exercise

diligence that income amounts are not duplicated.

Requirement for Business Reconciliation of Gross Receipts Removed The IRS has decided that businesses will not be required to reconcile their gross receipts

with merchant card transactions reported on Form 1099-K on their 2012 or later returns.

Backup Withholding on Merchant Reporting begins 2013 Although gross receipts reconciliation is not required on business returns, including

Schedule C, it is crucial that practitioners review the 1099K received by business clients

for possible name/number mismatches (especially when the business taxpayer is an

individual).

CP 2100 and CP 2100A are IRS-generated notices sent to payers that may be responsible

for backup withholding. Once a merchant processor receives a CP 2100, the “B” Notice

process must be followed. The merchant processor is required to backup withhold until

the letter is received, once a case moves to the second “B” Notice status.

Federal 27% backup withholding rate was extended for 2013 and California rate is 7%.

2012 Form 1099-C Changes The titles of Boxes 1, 2, and 6 have been changed. Box 1 has been changed from “Date

canceled” to “Date of identifiable event”. Box 2 has been changed from “Amount of debt

canceled” to “Amount of debt discharged”. Box 6 has been changed from “Bankruptcy

(if checked)” to “Identifiable event code”. There is a total of 8 codes. All but bankruptcy

code is for optional use in 2012.



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Note: Since Form 1099-C is required on virtually all cancellations, whether taxable or

nontaxable since 2009, it is reported by the National Taxpayer Advocate, that many

taxpayers report cancelled debt that either isn’t taxable, or is eligible for one of the

exclusions.

2012 California Form Changes

FTB 3520 Power of Attorney FTB completely revised this form to improve the flow and in preparation for the

implementation of EDR program. In keeping with federal requirements, joint filers must

now complete and submit a separate FTB 3520. Previous joint POAs will continue to be

honored.

Taxpayers can authorize a representative for all matters regardless of income or tax year.

This authority automatically expires 4 years from the date the taxpayer signs the POS or

from the date they file a new POA that revokes this authorization. Checkboxes have been



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added to identify specific acts a representative may perform on the taxpayer’s behalf. It

is a fill-and-print form on FTB website.

FTB Form 3541 Motion Picture Credit FTB 3541 will be a new form for 2011 tax returns, and is used to claim the Motion

Picture Credit.

SBX3-15 (CH 09-17) created the Film/TV Production Credit. This credit is:

20% of qualified expenditures that are attributable to production of the movie

picture; or

Up to a maximum of 25% of the qualified production cost of qualified motion

pictures or TV series by firms that have relocated their production to California.

Producers were required to first apply to the California Film Commission (CFC) for a

credit allocation, and receive a credit certificate from the commission. The CFC began

accepting applications July 1, 2009. The commission was limited to $ 100 million of

credit allocations in any fiscal year. Allocations began in FY 2009-2010 and the first tax

credits can be claimed for tax year 2011. A credit certificate is received once awarded.

The CFC allocated the previous year $ 100 million in tax credits available to approx. 30

projects, with 45 projects initially reported to be on a waiting list.

Note: In lieu of claiming the credit, taxpayers may also make an irrevocable election to

apply the credit amount against their California sales and use taxes.

Form 3551 Sale of Credit Attributable to an Independent Film Motion Picture Credits are very marketable. If sold, no later than 30 days after the sale of

the credit, the qualified taxpayer (seller) submits form FTB 3551, Sale of Credit

Attributable to an Independent Film, to notify FTB of the name, address, and tax

identification number of the film company listed on CFC form M, the seller, and the

buyer.

Note: If the film company is a pass-through entity, the qualified seller is the partner,

member, or shareholder. Additional information required is:

Tax Credit Certificate number shown on CFC form M;

Total Tax Credit Allocation Amount shown on CFC form M;

Partner, member, or shareholder’s distributive share of the credit;

Amount of credit that will be sold;

Amount of consideration the seller will receive from the buyer; and

Amount of credit the seller has applied or will apply against BOE qualified sales

and use taxes. (This portion of the credit may not be sold.)



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The form is sent by mail or fax to: Franchise Tax Board, PO Box 1779, Sacramento, CA

95827. Fax: (916) 855-5666

Schedule EO Pass-Through Entity Ownership Beginning with 2011, partnerships and LLCs will use Schedule EO to report their

ownership interests in entities that file federal Form 1065 or that are disregarded entities.

In the past, this information was requested in a statement attached to the return. The

proposed form requests the taxpayer to identify the name, SOS number, and FEIN for all

partnerships and LLCs taxable as partnerships, in which the taxpayer holds a partial

interest and for disregarded entities in which the taxpayer has full ownership. In addition,

FTB will ask the taxpayer to indicate which entities received California source income,

and to provide the profit and loss sharing percentages used to compute the amount of

income received by the owner.



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Table 3 Partner’s Share of Cost of Goods Sold, Deductions, Rental Income Table 3 will enable partnerships to report proportional cost of goods sold, ordinary

deductions, real estate rental income, and other rental income to all partnerships.

Currently, Limited Liability Companies (LLC) are unable to correctly compute the LLC

fee because these items are not found on Schedule K-1 (565) because the Schedule K-1 is

designed to report pass-through net income. Table 3 gathers information from the pass-

through entity’s own return as well as other Table 3’s the entity receives, facilitating the

path of reporting to an LLC subject to the LLC fee that will ultimately use the

information to complete the LLC Income Worksheet. The proposed Table 3 benefits

include:

1. Enhancing the ability of partnerships to accurately report their proportionate

shares of aggregate gross receipts to other partnerships and LLCs subject to the

LLC fee;

2. Providing a new table for partnerships and LLCs to report their pass-through

entity interests;

3. Enabling LLCs subject to the LLC fee to more easily compute their correct total

income from California sources; and

4. LLCs subject to the LLC fee will have the necessary information readily available

to complete the LLC Income Worksheet, reducing their reporting burden and ease

in tax preparation.

Form 592-A Payment Voucher for Foreign Partner or Member Withholding Beginning January 1, 2011, FTB began applying Federal Treas Reg § 1.1446-6

procedures to reduce or eliminate withholding of California tax on effectively connected

taxable income (ECTI) from California sources allocable to a foreign partner. The

foreign partner must first sign and send IRS Form 8804-C Certificate of Partner-Level

Items to Reduce Section 1446 Withholding to the partnership. The foreign partner must

sign and send Form 589, Nonresident Reduced Withholding Request to the Franchise Tax

Board (FTB) along with a signed copy of IRS Form 8804-C. The FTB will review the

request within 21 business days. If the request is approved, the partnership should remit

the reduced withholding amount to the FTB along with Form 592-A, Payment Voucher

for Foreign Partner or Member Withholding.

There is no provision in the law to allow waivers of withholding to foreign partners.

However, if a foreign partner has ECTI from California sources they may apply for

reduced withholding. Follow instructions using Form 589.

Form 589 Reduced Withholding Request Beginning August 29, 2011 taxpayers must file Form 589, online. The FTB will no

longer process faxed Forms 589.

A foreign partner must also attach a completed and signed federal Form 8804-C

Certificate of Partner-Level Items to Reduce Section 1446 Withholding to the Form 589.



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Enter the total of California amounts from federal Form 8804-C, lines 8a through 8f, to

Form 589, line 10.

If Form 589 is filed online and additional documentation must be submitted such as

federal Form 8804-C, federal Schedule E (Form 1040), expense breakdown, etc. the

documentation should be faxed to (916)845-9512. On the fax containing the

documentation, include the taxpayer’s name, TIN, and the confirmation number of the

online Form 589 submission. Allow 10 business days for processing online filing.

FUTA Tax Complicated by Expired Surtax The current FUTA rate decreased .2% from 6.2% to 6.0% on July 1, 2011. Employers,

who pay state unemployment taxes on a timely basis, usually receive an offset credit of

up to 5.4% of FUTA tax, resulting in a net rate of .6% on the first $ 7,000 of wages per

employee beginning 7/1/11. Employers reporting wages in “credit reduction” states

(states which were unable to repay borrowed federal funds) receive a reduced credit

offset, resulting in a net rate between .9% and 1.5%.

The federal FUTA rate decreased in July 2011 from 6.2% to 6.0%. Most employers

receive a credit of 5.4% for paying into their state unemployment fund, so that the net

rate was .8% (6.2-5.4) for many years. This .8% rate was reduced to .6% (6.0-5.4) during

2011. Since California had unpaid federal loans, California is one of the “credit

reduction” states, whose FUTA credit was reduced from 5.4 to 5.1 during 2011. This

resulted in a FUTA rate of .9% instead of .6% during 2011 (after the federal rate

decreased).

Since California continues to have unpaid federal loans, the 2012 FUTA credit will

decrease again for 2012 from 5.1 to 4.8, so that California’s FUTA rate for 2012

increases from .9% to 1.2%.

Other Conformity Items The following items are other areas of federal/California difference:

Interest Income Dividends from other states or their municipal obligations are not taxable on the federal

return. U.S. savings bond interest is taxable on the federal return.

California Interest Income Adjustments If a mutual fund has at least 50% of its assets invested in tax-exempt U.S. obligations

and/or in California or its municipal obligations, that amount of dividend is exempt from

California tax.

The following items of interest reported on the federal return are NOT taxable for

California purposes, and can be subtracted on California Schedule CA, Column B:



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U.S. savings bonds (except for interest from series EE U.S. savings bonds issued

after 1989 that qualified for the Education Savings Bond Program exclusion);

U.S. Treasury bills, notes, and bonds;

Any other bonds or obligations of the United States and its territories;

Interest from Ottoman Turkish Empire Settlement Payments; and/or

Interest income from children under age 19 or students under age 24 included on

the child’s federal tax return and reported on the California tax return by the

parent.

The following items of interest that were not reported on the federal return ARE taxable

on the California return and are added on California Schedule CA, Column C:

The federally exempt interest dividends from other states, or their municipal

obligations and/or from mutual funds that do not meet the 50% rule;

Non-California state bonds;

Non-California municipal bonds issued by a county, city, town, or other local

government unit;

Obligations of the District of Columbia issued after December 27, 1973;

Non-California bonds if the interest was passed through from S corporations,

trusts, partnerships, or Limited Liability Companies (LLCs);

Interest or other earnings earned from a Health Savings Account (HSA) are not

treated as taxed deferred. Interest or earnings in a HSA are taxable in the year

earned;

Interest on any bond or other obligation issued by the Government of American

Samoa; and/or

Interest income from children under age 19 or students under age 24 included on

the parent’s federal tax return and reported on the California tax return by the

child.

Principal Residence Exclusion for COD Income Qualified Principal Residence Indebtedness Exclusion (QPRI) takes precedence over the

insolvency exclusion, unless the taxpayer specifically elects to use the insolvency

exception. This federal relief is authorized by the Mortgage Forgiveness Debt Relief Act

of 2007 as extended by the Emergency Economic Recovery Act of 2008 (Extender bill),

applied to tax years 2007, 2008, 2009, 2010, 2011 and 2012.

Federal Legislation Alert The American Taxpayer Relief Act of 2012 (ATRA 2012: “fiscal cliff” legislation signed

into law 1/1/2013) extended qualified principal residence indebtedness exclusion through

the end of 2013.

California Legislation Alert California’s limited conformity, unless extended, expired at the end of 2012.Two

bills were introduced in California’s 2013-2014 legislative session to conform California

to the one-year federal extension for principal residence mortgage relief in ATRA 2012.



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Either AB 42 (Perea) or SB 30 (Calderon), if passed, would extend California’s limited

conformity to conform to the federal one-year extension of qualified principal residence

indebtedness exclusion.

QPRI Limitation Most taxpayers will benefit from using the federal mortgage relief provisions, where

applicable, but a few won’t. Due to an ordering rule in the law, the portion of the debt

that is not qualified principal residence debt is considered discharged first.

To calculate this restriction on using QPRI exclusion, taxpayers subtract nonqualified

debt from the 1099-C amount. The two basic types of nonqualified debt are:

1. Amount of the loan that exceeds the federal limit of $ 2 million (or California

limit of $ 800,000); and

2. Amounts not used to buy, build or improve the home.

The taxpayers who would be better served by excluding cancellation of debt income

(COD) under the insolvency provisions are:

Taxpayers whose discharges exceed the federal and state limits;

Taxpayers who will have a gain in excess of the $ 500,000/$ 250,000 exclusion

provisions of IRC § 121; and

Taxpayers whose tax attributes are in excess of any amount they could use before

they expire.

California Limited Conformity For taxable years beginning on or after January 1, 2009, California conforms to QPR

provisions of IRC § 108(a)(1)(E) and § 108(h)(2) with the following differences:

Qualified principal residence debt is limited to $ 800,000 ($ 400,000 for MFS),

instead of the federal $ 2 million ($ 1 million for MFS); and

The maximum cancellation of debt income exclusion is limited to $ 500,000

($ 250,000 MFS).

California also had limited conformity in 2007 and 2008, but the maximum exclusion

beginning in 2009 is double the amount for 2007 and 2008.

These differences are detrimental to taxpayers with larger loan balances on their

residences. This limited exclusion will apply to discharges occurring on or after

January 1, 2009 and before January 1, 2013 (2009-2012).



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EXAMPLE

Charlie purchased a California home in 2005 for $ 1.3 million. In 2012, the bank

foreclosed, when the balance of his refinanced recourse mortgage was $ 1 million and the

FMV of the home was $ 750,000, resulting in COD income of $ 250,000. All of

Charlie’s debt was qualified debt (acquisition debt).

For federal purposes, the $ 250,000 is fully excludable from income. For California

purposes, the maximum amount of debt balance eligible for exclusion is $ 800,000,

leaving an excess of $ 200,000 that is taxable (unless Charlie qualifies under another

exclusion provision like insolvency). The $ 250,000 actual COD income must be

reduced by this excess of $ 200,000, yielding only $ 50,000 eligible for exclusion under

the qualified principal residence exclusion provision (QPRI).

Insolvency Exclusion California does conform to federal insolvency provisions, and this provision is a

permanent part of federal law (no stated expiration date). In fact, when COD income

results from the foreclosure or short sale of a principal residence, and California’s limited

conformity does not allow for exclusion under QPRI, or if the debt is not qualified debt,

the taxpayer may still be able to exclude COD income under the insolvency provision.

The insolvency provision is available for COD arising from credit cards and rental

properties, as well.

2011 FTB Foreclosure Project In 2011 FTB conducted reviews of tax returns reporting COD income and determined

that most taxpayers were recognizing the correct amount of COD income. But, they did

discover errors that may have prevented the return from being selected for review:

More than 50% of the taxpayers had received an inaccurate Form 1099-C. FTB

recommended requesting revised Forms 1099-C before filing the state return.

Note: In reality, this is usually not going to result in a corrected form. Best

recommendation is to acknowledge the incorrect 1099-C on the return and then

report accurately.

Several taxpayers did not attach federal Form 982 Reduction of Tax Attributes

Due to Discharge of Indebtedness. Other taxpayers disclosed COD exclusions on

other forms and statements rather than completing Form 982. Still others did not

report the COD income, gain, or loss from the property disposed by foreclosure or

short sale.



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Note: In reality, the California return may need its own version of Form 982. FTB

should have developed one, and never did. Use the federal form and mark that it is for

California purposes at the top. The need for a separate form is especially important

when federal attributes are not the same as state attributes, and the amounts entered in

Part II are different between the federal return and the state return.

Theft Loss from Ponzi scheme Under Rev-Proc 2009-20 and Rev-Rul 2009-9, federal allows a “safe harbor” treatment

of theft losses as a result of Ponzi schemes, and provides for a 5-year NOL carryback.

California conforms to federal treatment of the Ponzi loss as a theft loss, but does not

conform to the carryback provisions, as California does not currently have a provision for

carryback of NOLs. CA NOL carrybacks are scheduled to phase-in beginning in 2013.

Community Property Rules Affect RDP Federal Returns in 2010 The federal decision requiring use of community property rules in preparation of the

federal tax return became effective for taxable years beginning on or after June 1, 2010

(CCA 201021050). This ruling affects approx. 58,000 RDPs in California.

When filing returns for RDP’s, practitioners must now use normal community property

rules, for both the federal single filing status return as well as the California returns, if

the RDP does not file joint with his/her partner, since California is a community property

state. This requires using an allocation worksheet to record the division of community

property shown on the return. This Allocation Worksheet is found in IRS Publication

555 Community Property, in Table 2, and should be attached to the federal tax return.

The IRS has stated that marking the income allocations on Forms W-2 and/or Forms

1099 in lieu of using the worksheet in Publication 555 is also acceptable.



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Income is split on community assets until the partnership is terminated. This is the same

as for other couples, except in one aspect. Although married persons may cease using

the community property rules when they separate with no intention of reuniting, RDPs

must actually have terminated the partnership.

Federal Definition of Community Property Absent a “pre-nuptial” or “post-nuptial” agreement, community property is property

that the RDPs acquire during their legal relationship while domiciled in a community

property state. This includes earnings and benefits, assets purchased from community

property resources, and income from community property assets. It does not include

gifts, inherited assets, or property brought into the relationship, unless such property is

intentionally or unintentionally comingled. Community property is also property that the

RDPs agree to convert from separate to community property, as well as any property that

cannot be identified as separate property.

Other Business Updates

California Charitable Contribution Deduction for Food AB 152 (2011-503, 10/5/11) created a California income tax credit for donations of fresh

fruits or fresh vegetables to a California food bank. AB 152 established a 5-year tax

credit for years beginning on or after January 1, 2012 and before January 1, 2017, equal

to 10% of the costs of fresh fruits or fresh vegetables donated to a California food bank

by a qualified taxpayer. A qualified taxpayer is defined as a person responsible for

planting the crop, managing the crop, and harvesting the crop. The cost would be the

cost that would otherwise be included in inventory costs.

The food banks are required to provide the value of the donation to the donor, and the

donor would be required to provide certification to FTB upon request.

California NOLs



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Although NOLs are reinstated for 2012, California has had a long history of suspension

of NOLs during difficult economic times.

2008 NOL Legislation AB 1452 (CH 2008-763, 9/30/2008), a budget trailer bill from 2008, amended how NOLs

would be used on California returns. NOLs were suspended for tax years 2008 and 2009,

except for certain small businesses (less than $ 500,000 of business income). Suspended

NOLs were scheduled to be eligible for an additional carry forward year for each year the

NOL was not useable.

Losses generated in 2008 and later years were scheduled to be eligible for a 20-year

carryover. Additionally, beginning with the 2011 year, California was scheduled to begin

a phase-in of a two-year NOL carryback.

2010 NOL Legislation Then, a budget trailer bill from 2010, SB 858 (CH 2010-721, October 19, 2010) delayed

the implementation of the phase-in of a 2 year carryback from 2011 to 2013 as follows:

50% for NOLs generated in 2013 (previously set to begin in 2011);

75% for NOLs generated in 2014 (previously set to begin in 2012) ; and

100% for NOLs generated in 2015 or later (previously set to begin in 2013).

SB 858 (2010) also included the following provisions:

5-year carrybacks for qualified disaster losses would not apply for California

purposes;

Suspended NOLs for taxable years 2010 and 2011 for taxpayers with modified

adjusted gross income (PIT) or pre-apportioned income (corporation tax law) of

$ 300,000 or more;

Extended the NOL carryover period by one year for a suspended year; and

Provided a retroactive exemption under corporation tax law from the 2008 NOL

suspension rules for a taxpayer that ceased to do business or had a final taxable

year ending prior to August 28, 2008, that sold or transferred substantially all of

its assets resulting in a gain on sale during a taxable year ending prior to

August 28, 2008, and the sale or transfer occurred pursuant to a Chapter 11

reorganization plan.

NOLs avoided any 2012 legislation that modified the provisions of SB 858 (2010). As

such, ALL taxpayers can utilize NOL carryovers on their 2012 returns!

NOLs incurred in 2000-2007 are eligible for a 10-year carryforward, but NOLs from

2008 and later years are eligible for a 20-year carryforward. Additionally, pending any

2013 legislation that could still be introduced, NOL carrybacks are currently scheduled to

begin with the 2013 year (next year).



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Legal Ruling 2011-04: Suspension of Net Operating Loss Deductions This FTB ruling from 2011explains how the NOL carryover period is computed when a

taxpayer’s loss was suspended in a prior year, and how and in what order the losses are

used. One key point is that when a loss is suspended, the entire loss may not be granted

an additional carryover.

California has periodically suspended the ability of personal and corporate taxpayers to

take a NOL deduction. For 2011, the suspension provisions do not apply and the

taxpayer can take an NOL deduction if a personal income taxpayer has less than

$ 300,000 of modified adjusted gross income, or a corporate taxpayer has less than

$ 300,000 of pre-apportioned income.

The carryover period for each year’s NOL is extended only where an NOL

deduction is denied, in whole or in part, because of the application of the suspension

provisions to that year’s NOL. As such, an NOL or NOL carryover will not have an

extended carryover period if no portion of the NOL deduction was denied by operation of

the suspension provisions.

EXAMPLE

W Corporation has $ 20,000,000 NOL from 2006 and a $ 20,000,000 NOL from 2007.

W has $ 500,000 of income subject to tax in 2008, and $ 500,000 of income subject to tax

in 2009. W does not have any income or loss in either the 2010 or 2011 tax years.

The 2006 NOL must be considered first. $ 500,000 is suspended for 2008, and an

additional $ 500,000 is suspended for 2009. Since the 2007 NOL is not affected in either

2008 or 2009 since it could not be used until the 2006 NOL is fully absorbed, the 2007

NOL is not suspended and the carryover period is not extended.

The carryover periods for the 2006 and 2007 NOLs was originally 10 years, and would

have expired at the end of 2016 and 2017 respectively. Due to the suspension, the

carryover period for the remaining 2006 NOL is extended by 4 years and expires in 2020.

Because none of the 2007 NOL is denied by operation of suspension, the 2007 NOL is

not extended. On January 1, 2012, the 2006 NOL has 9 remaining years and the 2007

NOL has 6 remaining years.

Definition of “Doing Business” For purposes of the franchise tax, “doing business in California” is defined as “actively

engaging in any transaction for the purpose of financial or pecuniary gain or

profit”[R&TC § 23101(a)].



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California’s “Bright-Line” Tests Additionally, beginning with the 2011 taxable year, a corporation will be considered to

be doing business in California during the year if it actively engages in any transaction

for the purpose of financial or pecuniary gain or profit in California, or it satisfied one of

the 4 tests below [R&TC § 23101(b)]. The addition of subdivision (b) to R&TC § 23101

now provide a “bright-line” test for purpose of defining “doing business in CA”. The

amounts were first indexed in 2012 (2nd

year), using the 2012 1.9% inflation rate.

1. The corporation is organized or commercially domiciled in California;

2. The corporation’s California sales, including sales by an agent or independent

contractor, exceed the lesser of $ 509,500 or 25% of the corporation’s total sales;

3. The corporation’s California real property and tangible personal property exceed

the lesser of $ 50,950 or 25% of the corporation’s total real property and tangible

personal property; or

4. The amount paid in California by the corporation for compensation exceeds the

lesser of $ 50,950 or 25% of the total compensation paid by the taxpayer.

Compensation is determined by using the rules for assigning payroll under R&TC

§ 25133.

An out-of-state taxpayer that has less than the threshold amounts of property, payroll and

sales in California may still be considered doing business in this state if the taxpayer

actively engages in any transaction for the purpose of financial or pecuniary gain or profit

in California.

EXAMPLE

Warranties 4 U is an out-of-state partnership that has employees who work out of their

homes in California. The employees sell and provide warranty work to California

customers. Although the partnership property, payroll and sales in California fall below

the threshold amounts, the partnership is considered to be “doing business in California”

through its employees, because the employees are “actively engaging” in transaction for

profit on behalf of the partnership.

EXAMPLE

ABC Corporation is an out-of-state corporation with $ 100,000 in total property,

$ 200,000 in total payroll, and $ 1 million in total sales, of which $ 400,000 were sales to

California customers. Although ABC Corp has no property or payroll in California, ABC

corporation is considered to be “doing business in California” because 40% of its total

sales (exceeds 25% threshold) are California sales ($ 400,000 ÷$ 1,000,000).



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Note: A corporation that is “not doing business in California” is subject to corporate

income tax if it is not qualified with the SOS but derives income from sources within

California, but is NOT subject to the $ 800 minimum. So, a corporate income taxpayer

that has no income in a given year will pay no tax. A franchise taxpayer must pay the

$ 800 minimum tax regardless of income or activity.

C corporations file Form 100 California Corporation Franchise or Income Tax Return.

S corporations file Form 100S California S Corporation Franchise or Income Tax

Return.

FTB Notice 2011-06

FTB released this notice on October 12, 2011, re: requests for written advice by

taxpayers who are unsure whether business activities constitute “doing business in CA”.

Subdivision (b) of R&TC § 23101, therefore, is a recent amendment and adds specific

conditions for “doing business” as stated above. These 4 new threshold tests, when met

by an entity, provide that the entity is “doing business” in California. However, when the

entity does not meet one or more of these conditions, the entity must still determine

whether it was “actively engaging in any transaction for the purpose of financial or

pecuniary gain or profit” under the general rule for “doing business”, which is found

within R&TC § 23101(a).

Per Notice 2011-06, FTB will accept requests for written advice on that issue, but will

continue to decline to rule on whether the specific factual threshold tests of R&TC §

23101(b) have been met. In previous Notice 2009-08, under Guidelines at paragraph C,

FTB described certain no-ruling areas, where they will not provide written advice. In

these Guidelines, no ruling will be issued where the answer to a question depends

principally upon factual issues. The FTB, then, will not provide written advice on “doing

business” under R&T(b) regardless of whether the corporation elects the SSF. C

23101(b) (the 4 threshold tests), given the factual nature of any such determination.

In Notice 2011-06, FTB states that “putative” taxpayers (supposed, alleged CA

taxpayers) may apply for the Voluntary Disclosure Program (VDP) concurrent to filing

for a Chief Counsel Ruling, even when the Chief Counsel Ruling determines the

taxpayer’s activities do constitute “doing business in CA”, and that a return filing

obligation exists, whether or not the ruling is ultimately issued to the taxpayer.

Lastly, Notice 2011-06 states that nothing in the notice supersedes the process in place

under R&TC § 23101.5 for petitioning the FTB for a determination whether a corporation

is “not doing business” in California.



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California’s Franchise Tax The California franchise tax is a tax on the right to do business in California. For

purposes of deductibility on federal returns, the tax accrues on the first day of the income

year. A cash-basis corporation deducts the taxes in the year paid on its federal tax return.

An accrual-basis corporation must still wait until the first day of the taxable year to take

the deduction, even though the taxes were paid in advance (IRS Rev-Rul 79-410).

To summarize:

Prior to 2000 the payment of the minimum franchise tax to the SOS at

incorporation or qualification was not deductible and merely increased the basis

of organization costs;

Amounts that a cash-basis corporation is not required to pay for its estimated

franchise tax, cannot be deducted until required. (This means that it is futile to

overpay estimated taxes, because any excess is not deductible); and

An accrual-basis corporation is limited to the actual franchise tax liability. These

corporations ignore when the amounts were actually paid, but they deduct the

prior-year tax on the current year return. In other words, for tax years beginning

on or after January 1, 2000, an accrual-basis corporation that reflects a franchise

tax liability of $ 800 on its 2010 California return will deduct the $ 800 on its

2011 federal return. It will not accrue the tax on its 2010 return.

Rev-Proc 2011-14: Timing of Federal Deduction for State Taxes Rev-Proc 2011-14 provides a method for an accrual corporation to change its method of

accounting for California franchise taxes from deducting the payment in the year after the

payment on the federal return to deducting the payment in the year the payment is made.

The change is available under the automatic consent procedures, and is referenced in at

§ 19.09. The automatic accounting method change number is “154”.

2011 California Corporation Tax Law Changes California adopted and amended the following statutes that change how multistate

corporations are taxed in California. The following California R&TC sections changed

for taxable years beginning on or after January 1, 2011:

R&TC §23101—Modifies the definition of “doing business” in California

R&TC § 25120—Provides for the definition of “gross receipts”

R&TC § 25128.5—Single Sales Factor Election

R&TC § 25135—Finnegan Rule adopted (sales from tangible personal property)

R&TC § 25136—Assigning sales from other than tangible personal property.



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Single Sales Factor Election Available for 2011 SBX3-15 (CH 2009-17) authorized a single sales factor method of apportionment

beginning with the 2011 taxable year.

The California statutory scheme for the sales factor of the apportionment formula has

undergone two major changes during the last few years:

1. The Legislature replaced the currently operative rules for sales of “other than

tangible property” that were contained in R&TC § 25136 with a new set of rules

that became operative on January 1, 2011; and

2. In SB 858, the Legislature brought back the old rules and made them applicable to

a certain group of taxpayers, while retaining the “new rules” for other taxpayers.

SB 858 (2010 budget trailer bill) modified use of the single sales factor, for businesses

that make this election on or after January 1, 2011. The statutory scheme now provides

under R&TC 25136(a) that for taxable years beginning before January 1, 2011, and for

taxable years beginning on or after January 1, 2011, for which an election under R&TC §

25128.5(a) has not been made (single sales factor), sales other than sales of tangible

personal property are assigned based on where the income-producing activity is

performed.

R&TC § 25136(b) will now provide that sales other than tangible personal property are

assigned to the numerator of the sales factor based upon the location where the benefit of

the services was received or the location of the use of the intangibles.

Legislative Alert With the passage of Proposition 39, apportioning businesses will be required to use the

single sales factor apportionment method beginning in 2013.

Without the election Businesses who do not elect single sales factor apportionment (or use the 4-factor

model), will source the sale of intangibles using the cost-of-performance rules (R&TC

§ 25136) by using the pre-2011 rules for sourcing income to California which require:

Sales of tangible personal property are assigned to California if the product is

delivered or shipped to a purchaser in this state, and the taxpayer (seller) is

taxable in this state;


delivered or shipped from California to a purchaser out-of-state, and the taxpayer

(seller) is not taxable in the state of destination;

Sales of tangible personal property to the US Government are assigned to

California if the goods are shipped from California;

Sales from the performance of personal services are assigned to California if the

services are performed in California. If personal services are performed in more

than one state, then the receipts from the services are assigned to California based



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on the ratio of time spent performing such services in the state to total time spent

in performing such services everywhere;

Sales from intangibles and all other services are assigned to California if the

income producing activity that gave rise to the receipts is performed wholly

within California. If the income producing activity is performed within and

outside the state, then the sales from intangibles and all other services are

assigned to California if the greater cost of performance of the income producing

activity is performed in this state; and

Sales from the sale, rental, lease, or licensing of real property and the receipts

derived from the rental, lease, or licensing of tangible personal property are

assigned to California if the property is located in California.

With the election Businesses that do elect to use the single sales factor must use market-based sourcing to

determine if sales from services are sourced to California. In other words, these

taxpayers are required to use the post-2010 rules for assigning sales of intangibles and

services as follows:


delivered or shipped to a purchaser in this state, and the taxpayer (seller) or any

member of the combined reporting group is taxable in this state;


delivered or shipped to a purchaser out-of-state, and the taxpayer (seller) or any

member of the combined reporting group is not taxable in the state of destination;

Sales of tangible personal property to the US Government are assigned to

California if the goods are shipped from California;

Sales from services are in this state to the extent the purchaser of the service

receives the benefit of the service in this state;

Sales from intangible property are in this state to the extent the property is used in

this state. In the case of marketable securities, sales are in this state if the

customer is in this state;

Sales from the sale, lease, rental, or licensing of real property are in this state if

the real property is located in this state; and

Sales from the rental, lease, or licensing of tangible personal property are in this

state if the property is located in this state.

Note: FTB adopted Regulation § 25128.5, effective October 22, 2011 which clarifies the

single sales factor filing election newly available to multistate taxpayers that apportion

their business income derived from sources in California to determine the amount subject

to taxation in California. The regulations provide information as to how to make a timely

election to use the single sales factor.

Public Law 86-272 and Nexus Issues PL 86-272 still applies to sellers of tangible personal property. As a result, if a taxpayer’s

activities in California stay within the protections of PL 86-272, a taxpayer also remains



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protected from the imposition of taxes that are computed based on net income, namely,

the California franchise and income tax. But, if a taxpayer is considered to be “doing

business in California” either under R&TC §§ 23101(a) or 20101(b), it still has a filing

requirement and will be subject to the minimum tax, because that tax is not computed

based on net income, and therefore is not subject to the protections of PL 86-272.

EXAMPLE

DEF Corporation, an out-of-state corporation, sells tangible goods over the internet and

qualifies for protection under PL 86-272. For taxable year 2011, DEF Corporation has

$ 1 million of sales but no property or payroll in California. DEF Corporation is

considered to be “doing business in California” because it has sales of $ 1 million in

California. Therefore, DEF Corporation must file a California return to pay the minimum

tax ($ 800). However, since DEF Corporation is protected under PL 86-272, it will not

be subject to California franchise tax.

EXAMPLE

XYZ Corporation is an out-of-state corporation with no property or payroll in California.

It is a service provider with $ 2 million in sales to purchasers who receive the benefit of

the corporation’s services in California. The services are from income-producing activity

that is performed outside of California. XYZ Corporation uses the 4-factor

apportionment formula. As a result, none of the corporation’s income is apportioned to

California. XYZ Corporation is considered to be “doing business in California” because

it has sales of services in California of $ 2 million. Sales of services and intangibles are

sourced under R&TC § 25136(b) for purposes of applying the “bright-line test, regardless

of whether the sales are sourced under R&TC § 25136(a) for income apportionment (that

is, regardless of whether the taxpayer elects single sales factor apportionment). XYZ will

be liable for the minimum tax. PL 86-272 does not protect the corporation, because it

does not apply to service providers, nor does it protect against the minimum tax (because

that tax is not income-based).

Secretary of State Office Update

Secretary of State Procedure Change Beginning September 26, 2011, the Business Programs Division of the CA SOS ceased

sending a blank statement of information to newly formed corporations and LLCs.

Instead, the CA SOS began sending out welcome letters congratulating newly formed



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entities and providing helpful information regarding due dates of the statement of

information, as well as supplying additional business information or resources.

SB 1532 (CH 2012-494) Initial Street and Mailing Address 1. SB 1532 requires California entities to include an initial street address on

formation documents filed with the Secretary of State, as well as the name and

street address of its initial agent for service of process. The formation documents

must also provide the initial mailing address, if different from the street address.

2. SB 1532 requires that changes to initial address information for both corporations

and LLCs be made only through the Statement of Information. It prohibits

changing address through amendments or restatements of articles.

3. SB 1532 removes the provision that requires the SOS to physically compare,

approve or certify (file-stamp) customer-submitted copies of filed documents, and

instead allows the SOS to supply a copy of filed documents to customers without

charge for any document with a filing fee of $ 25 or more. Additional copies may

be requested and paid for at the time of filing. Additional copies are $ 1.00 for

the first page and $ 0.50 for each additional page. Each certified copy requires an

additional $ 5.00 certification fee.

The filing fee for both corporations and LLCs is $ 20. Corporations have to pay

an additional $ 5.000 disclosure fee. Therefore, customers requesting copies of a

Statement of information or any other filing with a filing fee under $ 25 will need

to pay for copies.

Practitioner Update

PTIN Renewal Update As of 1/3/13, about 73% of 2012 PTIN holders had renewed for 2013. IRS indicated that

this duplicates the pattern from last year, as renewals continued at a strong pace

in January. PTINs must be renewed annually before a practitioner begins preparing

returns this filing season. All paper renewals are being worked timely and well within the

4-6 week response time.

Beginning January 14, 2013 IRS will start issuing letters stating "Your PTIN has

expired."

An additional 37,000+ new first-time PTINs have been issued for 2013.



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Consents to Disclose and Consents to Use Tax Return Information (Rev-Proc 2013-14, December 26, 2012) The IRS provides guidance on required language on taxpayers’ consents to disclose or

use return information.

IRC § 7216(a) imposes criminal penalties on tax return preparers who knowingly or

recklessly make unauthorized disclosures or uses of information furnished in connect

with the preparation of an income tax return. IRC § 6713 prescribes a civil penalty for

unauthorized disclosures or uses of $ 250 for each disclosure/use, not to exceed a total of

$ 10,000 for a calendar year.

All consents must be voluntary and cannot be conditioned on the taxpayer agreeing to use

the preparer’s services. Opt-out consent is not permitted.

Section 5 of the Rev-Proc provides the mandatory language for the following 4

situations:

1. Consents to disclose tax return information in a context other than tax return

preparation or auxiliary services;

a. Use to send information to other financial professionals at the request of

the taxpayer.

2. Consent to disclose tax return information in tax return preparation or auxiliary

services context.

a. Use if a client asks for you to send tax return information to their new

preparer; or

b. If you assist a preparer in a consulting capacity.

3. All consents to use tax return information; and

a. Use for tax-related services, such as tax planning, advice related to

treatment of investments, year-end planning and preparation of revised

estimated tax payments and required minimum distributions; and

b. Use for responding to client other tax and financial questions.

4. Consent to disclose tax return information to a tax return preparer location outside

of the United States.



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Appendix



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Documents

2012 Tax Update for the California Professional...on the California Employment Development Department's (EDD) Small Business Employer’s Advisory Committee (SBEAC). In 2010, Vicki