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Chapter 16: Rental Property

Overview Chapter Description Upon completion of this chapter, students will recognize the two major differences between federal and California laws governing rental property, including the fact that all rental real estate activities are treated as passive activities under California law. Students will be introduced to noncompliance issues regarding substandard rental housing. Students will become aware of common mistakes made in the reporting of rental losses. Lastly, students will be informed of how to recognize differences between federal and California reporting of rental income and deduction items from pass-through entities. The following content is based on 2018 tax law; however, discussions of prior year tax law will be addressed as applicable.

Learning Objectives

1) Summarize the differences between California and federal rental real estate net income. 2) Describe passive activity losses and loss limitations. 3) Explain the consequences of noncompliance for substandard rental housing (SRH). 4) Identify common taxpayer errors made when reporting a rental loss. 5) Determine items of income and deductions from pass-through entities.

Key Terms

Material Participation Passive Activity Substandard Rental Housing (SRH)

Objective #1: Differences Between California and Federal Rental Real Estate In general, California law conforms to federal law. Key differences in the federal and state law governing rental property for California are:

In 1994, the federal government finalized regulations under IRC Section 469 which specified that rental real estate activities performed by taxpayers in a real property business are not automatically treated as passive activities. California did not conform to the federal provision. Instead, California treats all rental activities as passive activities.

California Depreciation rules did not conform to changes made by the Economic Recovery Tax Act of 1981. Exception: Residential rental real estate constructed and placed in service during the period July 1, 1985 through December 31, 1986.

Federal basis may differ from California basis, which in turn may affect depreciation. The federal and California basis may not align due to differences in depreciation methods, accelerated write-offs, and special credits.

Student Note: For more information on differences between federal and California depreciation, review Chapter 14, Depreciation.


Form FTB 3885A is used to determine the adjustment for differences in the amount of depreciation and amortization allowed as a deduction using California law.

1

If there is a difference between the California and federal depreciation amounts, an adjustment will be required on Schedule CA (540 or 540NR), line 17, column B or column C.

2

1 Form FTB 3885A 2 Schedule CA (540), Part I, Section B


Review Question 1 Marsha and Greg are married and reported rental real estate income from their five properties on federal Schedule E. During the tax year, they had an addition built on to one of their properties, which increased several of their expenses. Of the following rental expenses, which could require a California adjustment? a) Advertising expenses b) Expenses for repairs c) Utility expenses d) Depreciation expenses

Objective #2: Passive Activity Losses and Loss Limitations Beginning with 1987 tax returns, California generally conforms to federal passive activity rules. Special allowances for active participants are the same. However, the federal special treatment for real estate professionals may cause differences between California and federal passive activity losses (PALs). California passive activities are reported on Form FTB 3801 (which is virtually identical to federal Form 8582). Form FTB 3801 determines differences between federal and California PALs. All necessary adjustments are entered on Schedule CA (540 or 540NR), line 17, column B or column C.

3 Rentals are deemed passive activities and losses are not currently deductible unless:

Passive income exists (losses are allowed to the extent of passive income); The taxpayer actively participates in a rental real estate activity and qualifies for the

$25,000 special allowance – IRC §469(i); There is a qualifying disposition during the taxable year – IRC §469(g); or The taxpayer meets the material participation requirements for real estate professionals –

IRC §469(c)(7).

3 Form FTB 3801, Part I


Material Participation California does not conform to federal law regarding material participation in rental real estate activities. Therefore, an election under IRC §469(c)(7) does not apply for California purposes. Rental activities are generally considered passive activities, even when a taxpayer materially participates in them. Under federal law, rental real estate activities in which a real estate professional materially participates are non-passive activities. A taxpayer qualifies as a real estate professional if both of the following criteria are met:

More than half of the personal services performed by the taxpayer in all trades or businesses during the tax year were performed in real property trades or businesses in which the taxpayer materially participated; and

The taxpayer performed more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participated.

Student Note: This requirement applies separately to each spouse on joint returns. Also, real property trades or businesses do not include rental property management.

If the taxpayer (and/or spouse) satisfies these requirements, then rental activities are not considered passive activities. For purposes of determining whether the taxpayer materially participated in rental real estate activities, each interest in rental real estate is a separate activity unless the taxpayer elects to treat all interests in rental real estate as one activity. Taxpayers are considered a material participant in an activity if they are involved in its operations on a regular, continuous, and substantial basis during the tax year. Nonresidents and Part-Year Residents Nonresidents are subject to tax only on California sourced income, i.e., real property located in California. Similarly, part-year residents living outside of California are subject to tax only on California sourced income. For nonresidents, only suspended passive losses from California rental property carry forward to the following tax year. For taxpayers moving into California with prior year suspended losses, the losses must be restated as if they were California residents for all prior years. Part-year residents divide taxation between California and another state based on time in each location. When passive activities are involved, especially suspended losses, the computations are complex. Suspended losses are computed as if the taxpayer was a California resident for all prior years. Then, suspended losses are computed as if the taxpayer was a nonresident for all prior years. Finally, both suspended passive loss amounts must be prorated based on the period of California residency and the period of nonresidency during the year. For more information, see FTB Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency.


Review Question 2 Lisa owns office spaces and rents them to other businesses. She spent 700 hours during the tax year performing management services for these properties, which amounted to 75% of her total work time. Which of the following statements is correct? a) She materially participated in the business. b) She is not a material participant; all activities will be considered passive. c) 700 hours of services related to her real property business qualifies as a non-passive

activity. d) 75% of total work time devoted to her real property business qualifies as a non-passive

activity.

Objective #3: Substandard Rental Housing (SRH) Substandard housing is property in violation of state or local health, safety, or building codes. State and local regulatory agencies are responsible for determining when housing is in violation of California Health and Safety Codes. The Substandard Housing Program assists the state and local agencies and helps promote the compliance of substandard property owners. The program benefits regulatory agencies by disallowing certain deductions on the noncompliant property owner’s tax return and through collecting additional tax, which assists in rehabilitation. Tax revenues generated are allocated and disbursed to the cities and counties that notified the FTB of the substandard housing. Substandard housing rules apply to occupied dwellings from which the taxpayer receives rental income as well as abandoned or unoccupied dwellings for which the following applies:

For occupied dwellings, a state or local government regulatory agency has determined that the housing violates state law or local codes dealing with health, safety, or building.

For dwellings that are unoccupied or abandoned for at least 90 days, a state or local government regulatory agency has cited the housing for conditions that constitute a serious violation of state law or local codes dealing with health, safety, or building, and that constitute a threat to public health and safety. 4

The property is considered substandard from the date of noncompliance to the date of compliance, as determined by the regulatory agency. The property remains substandard, even if it has been repaired, until the regulatory agency re-inspects it and issues a Notice of Property Compliance (FTB 1011). If the property owner fails to bring the property into compliance, the Franchise Tax Board (FTB) will be notified of the violation(s). The Franchise Tax Board will disallow deductions claimed for interest, taxes, amortization, and depreciation. The disallowance of deductions is imposed after the FTB receives notification, which usually occurs after tax returns have been filed. The property owner will receive FTB 5830, Notice of Proposed Assessment (NPA), if additional tax is due as a result of adjustments made to his tax return. When the property is noncompliant for part of a year, deductions are disallowed at a rate of 1/12 for each month the property is noncompliant. If the property has been sold, deductions are disallowed from the date of noncompliance to the date the property was sold. Deductions are disallowed only on the noncompliant property (i.e., not on other compliant properties).

4 R&TC §17274


There is good news in this process. Affected property owners will initially receive a “warning” in the form of a written notice of violation issued by a state or local regulatory agency before the notice of noncompliance, giving property owners a reasonable amount of time to bring their property into compliance. A notice of noncompliance will be issued if the property has not been brought into compliance within 6 months. However, for employee housing, the time frame is only 30 days. The agency will first notify the property owner of their intent to notify the FTB unless the property owner files an appeal within 10 days of the notice. If the appeal is not filed, then the agency will notify the FTB.

5 Review Question 3 Rudy owns a small apartment building with four occupied units currently in violation of safety codes and is at risk of receiving a notification of violation for substandard rental housing (SRH). How long does Rudy have to bring his property up to standard before he is issued a Notice of Property Noncompliance and who is responsible for issuing the notice? a) 30 days; the state of California b) 6 months; the Franchise Tax Board (FTB) c) 6 months; a California or local regulatory agency d) 30 days; the Franchise Tax Board (FTB)

5 FTB 1010, Notice of Property Noncompliance Substandard Rental Housing


Objective #4: Common Errors in Rental Loss Reporting Schedule E rental losses are passive activity losses under both federal and California law. These passive activity losses are deductible only to the extent of passive activity income. Net passive losses which are unallowed (suspended) for the current tax year may be carried forward to future tax years until used up. Gain generated from the sale of a passive activity property is passive income and may be used in determining net losses allowed. Passive activity losses can be complex problems. Some areas of particular concern follow.

1. Passive versus non-passive rental real estate activities – Determining whether an activity is passive is not as simple as it may seem. According to both federal and California tax law, a passive activity includes any trade or business in which the taxpayer does not materially participate. Any rental activity, regardless of participation, is a passive activity by default. Material participation rules (real estate professionals) may turn a passive activity to a non-passive activity. As discussed previously, the qualification for this treatment is complex and easily misunderstood. For California tax purposes all rental activities (even for real estate professionals) are considered passive activities.

2. Special deduction for passive rental real estate losses – California conforms to the federal special allowance rules for active participation by a taxpayer in rental real estate activities. The taxpayer must own at least 10% of all interests in the business and actively participate in rental operations. If the preceding is true, up to $25,000 ($12,500 if Married Filing Separately) of passive rental real estate losses may be used to offset non-passive income. This allowance is phased out as a taxpayer’s modified adjusted gross income (MAGI) exceeds $100,000 (reduced by 50¢ for every $1 that MAGI exceeds $100,000). Once MAGI reaches $150,000, the $25,000 special allowance is reduced to zero. For Married Filing Separately filers, the allowance is $12,500 and phase-out begins when MAGI exceeds $50,000 and is eliminated when MAGI reaches $75,000. Federal Form 8582 and California Form 3801 provide instructions on how to calculate the reduced deduction. (Both forms are titled Passive Activity Loss Limitations.)

3. §1031 (“like-kind”) exchanges and suspended passive losses – When a passive activity property (e.g., residential rental) is disposed of in a fully taxable sale to an unrelated person, it becomes non-passive. The losses allocable to the activity are not limited by the PAL rules. Any gain from the sale is treated as passive income and will be used in the income and loss calculations for passive loss limitation. A qualified exchange allows the taxpayer to defer recognizing (paying tax on) the gain. The basis for property acquired in an exchange is based on the basis of the property disposed of. In effect, the old property is still tied to the new property and, therefore, the “sale” does not satisfy the requirement for a complete disposition. Effective January 1, 2014, individuals and business entities must file Form FTB 3840, California Like-Kind Exchanges, if they enter into a like-kind exchange of California property for property outside of California and defer any gain or loss under IRC §1031. Form FTB 3840 must continue to be filed for each taxable year following the exchange until the replacement property is disposed of in a taxable sale (i.e., California deferred gain or loss is recognized). If taxpayers have significant losses in the rental property they are selling, the best option may be to sell the property outright rather than do a §1031 exchange. By doing so, all


the suspended losses for that property can be used to offset the recognized gain from the sale of the property. If taxpayers have a significant realized gain on the rental property they are selling, the best option may be to do a §1031 exchange and use the suspended losses on that property to offset boot recognized on the exchange.

Review Question 4 Carmen owns several beach houses on the coast, which she rents out seasonally to vacationers. During the tax year, she sustained a significant rental real estate loss of $32,000 due to unforeseen expenditures. She actively participates in her rental business and is hoping to offset some of her losses against her other income. Her modified adjusted gross income (MAGI) for the year was $112,000. Based on the above facts, what is the maximum deduction Carmen may use to offset her non-passive income? a) $26,000 b) $19,000 c) $13,000 d) $20,000

Objective #5: Income and Deductions from Pass-Through Entities Pass-through entities (PTEs) include partnerships (LLCs), S corporations, and estates and trusts. They report net income from rental activities on their respective version of federal Form K-1 (1065, 1120S, or 1041). Because the activities themselves are subject to the same federal and California tax law differences, the California version of the K-1 (565, 568, 100S, or 541) may reflect the differences.

Student Note: LLCs (limited liability companies) do not have their own federal tax return. In most cases, they file as a partnership but may elect to file as an S corporation. California does have a tax return for LLCs that are classified as a partnership (Form 568, Limited Liability Company Return of Income).

Refer to the instructions for Schedule K-1 (565, 568, 100S, or 541) to ensure proper reporting of income and deduction items. Rental property activities for PTEs are reported on Schedule CA (540 or 540NR), line 17, in column B or column C depending on whether the difference is negative or positive, respectively. Under IRC Section 199A, a qualified business income (QBI) deduction for businesses, including pass-through entities, became effective on January 1, 2018. Although it is considered a business deduction, it is reported directly on federal Form 1040 (line 9). California does not conform to the QBI deduction and offers no such similar deduction.

Student Note: Part-year residents must allocate income according to the proportion of the year’s period of residency versus the proportion of the year’s period of nonresidency. This must be done in a manner that reflects the actual date that partnership, S corporation, and certain trust income was realized.

For more information, see FTB Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency, located in your online course in the Publications folder (in the Resources and Downloads section).


Review Question 5 Robert receives pass-through income from his equity ownership in a California-based S corporation. To determine whether items of income and deductions differ between federal and California amounts, which of the following schedules should Robert refer to? a) Federal Schedule K-1 (1120S) and California Schedule K-1 (100S) b) Federal Schedule K-1 (1041) and California Schedule K-1 (541) c) Federal Schedule K-1 (1065) and California Schedule K-1 (565) d) Federal Schedule K-1 (1041) and California Schedule K-1 (568)

Reading References for Chapter 16: FTB Pub 1100 – Taxation of Nonresidents and Individuals Who Change Residency,

pages 19-22 Form FTB 3801 Form FTB 3801 Instructions Schedule CA (540) Instructions, page 4


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Copyright © 2019, The Income Tax School, Inc. – All Rights Reserved SQLA - 16.1

Chapter 16: Study Questions

1. Darius is the owner of several homes, which he rents to families. One of the older houses needs some repairs and maintenance. Which of the following issues could cause him to be in violation of California rental housing codes?

a) Old and unsightly looking exterior paint job b) Two window screens with tears in them c) A broken window panel on the back door d) New wiring needed for cable/internet connection (was working until a few months ago)

2. Paris actively participates in her rental real estate business, of which she is the sole owner.

During the tax year, she sustained a net rental loss. What California form should Paris use to figure her allowable special deduction, which will be used to offset her active income?

a) Schedule CA (540) b) Form FTB 3885A c) Schedule E d) Form FTB 3801

3. If the State of California or a local regulatory agency declares California rental real estate in

violation of health, safety, or building codes and the substandard rental housing has not been brought up to standard within six months, the property owner can be:

a) Denied certain tax deductions b) Subject to having the property seized c) Subject to having the property destroyed d) Denied rights of ownership

4. Sammy, a single taxpayer, owns and actively participates in a rental real estate trade.

California conforms to the federal special allowance rules for those taxpayers who actively participate in rental real estate activities. Sammy’s net loss from his passive activities in that trade was $28,000 and his MAGI for the tax year was $110,000. Under this rule, what is the maximum amount of his passive rental real estate loss which may be used to offset his non-passive income?

a) $25,000 b) $28,000 c) $20,000 d) $23,000

5. Use the same scenario as above, except Sammy’s modified adjusted gross income (MAGI) is

$160,000. The maximum amount of passive rental real estate loss Sammy can use to offset non-passive income will be reduced to zero when his MAGI exceeds what amount?

a) $100,000 b) $160,000 c) $150,000 d) $125,000


Chapter 16: Learning Activity

Important Note: This scenario has been modified to include Form W-2 information that was not a part of the federal scenario. Review the scenario carefully.

Scenario – Kim Yamaguchi Complete a California state tax return for Kim Yamaguchi. Kim Yamaguchi, single (age 38, DOB: 7/14/1980, SSN: 223-01-6215), owns two residential rental properties. Kim actively participates in the rental operations and does not use the houses personally. Mr. Yamaguchi lives at 3548 Sunflower Lane, Idyllwild, CA 92549. Kim does not wish to designate $3 of his taxes for the Presidential Election Campaign Fund. He was covered by health insurance the entire year and is employed as a cybersecurity specialist. Kim owns his home and did not pay rent. Kim’s first rental property is located at 7211 Mountain Road, Idyllwild, CA 92549. The house was purchased on May 5, 2014 for $175,000, of which the land portion was $35,000. He received $14,300 in rent and incurred the following expenses:

Mortgage interest $ 5,671 Taxes $ 1,325 Lawn care 640 Insurance 472 Trash service 180 Repairs 379 Mileage 82 miles

Kim’s second rental property is located near Malibu beach. The address is 2614 Pelican Lane, Malibu, CA 90265. He purchased the house on January 3, 2018 for $189,500, of which the land portion was $65,000. He received $23,600 in rent and incurred the following expenses:

Electricity $ 1,220 Water $ 284 Telephone 288 Insurance 632 Trash service 160 Repairs 464 Mortgage interest 8,990 Taxes 3,345 Lawn care 920 Advertising 624 Cleaning services 900

Kim made two trips to the rental property in Malibu. His first trip in April was 670 miles and the second trip in September was also 670 miles. His total miles driven in 2018 were 18,950. For clarity, please use Form 540 to do all California returns. The Federal Form 1040 and Schedule E is provided after the scenario.


a Employee’s social security number

223-01-6215 OMB No.1545-0008

b Employer identification number (EIN) 53-0325789

1 Wages, tips, other compensation 95000.00

2 Federal income tax withheld 16750.94

c Employer’s name, address, and ZIP code COMPUTER ASSOCIATES 458 Technology Blvd. Idyllwild, CA 92549

3 Social security wages 102000.00

4 Social security tax withheld 6324.00

5 Medicare wages and tips 102000.00

6 Medicare tax withheld 1580.50

7 Social security tips 8 Allocated tips

d Control number

9 Verification code 10 Dependent care benefits

e Employee’s first name and initial

Kim

Last name Suff.

Yamaguchi

11 Nonqualified plans

12a See instructions for box 12 C o d e

D 7000.00 3548 Sunflower Lane Idyllwild, CA 92549 f Employee’s address and ZIP code

13 Statutory Retirement Third-party employee plan sick pay

12b C o d e

14 Other CASDI – 950.00

12c C o d e

12d C o d e

15 State Employer’s state ID number 16 State wages, tips, etc. 95000.00

17 State income tax 6256.20

18 Local wages, tips, etc. 19 Local income tax

20 Locality name CA 53-0658-1

Form W-2 Wage and Tax Statement 20XX Department of the Treasury – Internal Revenue Service

Copy B - To Be Filed With Employee’s FEDERAL Tax Return. This information is being furnished to the Internal Revenue Service.


Chapter 16: Learning Activity Questions

1. Answer the following question based on the tax return you prepared for Kim Yamaguchi.

Select the exemption amount:

A) $354 B) $118 C) $236 D) $ 0


Select the CA taxable income:

A) $96,202 B) $90,599 C) $95,000 D) $91,801


Select the tax from the CA Tax Tables:

A) $6,088 B) $5,791 C) $5,679 D) $6,200


Select the CA income tax withheld:

A) $5,673 B) $6,256 C) $ 0 D) $5,791


Select the refund:

A) $583 B) $174 C) $695 D) $286


Chapter 17: Amended Returns, Estimated Tax Payments, Injured and Innocent Spouse, and More

Overview

Chapter Description Upon completion of this chapter, students will understand the requirements associated with filing an amended California income tax return. Students will be able to determine when estimated tax payments are required and when to pay them. Students will be able to determine when a taxpayer is an innocent spouse for California purposes and how to request relief for being an innocent joint filer. Students will be able to define other topics, such as an Offer in Compromise and family support payments. Students will comprehend extensions for filing state returns and the interest and penalties charged due to late filing of returns and/or late payment of income tax. Lastly, students will develop a solid awareness of California Voluntary Contribution Funds. The following content is based on 2018 tax law; however, discussions of prior year tax law will be addressed as applicable.

Learning Objectives

1) Identify when and how to complete and file an amended California income tax return. 2) Recognize when estimated tax payments are required and how to make the payments. 3) Differentiate between an innocent spouse and an injured spouse for California purposes. 4) Describe an Offer in Compromise. 5) Discuss how family support payments are enforced in California. 6) Examine the interest and penalties associated with late payment of state income tax due

and late filing of the California state tax return. 7) Describe the process of obtaining an extension to file a California individual income tax

return. 8) Identify the California Voluntary Contribution Funds available on state tax returns.

Key Terms

Appreciated Contributions Family Support Payments Injured Spouse Innocent Spouse Offer in Compromise (OIC) Voluntary Contribution Funds

Objective #1: Amended Returns

Which Forms to Use If a taxpayer discovers a need to amend his California state return because of an error or omission from the original return, he may use Form 540, 540EZ, or 540NR to amend his original or previously filed California return. If the FTB adjusted the taxpayer’s return, use the amounts as adjusted by the FTB. Check the box at the top of Form 540 to indicate it is an amended return. Do not attach the previously filed return to the amended return.


1

California Statute of Limitations Original Return Was Filed On or Before the Original Due Date If the taxpayer is making a claim for a refund, the amended return must be filed within one year from the date of overpayment of tax or within four years from the original due date of the return (usually April 15th), whichever time period expires later. Original Return Was Filed Within the Extension Period If the taxpayer is making a claim for a refund, the amended return must be filed within one year from the date of overpayment or within four years from the date the original return was filed, whichever time period expires later. Original Return Was Filed After October 15th If the taxpayer is making a claim for a refund, the amended return must be filed within one year from the date of overpayment or within four years from the original due date of the return (usually April 15th), whichever time period expires later. Schedule X For tax years beginning on or after January 1, 2017, use Schedule X, California Explanation of Amended Return Changes, to determine any additional amount of tax owed or refund due to the taxpayer. Attach Schedule X to the taxpayer’s amended tax return. Prior to 2017, Form 540X, Amended Individual Income Tax Return, was used to amend California tax returns. The taxpayer also may file an informal claim for refund by filing Schedule X. An informal claim may be filed even if the amount of tax, penalties and interest has not been paid. The informal claim will delay the expiration of the statute of limitations and protect the taxpayer’s right to appeal to the Office of Tax Appeals (OTA) or court. Check box “l” for “Informal claim” on Schedule X, Part II, line 1. Mail Schedule X to:

STATE OF CALIFORNIA FRANCHISE TAX BOARD PO BOX 942840 SACRAMENTO CA 94240-0040

1 Form 540


2

Federal Notices If the taxpayer received a federal notice informing him that his AGI changed due to an error on his federal return, then he may need to amend his California income tax return for the corresponding year. Changes must be reported to the FTB within six months if the IRS evaluates and changes the taxpayer’s federal income tax return and finds that he owes additional tax. If the changes made by the IRS do not affect the taxpayer’s California tax liability, the taxpayer is not obligated to inform the FTB. If the IRS changes result in a California tax refund, the taxpayer must use Form 540 to amend his return within two years if he wishes to claim the refund. If Form 540 is filed with respect to IRS changes, include a copy of the final federal determination letter (if additional tax is due) and all schedules and data supporting the IRS changes. In addition, calculations used to determine the California liability may be needed if the change is due to other than normal computations (i.e., tax tables or tax rate schedules).

2 Schedule X


Where to File The Instructions for Schedule X provides two main addresses for mailing amended returns; one for taxpayers who owe state tax and one for those who have a zero balance, are due a refund, or have paid electronically. The mailing address for taxpayers amending a return and owe state tax is:

FRANCHISE TAX BOARD PO BOX 942867 SACRAMENTO, CA 94267-0001

The mailing address for taxpayers amending a return and are due a refund, have a zero balance, or have paid electronically is:

FRANCHISE TAX BOARD PO BOX 942840 SACRAMENTO, CA 94240-0001

Most penalties imposed by the IRS also apply under California law. If the taxpayer is including penalties in his payment with the amended return, the amount of the penalties should be entered on line 8a of Schedule X. A statement should be attached which includes detailed information for each penalty, such as the type of penalty, the IRC or California Revenue & Taxation Code (R&TC) section which provides for assessment of the penalty, and a schedule showing how each was computed. See Schedule X instructions, line 8a, for additional information.

Filing Status The taxpayer’s filing status on the California tax return must be the same as on the federal tax return unless the taxpayer is a same-sex married individual or an RDP. If they are a same-sex married individual or an RDP, and their filing status was Single on the federal return, his filing status must be Married/RDP Filing Jointly or Married/RDP Filing Separately on his California tax return. If the taxpayer is a same-sex married individual or an RDP, and their filing status was Head of Household on the federal return, they may be eligible for the Head of Household filing status for California if they meet the requirements to be considered not married or considered not in a registered domestic partnership.

Changing Filing Status If the taxpayer changed their filing status on his federal amended tax return, Form 1040X, they need to change their filing status for California tax purposes. A married couple who filed a joint federal tax return may file separately on the California tax return if:

The taxpayer or spouse/RDP was an active member of the U.S. armed forces (or any auxiliary military branch) during the year being amended.

The taxpayer or spouse/RDP was a nonresident for the entire year and had no California source income during the year being amended.

Changing from Separate Tax Returns to a Joint Tax Return If a married couple or RDPs filed separate tax returns, generally, they can change to a joint tax return any time within four years from the original due date of the separate tax return(s). To amend from separate tax returns to a joint tax return, follow the Form 540 instructions to complete one amended tax return. Both spouses/RDPs must sign the amended return.


Review Question 1 On April 1, 2019, Demi filed a 2018 California tax return and owed tax of $175. She paid the tax due at the time she filed her return. Due to an error on her return, she was actually due a refund of $25. If she wants to claim the refund, how long does she have to file an amended return and how much will her refund be? a) Until 04/01/2020; $175 b) Until 04/15/2023; $175 c) Until 04/15/2023; $200 d) Until 04/01/2020; $200

Objective #2: Estimated Tax Payments

Due Dates California estimated tax payments are payable in four installments. The required installments are not divided into equal payments of 25% like federal estimated taxes; however, the California due dates are the same as the federal due dates: April 15th, June 15th, September 15th, and January 15th (of the following year).

Make Estimated Payments California generally requires estimated tax payments to be made if the taxpayer expects to owe tax of at least $500 ($250 if Married/RDP Filing Separately), after subtracting withholding and credits, and withholding and credits are expected to be less than the smaller of:

90% of the tax shown on the current year tax return (estimate); or 100% of the tax shown on the prior year tax return including AMT.

Student Note: The prior year tax table is used because the current year tax tables are generally not published until October; i.e., 2019 tax tables are not available when estimating 2019 taxes. Estimated taxes are usually computed before April for any given tax year.

Higher-Income Taxpayers Higher-income taxpayers with adjusted gross incomes above $150,000 ($75,000 for Married/RDP Filing Separately) must figure their required annual payment (estimated tax) on 90% of their 2019 tax estimate or 110% of their 2018 tax including AMT, whichever is less. Taxpayers with AGIs of $1,000,000 or more ($500,000 if Married/RDP Filing Separately) must use their 2019 tax estimate to figure their 2019 required annual payment amount.

Payment Percentages For California, the percentage of the required annual payment which must be paid with each installment differs from the four equal quarterly federal amounts. To avoid an underpayment penalty, at least 30% of the total estimated tax liability must be paid for the first installment (April 15th), 40% must be paid for the second installment (June 15th), no payment is due for the third installment (unless the taxpayer is behind in payments), and 30% must be paid for the fourth and final installment (January 1st). Estimated tax payments are made using Form 540-ES, Estimated Tax for Individuals. In place of paying a fourth installment, taxpayers may choose to file an early tax return by January 31st, 2020 and pay the remaining balance due.


If estimated tax payments are not made in a timely fashion, an installment is underpaid, or a required estimated payment is not made, a penalty may be assessed. Penalties are calculated separately for each installment due date. So, even if a taxpayer makes up for an underpayment of estimated tax for an earlier installment due date by catching up on a later installment due date, he may still owe a penalty for the earlier installment due date. For more information, see the Instructions for Form FTB 5805, Underpayment of Estimated Tax by Individuals and Fiduciaries. Although the FTB penalty rates may be different, the way the federal underpayment penalty is figured on IRS Form 2210 is similar to the way the California underpayment penalty is figured on Form FTB 5805. Taxpayers also have the option of allowing the FTB to calculate the penalty for them. Both California and federal tax law have certain exceptions and special circumstances which may enable taxpayers to get the penalty waived. See Waiver of the Penalty on page 1 of the Instructions for Form FTB 5805. This topic is also covered on page 18 of the California 540 Personal Income Tax Booklet. Prior to a tax law change enacted in 2012, installments were made in four equal payments of 25% each, the same as federal law. Review Question 2 Tobey expects to owe tax on his 2019 California tax return. His 2018 tax liability was $1,200. He expects his 2019 tax liability to be $1,400. His AGI is usually between $50,000 and $60,000 each year. To avoid an underpayment of estimated tax penalty, what is the minimum amount of estimated tax Tobey must pay for the 2019 tax year? a) $1,200 b) $1,400 c) $1,260 d) $ 500

Objective #3: Innocent or Injured Spouse

Innocent Spouse Relief Generally, when married/RDP taxpayers file a joint tax return, both taxpayer and spouse/RDP are each responsible for paying any tax, penalties, or interest due. Federal tax law provides relief for spouses under two provisions: Innocent Spouse and Injured Spouse, each with its own set of qualifications. California has adopted an Innocent Joint Filer provision but has no provision for injured spouses. Conditions Which Must Be Met Taxpayers may qualify for the innocent joint filer relief if they meet all of the following conditions:

Filed a valid joint tax return; At the time he/she signed the jointly filed tax return, he/she was unaware of the items that

resulted in an audit assessment of additional tax; His/her spouse created the liability; According to all of the facts and circumstances, it would be unfair to hold him/her liable

for the liability; and Submitted Form FTB 705, Innocent Joint Filer Relief Request, no later than 2 years after

the date the FTB began involuntary collection activities against him/her.


Form FTB 705 To make a request for California tax assessment relief, the innocent spouse must submit Form FTB 705.

3

Injured Spouse Relief Under federal law, a taxpayer may seek injured spouse relief if all or part of his/her refund on a joint return is used to pay his/her spouse’s past-due debt. California law does not have an injured spouse provision. Review Question 3 Sally and Danny file joint federal and state tax returns. Danny owes money on past student loans, which will be taken out of their joint state refund. Sally does not think it is fair that she cannot receive her portion of the refund. What action can Sally take in order to receive her portion of the state refund? a) File Form FTB 705, Innocent Joint Filer Relief Request. b) File federal Form 8379, Injured Spouse Allocation. c) Nothing; California has no injured spouse provision. d) File a request for injured spouse relief with the FTB.

3 Form FTB 705 (Rev 08-2016)


Objective #4: Offer in Compromise (OIC) Both federal and California provide a mechanism to reduce or eliminate tax liabilities that taxpayers are unable to pay and will probably be unable to pay in the foreseeable future. The taxpayer makes an offer of an amount to settle the debt, e.g., tax debt is $100,000 and the taxpayer makes an offer of $25,000. Although the programs are subject to their own terms and conditions, the bottom line is the IRS and the FTB will reduce or eliminate a tax debt. In each case, the agreement is based on a determination that the amount offered to settle the debt represents the most the IRS or FTB expects to collect within a reasonable amount of time. Before preparing an OIC, a taxpayer should review the information provided in the FTB 4905 PIT Booklet. A taxpayer may be a candidate if he is an individual who does not have the income, assets, or means to pay the tax liability now or in the foreseeable future. The Offer in Compromise program allows taxpayers to offer a lesser amount for payment of an undisputed final tax liability.

Factors and Circumstances Although the FTB evaluates each case based on its own unique facts and circumstances, the FTB weighs the following factors strongly when making the evaluation:

The taxpayer's ability to pay The taxpayer’s equity in assets The taxpayer's present and future income The taxpayer's present and future expenses The potential for changed circumstances Whether the offer is in the best interest of the state 4

Application Process The application process must be completed thoroughly according to the requirements set forth by the FTB. They will only process an Offer in Compromise application if all of the required tax returns have been filed. If there is no filing requirement, it must be noted on the application. The Offer in Compromise application must be completed in full, with all supporting documentation provided. There must be an agreement between the FTB and the taxpayer as to how much of the tax is still owed. The taxpayer must give permission to the FTB to access his credit report and conduct an investigation to verify the validity of the information provided by the taxpayer on his application.

Collateral Agreement A collateral agreement with a term of 5 years may be required if the taxpayer has a meaningful potential for earnings growth. A collateral agreement requires a taxpayer to pay a larger amount or 100% of the original tax liability if, during the 5-year period following approval, the taxpayer earns more than was anticipated. If this is the case, an agreed upon earnings threshold will be established and a percentage of future earnings that exceed that threshold must be paid. Collection activity is not automatically suspended upon submission of an OIC to the FTB. If a delay puts the ability to collect tax in jeopardy, collection efforts may continue. Additionally, interest, penalties, and fees will continue to accrue as prescribed by law.

4 FTB 4905 PIT Booklet, Offer in Compromise for Individuals (https://www.ftb.ca.gov/forms/misc/4905pit.pdf), page 1


Submit Payment Offered funds should not be submitted until the FTB requests them and they should be submitted only with a cashier’s check or money order. If an offered amount is accepted, it must be paid in one lump sum. There is a multi-agency “streamlined” application form for OIC that uses a single form DE 999CA for submission to the Franchise Tax Board (FTB), the Board of Equalization (BOE), or the Economic Development Department (EDD), whichever agency applies. Either form (FTB 4905 PIT or DE 999CA) is acceptable when submitting to the FTB. There is virtually no difference. Review Question 4 Aaron has filed all of his required California tax returns over the years but finds himself in a predicament with a $24,800 non-disputed final tax liability. Due to increasing business losses, he will be forced to go out of business in the very near future. He wants to propose an Office in Compromise (OIC) to the FTB. The FTB will strongly consider all of the following items except: a) His future expenses b) His future income potential c) The amount of equity in his home d) His past income

Objective #5: Family Support Payments Both federal and California conform to alimony and child support, i.e., alimony is deductible and child support is not deductible by the payer. Likewise, alimony is taxable and child support is tax-free for the recipient. The problem for tax preparation is when the divorce decree specifies an amount for “family support” and does not specify the amount(s) intended for alimony and/or child support. This is an issue for California tax returns because the FTB states that family support is treated as alimony for tax returns. If the divorce decree or separation instrument provides for “family support” but no amount of the family support is designated as child support, then the entire payment is considered alimony.5 The IRS, on the other hand, provides guidance that allows taxpayers on the federal tax return to determine, by circumstances, how much family support is child support. As a result, there is a potential nonconformity issue. IRS Publication 504, Divorced or Separated Individuals, provides the following explanation:

Specifically designated as child support. A payment will be treated as specifically designated as child support to the extent that the payment is reduced either:

On the happening of a contingency relating to the taxpayer’s child, or At a time that can be clearly associated with the contingency.

Contingency relating to the taxpayer’s child. A contingency relates to the taxpayer’s child if it depends on any event relating to that child. It does not matter whether the event is certain or likely to occur. Events relating to the taxpayer’s child include the child's:

Becoming employed, Dying, Leaving the household, Leaving school, Marrying, or

5 FTB 2429 (Rev 04-2008), Alimony Frequently Asked Questions (https://www.ftb.ca.gov/forms/misc/2429.pdf), page 1


Reaching a specified age or income level.

Clearly associated with a contingency. Payments that would otherwise qualify as alimony are presumed to be reduced at a time clearly associated with the happening of a contingency relating to the taxpayer’s child only in the following situations.

1. The payments are to be reduced not more than 6 months before or after the date the child will reach 18, 21, or local age of majority.

2. The payments are to be reduced on two or more occasions that occur not more than 1 year before or after a different one of the taxpayer’s children reaches a certain age from 18 to 24. This certain age must be the same for each child, but need not be a whole number of years. 6

Family support payments are determined in divorce court and there are distinct and separate formulas for determining both child support and spousal support (a.k.a. alimony). The problem is that the court combines the amounts into a single family support obligation in the decree. So, when there are children, there is no doubt that the family support will include both child support and alimony. Court cases have been divided when determining how to determine alimony. The case that seems to provide conformity between federal and California treatment is Wells v. Commissioner, T.C. Memo. 1998-2. Preparers must use their best judgment when dealing with this issue as there is no “black and white” resource. In 2019, alimony will not be included in income by the recipient nor deducted by the payor under Federal law. These changes may affect how California handles these payments.

Review Question 5 Angelica went through a legal divorce in 2018 and her divorce decree stated the amount of family support payments she would receive from her ex-husband. The family support payments include both child support and alimony payments. The amount of child support is designated in the divorce decree. Is Angelica required to report the family support as income on her California tax return? a) Yes; she must include all family support payments. b) Yes; she must include the alimony payments. c) Yes; she must include the child support payments. d) No; family support payments are not taxed.

6 IRS Publication 504, Divorced or Separated Individuals, page 17


Objective #6: Interest and Penalties

Interest Charged on Late Filing or Late Payment Penalty Any late filing or late payment penalty imposed on a taxpayer will be charged interest for a period to include the original due date of the return through the date paid. Interest on underpayment of estimated tax will be charged on the underpaid amount starting from the date the installment was due through the date the installment was paid or the date the return was due, whichever is earlier. Additionally, other penalties not paid within 15 days will be charged interest from the billing notice date until the payment date. The interest rate is adjusted twice a year and interest is compounded daily. The FTB has a chart of interest rates (since 1976) available on the FTB website.

Student Note: Interest is mandatory. The FTB cannot waive the charge.

Late Filing Penalty A late filing penalty for a delinquent return plus interest figured from the original due date of the tax return will be assessed if the taxpayer does not file his return by October 15th, 2018 (or other extension date, if applicable). For every month that the return is late, the penalty is 5% of the unpaid tax due up to a maximum total penalty of 25% of the tax not paid. If the return is filed more than 60 days late, the minimum penalty is the lesser of $135 or 100% of the balance due.

Late Payment of Tax Penalty When a taxpayer pays tax due after the original filing date, there is a late payment penalty assessed. The penalty is 5% of the unpaid tax plus ½ % of 1 % for each month (or fraction of a month) that the tax remains unpaid for 40 months. 25% of the unpaid tax is the maximum penalty. Penalties are imposed even if an extension of time to file was allowed. The extension is for time to file, not pay. If the taxpayer has paid at least 90% of the tax shown on the return by the original due date of the tax return or 100% of the prior year’s tax, the FTB will waive the penalty based on reasonable cause. If, after April 17th, 2019 (or the original due date of the return), the taxpayer discovers that the tax due was understated, the remainder of the tax due should be paid as soon as possible. Otherwise, penalties and interest will continue to accumulate. This can be done using another Form FTB 3519, Payment for Automatic Extension for Individuals.

Other Penalties If a payment is returned for insufficient funds, California may impose other penalties. Negligence, substantial understatement of tax, and fraud would be grounds for the imposition of other penalties, such as criminal penalties (fines or imprisonment). Review Question 6 Tyler filed his California state tax return late this year on December 18th. The tax due shown on his return was $120. What is Tyler’s penalty for filing a late California income tax return? a) $120 b) $ 12 c) $135 d) $ 30


Objective #7: Extensions Interest and penalties are assessed when tax due amounts are not paid timely. The due date for individual return filing and paying tax is the 15th day of the 4th month of the year following the tax year. For a calendar year taxpayer, that is April 15th unless that date is not a business day (a holiday or weekend).

Student Note: Extensions are granted to allow tax returns to be filed at a later date, but they are NOT an extension of time to pay taxes.

Calendar-year taxpayers who reside or are traveling outside of the United States must file and pay any tax due by June 15th (next business day if the 15th is on a weekend or holiday). These taxpayers must write “Outside the USA on April 15th, 2019” in red ink at the top of their returns when filing. This extension, when combined with the automatic six-month paperless extension, extends the due date six months to December 15th. In 2019, the next business day is December 16th. If the taxpayer expects to owe tax and cannot file his return by the original due date of the tax return, he should remit payment along with Form FTB 3519, Payment for Automatic Extension for Individuals, to the FTB by the original tax return due date in order to avoid late penalties and interest. This will extend the due date for filing the return by six months from the original due date of the return. If the taxpayer does not owe any tax, a six-month extension is automatically granted and Form FTB 3519 should not be filed. Once an extension payment or estimated payment is made which exceeds $20,000 or an original return with a tax liability greater than $80,000 is filed, the taxpayer is required to remit all future payments electronically. In this case, if an electronic payment is not made as required, the taxpayer will be subject to a 1% penalty for noncompliance. Electronic payments can be made directly on the FTB’s website (www.ftb.ca.gov).

7

7 Form FTB 3519 (PIT)


Review Question 7 Zack was traveling abroad from January through May of this year. He filed Form FTB 3519 and paid the amount of tax he expects to owe the same week he returned. By what date does Zack have to file his California tax return to avoid late filing penalties? a) As soon as possible; his return was due April 15th. b) June 15th c) December 15th d) October 15th

Objective #8: California Voluntary Contribution Funds California taxpayers can make voluntary contributions directly on their tax returns to a variety of funds. This can be done whether the taxpayer will receive a refund or will owe tax. Contributions will decrease the refund or increase the balance due. Contributions must be made in whole dollar amounts. Contributions may only be made to qualified funds included on the current year Form 540 or Form 540NR (funds must qualify for inclusion on the tax return each tax year). Once the return has been filed, contribution amount(s) cannot be changed. Each fund has its own code. The funds listed below are the available voluntary funds on the 2018 California tax return. Funds that are missing this year may be qualified and reinstated next year.

California Seniors Special Fund, Code 400: Only taxpayers or spouses claiming the senior exemption credit may contribute to this fund and the contribution may not exceed the amount of the credit claimed. A combined total contribution of up to $236 or $118 per spouse/RDP may be made by the taxpayer and/or spouse/RDP who is 65 or older as of 1/1/2019. All contributions made go to a non-profit agency that provides advice on and sponsors issues facing senior citizens.

Alzheimer’s Disease/Related Disorders Fund, Code 401: Contributions go toward providing grants to California scientists for studies related to Alzheimer’s disease and similar disorders. California has a growing population with the disease and believes attention, resources, and research is needed to combat this increasing health crisis.

Rare and Endangered Species Preservation Program, Code 403: California has many endangered and threatened species of wildlife. Contributions will help with the protection and conservation of the many species and the land they need to survive on.

California Breast Cancer Research Fund, Code 405: With breast cancer being the most common cancer affecting women in California, contributions to this fund will go toward preventing and curing breast cancer through research on prevention and improved treatment.

California Firefighters’ Memorial Fund, Code 406: Contributions go toward several issues related to California’s fallen firefighters. Maintenance of State Capitol memorial grounds, ceremonies honoring them, and assistance provided to survivors are the priorities.

Emergency Food for Families Fund, Code 407: Contributions go to local food banks that help feed the hungry. Food for delivery to food banks, pantries, and soup kitchens will be purchased and dispensed throughout California.

California Peace Officer Memorial Foundation Fund, Code 408: Contributions are used to honor and preserve the memory of fallen peace officers throughout the state and help out the surviving families. Preserving the memorial on the State Capitol grounds and honoring their memory through ceremonies and substantial support to their families are priorities.

California Sea Otter Fund, Code 410: Two organizations share the contributions 50/50 from this contribution fund. One is the California Coastal Conservancy (reducing sea otter mortality) and the other is the Department of Fish and Wildlife.


California Cancer Research Fund, Code 413: Research related to causes, detection, and prevention of cancer are funded through taxpayer contributions to this fund. Education and awareness activities will be targeted to higher-risk communities.

School Supplies for Homeless Children Fund, Code 422: Health-oriented products and school supplies for homeless children are the priorities of this established fund.

State Parks Protection Fund/Parks Pass Purchase, Code 423: Contributions to this fund go toward the preservation of California state parks and the cost of parking at state parks where parking fees are collected on a day-use basis. If a taxpayer’s contribution equals or exceeds $195, the taxpayer will receive a single Vehicle Day Use Annual Pass. Amounts contributed in excess of the parks pass cost may be deducted as a charitable contribution for the year in which the voluntary contribution is made. Any contribution less than $195 will be treated as a voluntary contribution and may be deducted as a charitable contribution. 8

Protect Our Coast and Oceans Fund, Code 424: Grants and programs that preserve and improve the coast and promote marine and coastal educational opportunities that will benefit certain underserved communities are funded by contributions to this fund.

Keep Arts in Schools Fund, Code 425: The Arts Council will receive funds contributed for the purpose of allocating grants to worthy individuals and organizations that offer arts programs for children in preschool through grade 12.

State Children’s Trust Fund for the Prevention of Child Abuse, Code 430: Contributions are used to support child abuse programs that have demonstrated success, public education focused on changing adult behaviors and educating parents, forward-thinking research into identifying the best practices, and the replication of those practices in the ongoing goal to prevent child abuse and neglect.

Prevention of Animal Homelessness and Cruelty Fund, Code 431: Contributions are used to help fund programs focused on the prevention and elimination of animal cruelty and homelessness, research exploring effective approaches to prevent and eliminate pet homelessness, and the prevention, investigation, and prosecution of those persons perpetrating animal cruelty and neglect.

Revive the Salton Sea Fund, Code 432: Contributions are used for the maintenance and restoration of the Salton Sea and to develop techniques for providing ongoing public awareness.

California Domestic Violence Victims Fund, Code 433: Contributions are used for distributing funds to the recipients of active grants overseen by the Comprehensive Statewide Domestic Violence Program within the Office of Emergency Services.

Special Olympics Fund, Code 434: Contributions are used to benefit Special Olympics Southern California and Special Olympics Northern California, with the purpose of continuing to showcase the achievements and capabilities of those individuals with intellectual disabilities.

Type 1 Diabetes Research Fund, Code 435: Contributions go to the University of California to execute and oversee the distributions of grants to authorized diabetes research organizations.

*California YMCA Youth and Government Fund, Code 436: Funds are for supporting civic education programs, such as the YMCA Youth and Government Program, the African American Leaders for Tomorrow Program, the Asian Pacific Youth Leadership Project, and the Chicano Latino Youth Leadership Project.

*Habitat for Humanity Fund, Code 437: Contributions are used to build affordable housing in California for lower-income taxpayers.

*California Senior Citizen Advocacy Fund, Code 438: Contributions are used to represent senior citizens during the California Senior Legislature sessions and to support its ongoing activities dedicated to the benefit of older persons.

8 https://www.ftb.ca.gov/individuals/vcfsr/indvolcon.shtml


*Native California Wildlife Rehabilitation Fund, Code 439: Contributions are used to support the recovery and rehabilitation of sick, injured, or orphaned wildlife native to California, and to provide conservation education.

*Rape Backlog Kit Fund, Code 440: Testing DNA in the processing of rape kits is paid for from the contributions to this fund.

Student Note: An asterisk (*) denotes the fund became effective on January 1st, 2018.

The contributions to all of the above funds are deductible as charitable contributions for the tax year in which the donation is made, which would be the year the return is filed.

Recently Expired/Repealed Voluntary Contribution Funds Normally, from one tax year to the next, one or more Voluntary Contribution Funds are removed from the California state tax return and a few new (or reinstated) funds become available. The ftb.ca.gov website has a listing of voluntary contribution funds including the initial tax return year and the final tax return year. Taxpayers should contact their legislators if they are concerned about the date the voluntary fund will be removed from statute. Review Question 8 Corbin, born and raised in California, is very passionate about giving back to California-based charities. His state return shows tax due of $95. He decided to contribute a total of $200 to three Voluntary Contribution Funds. How will this affect the amount owed for the tax year? a) His voluntary contributions will increase the amount owed by $200. b) The amount owed will not be affected by his voluntary contributions. c) His voluntary contributions will decrease the amount owed by $200. d) The amount owed will decrease because he may deduct the voluntary contributions as

itemized deductions. Review Question 9 Charlie and Charise supported several charities when they filed their 2018 California return. The total contributions were $120. How will the contributions be handled on their tax returns? a) They can claim the $120 on their 2018 federal and California tax returns. b) They can claim the $120 on their 2019 federal tax return and $120 on their 2018 California

tax return. c) They can claim the $120 on their 2018 federal tax return and $120 on their 2019 California

tax return. d) They can claim the $120 on their 2019 federal and California tax returns. Reading References for Chapter 17: Form FTB 705 Form FTB 3519 with Instructions Form FTB 5805 Form FTB 5805 Instructions Schedule X Schedule X Instructions 540 Personal Income Tax Booklet, pages 29-30 FTB 4905 PIT Booklet – Offer in Compromise for Individuals


Chapter 17: Study Questions

1. Harley is self-employed and expects to owe tax on his 2019 California tax return. His 2018 tax liability was $13,000. He expects his 2019 tax liability to be $16,000. His California AGI for tax year 2018 was $175,000 and he projects California AGI of $190,000 for tax year 2019. To avoid an underpayment of estimated tax penalty, which of the following is the required annual payment amount Harley must make for the 2019 tax year?

a) $14,300 b) $13,000 c) $14,400 d) $16,000

2. Mandy is married to Levi and they file joint federal and state tax returns. Mandy was

surprised to find out later there was a tax liability because her husband incorrectly reported information on the California return. How can she request relief from joint liability?

a) File for California Injured Spouse Relief. b) There is no relief available; she is jointly liable for the tax liability. c) File Form 8379, Injured Spouse Allocation. d) File Form FTB 705, Innocent Joint Filer Relief Request.

3. Vicki is a wildlife enthusiast who believes in protecting species and improving and preserving

their habitats. All of the following Voluntary Contribution Funds, listed by code below, would meet the goals of her mission except:

a) Code 424 b) Code 431 c) Code 403 d) Code 410

4. Emily, a single mother of twins, receives both child support ($8,000/year) and alimony

($10,000/year) as family support payments from her ex-husband. How should she report these payments on her California tax return?

a) She doesn’t need to include the family support payments of $18,000 on her California tax

return. b) She must include the family support payments of $18,000 on her California tax return. c) She must include the child support payments of $8,000 on her California tax return. d) She must include the alimony payments of $10,000 on her California tax return.

5. Conan already knows he will not owe any tax for the taxable year, but he has not had time to

complete his California tax return. What is he required to do to obtain an automatic extension?

a) He is not required to do anything. b) He must file Form FTB 3519. c) If a federal extension was filed, he must mail a copy to the FTB. d) He must contact the FTB directly to request an extension.


6. Stuart wishes to contribute $400 to the State Parks Protection Fund/Parks Pass Purchase on his 2018 tax return. He would like to include the donation amount on his return as a charitable contribution. What amount and when can he deduct this as an itemized deduction on his tax return?

a) $400; deductible on his 2018 return b) $205; deductible on his 2019 return c) $400; deductible on his 2019 return d) $205; deductible on his 2018 return


Chapter 17: Learning Activity

Important Note: This scenario has been modified to include information that was not a part of the federal scenario. Review the scenario carefully.

Scenario – Daniel and Penny Strickland Complete a California state return for Daniel and Penny Strickland. Daniel (age 35, DOB: 4/21/1983, SSN: 502-01-1589) and Penny Strickland (age 29, DOB: 11/25/1989, SSN: 223-01-8146) were married in August and have decided to file a joint return. They live at 3434 Persimmon Way, Idyllwild, CA 92549. Both Daniel and Penny wish to contribute $3 to the Presidential Election Campaign. They were both covered by a health insurance plan for the year. Daniel has two children from a previous marriage for whom he is currently paying child support. Three years ago, Daniel was out of work for 18 months due to a medical condition and as a result, his child support payments became delinquent. The Internal Revenue Service was notified of his arrearage and seized his previous year’s federal tax refund. Daniel still owes more than $12,000 in delinquent child support and is aware that his current year federal tax refund will also be seized. Penny wants to ensure that she receives her portion of the refund. Penny is still paying on student loans and paid $969 in student loan interest during the tax year. Daniel is a nurse and Penny is a teacher; they have been employed all year and both had federal and state taxes withheld from their wages. The Strickland’s paid rent during the entire year to Homes R Us, P.O. Box 789, Idyllwild, CA 92549; phone 555-444-1616. Daniel and Penny want to contribute to two of the California Voluntary Contributions Funds: $400 to the State Parks Protection Fund/Parks Pass Purchase Fund and $100 to the California Breast Cancer Research Fund. Their financial statements follow. The Federal Form 1040 and Schedule 1 are provided after the scenario. For clarity, please use Form 540 to do all California returns.


a Employee’s SSN 223-01-8146



OMB No. 1545-0008



b Employer identification number 57-5544661



c Employer’s name address and ZIP code Sacred Heart Academy 200 Seminary Lane Idyllwild, CA 92549

e Employee’s first name and initial Penny

Last name Suff. Strickland

3434 Persimmon Way Idyllwild, CA 92549 f Employee’s address and ZIP code d Control Number

7 Social Security tips

8 Allocated tips

9 10 Dependent care benefits 11 Nonqualified plans 12a D

1200.00


12b

12c

12d

13 Statuary employee Retirement plan Third-party sick pay

15 State CA

Employer’s state ID number 575544661

16 State wages, tips, etc. 38442.00


18 Local wages, tips, etc.

19 Local income tax 20 Locality name

Form W-2 Wage and Tax Statement 20XX Copy B to be filed with employee’s Federal Income Tax Return

This information is being furnished to the Internal Revenue Service. If you are required to file a tax return, a negligence penalty or other sanction may be imposed on you if this income is taxable and you fail to report it.


a Employee’s social security number 502-01-1589 OMB No.1545-0008

b Employer identification number (EIN) 63-0005123



c Employer’s name, address, and ZIP code St. Mary’s Hospital 211 Wheaton Blvd Idyllwild, CA 92549





7 Social security tips

8 Allocated tips

d Control number

9 Verification code 10 Dependent care benefits

e Employee’s first name and initial

Daniel

Last name Suff.

Strickland

11 Nonqualified plans

12a See instructions for box 12 C o d e

3434 Persimmon Lane Idyllwild, CA 92549 f Employee’s address and ZIP code

13 Statutory Retirement Third-party employee plan sick pay

12b C o d e


12c C o d e

12d C o d e

15 State Employer’s state ID number 16 State wages, tips, etc. 42681.52


18 Local wages, tips, etc.

19 Local income tax

20 Locality name CA 630005123

Form W-2 Wage and Tax Statement 20XX Department of the Treasury – Internal Revenue Service

Copy B - To Be Filed With Employee’s FEDERAL Tax Return. This information is being furnished to the Internal Revenue Service.


Chapter 17: Learning Activity Questions

1. Answer the following question based on the tax return you prepared for Daniel and Penny Strickland.

Select the exemption amount:

A) $118 B) $236 C) $354 D) $472


Select the CA taxable income:

A) $71,353 B) $80,155 C) $72,322 D) $75,919


Select the tax from the CA Tax Tables:

A) $2,552 B) $2,024 C) $2,294 D) $2,078


Select the CA income tax withheld:

A) $2,438 B) $2,207 C) $5,375 D) $4,645


Select the refund:

A) $2,477 B) $2,207 C) $2,423 D) $1,949


Chapter 18: AMT, Other State Credits, and ACA

Overview

Chapter Description Upon completion of this chapter, students will understand which taxpayers are subject to the California alternative minimum tax (AMT) and which taxpayers are eligible to claim credit for prior year AMT. Students will be able to decide when a taxpayer is eligible for California’s Other State Tax Credit and what form to use for the calculation of the credit. Finally, students will understand the filing requirements associated with the Affordable Care Act. The following content is based on 2018 tax law; however, discussions of prior year tax law will be addressed as applicable.

Learning Objectives

1) Review which taxpayers are affected by the California Alternative Minimum Tax (AMT) and what factors may affect the calculation of AMT, and determine who qualifies to claim the credit for prior year AMT.

2) Determine the tax treatment for taxes paid to another state. 3) Identify the forms associated with the Affordable Care Act.

Key Terms

Alternative Minimum Tax ACA

Objective #1: California Alternative Minimum Tax

How to Figure California AMT Like its federal counterpart, California has an Alternative Minimum Tax (AMT). In general, California AMT conforms to the federal law, although there are some differences. The California AMT is determined and reported on Schedule P (540), Alternative Minimum Tax and Credit Limitations – Residents. The alternative minimum tax rate remains at 7%.


1 The AMT for Nonresidents and Part-Year Residents is determined and reported on Schedule P (540NR), Alternative Minimum Tax and Credit Limitations – Nonresidents or Part-Year Residents. AMT is imposed when Tentative Alternative Minimum Tax (Schedule P, line 24) is greater than regular tax (Form 540, line 31).

𝐴𝑀𝑇 = Tentative AMT − Regular Tax Before Credits

𝑇𝑒𝑛𝑡𝑎𝑡𝑖𝑣𝑒 𝐴𝑀𝑇 = [AMTI – Exemption Amount] × 7%

AMTI = Alternative Minimum Taxable Income AMT Exemption Amount Line 22 Schedule P (540)

Single/Head of Household $71,531 Married Filing Jointly $95,373 Married Filing Separately $47,685

AMT Exemption Phased-out Threshold Line 21 Schedule P (540) The exemption is phased out as income exceeds limits:

Single/Head of Household $268,237 Married Filing Jointly $389,013 Married Filing Separately $291,760

Children Under Age 24 All taxpayers are subject to AMT regardless of age. For certain children, the exemption amount is limited to earned income plus $7,600 if any of these conditions apply:

The child was under age 18 at the end of 2018; The child was age 18 at the end of 2018 and did not have earned income that was more

than half of his support; or The child was a full-time student over age 18 and under age 24 at the end of 2018 and did

not have earned income that was more than half of his support.

1 Schedule P (540), Alternative Minimum Tax and Credit Limitations – Residents


When any of these apply, the exemption is computed using the Exemption worksheet found in the Instructions for Schedule P (540) or Schedule P (540NR). This worksheet should not be completed if the child filed a 2018 joint tax return or if both parents were deceased as of December 31, 2018.

Example 1: Victor has lived in California for several years. He is using the Single filing status on his return this year. His alternative minimum taxable income is $194,000. The worksheet below shows the calculation to determine Victor’s exemption amount.

Victor’s exemption amount is $71,531.


Example 2: Amy, 16-year-old, has some income-producing investments that generated special deductions and exclusions from income on her CA state tax return. During the tax year, Amy has $2,300 earned income from her part-time job. Her AMTI on Schedule P (540), Part I, line 21 is $28,500. Determine Amy’s exemption amount.

Amy’s exemption amount is $9,900.

AMTI Exclusion The qualified taxpayer must exclude the following items when calculating AMTI:

Income Positive and negative adjustments Preference items attributable to any trade or business

Adjustments and preference items are excluded when calculating deductions, which may result in AMT carryovers. Qualified Taxpayer The taxpayer is a qualified taxpayer if both of the following conditions are met:

He owns or has an ownership interest in a trade or business. His aggregate gross receipts (less returns and allowances) from all trades or business

for which he is the owner or has an ownership interest is less than $1,000,000 during the tax year.


Calculation of AMTI

Total adjustments and preferences (line 14 of Schedule P (540))

+ Taxable income (Form 540, line 19) + Net operating loss (NOL) deductions (from Schedule CA (540) Part

I lines 21b,21d, 21e column B. Enter as positive number - AMTI exclusion. If the taxpayer’s federal AGI is less than the amount listed below for

his filing status, skip this line. If he itemized deductions and his federal AGI is greater than the amount listed below for his filing status, enter the itemized deductions from Schedule CA (540), Part II, line 43: Single or Married/RDP Filing Separately …………….….$194,504 Married/RDP Filing Jointly or Qualifying Widow(er) ……$389,013 Head of Household ………………………………………...$291,760

- Alternative minimum tax NOL deduction (line 20 of Schedule P (540) = Alternative Minimum Taxable Income (AMTI)

Gross Receipts Gross receipts may include, but are not limited to, items reported on:

Federal Schedule C, Profit or Loss from Business; Federal Schedule D, Capital Gains, and Losses; Federal Schedule E, Supplemental Income and Loss (other than income from a trust); Federal Schedule F, Profit or Loss from Farming; Federal Form 4797, Sales of Business Property (figured in accordance with California law); California Schedule D-1, Sales of Business Property, (if required to complete it) that are

associated with a trade or business. Ownership Interest In the case of an ownership interest, include only the proportional share of gross receipts of any trade or business from a partnership, S corporation, regulated investment company (RIC), a real estate investment trust (REIT), or real estate mortgage investment conduit (REMIC) in accordance with the taxpayer’s ownership interest in the enterprise. Apply the $1,000,000 test to the return regardless of filing status. The threshold does not become $2,000,000 for married /RDP taxpayers filing jointly.2

Credit for Prior Years Alternative Minimum Tax Similar to federal AMT credit, California offers credit to taxpayers who paid AMT for certain types of preference items in prior tax years. For individuals and fiduciaries, Form FTB 3510 is used to determine the potential credit and any amount to be carried forward to future tax years.

2 Schedule P (540) Instructions, Page 2


3

Review Question 1 Minnie is 17 years old and has several income-producing investments that generated special deductions and exclusions from income on her state tax return. During the tax year, Minnie earned $1,850 as a lifeguard at the country club. Her taxable income on line 19 (Form 540) is $7,300. Her federal AGI is less than the amount listed for her filing status. Her alternative minimum tax NOL deduction is zero. Minnie may owe AMT if her “preference items” listed on Schedule P (540) are greater than which of the following? a) $9,450 b) $2,150 c) $1,850 d) $7,600

Objective #2: Credit for Taxes Paid to Other States

General Information In some cases, California allows a credit against California tax liability for income tax paid to another state, territory, or possession of the United States. The credit is allowed to relieve double taxation. The tax credit can only be applied to taxes imposed on net income, not to any tax imposed on gross income. Taxpayers may qualify for a credit for income taxes paid to another state when the same income that is taxed by the other state is also taxed by California. Other state income taxes which are paid to the other state do not necessarily have to be in the same year if the taxes relate to the same transaction. 4

3 Form FTB 3510, Credit for Prior Year Alternative Minimum Tax — Individuals or Fiduciaries 4 Instructions for Schedule S, page 1


The taxpayer must include Schedule S, Ot

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