California's
Tax Expenditure Programs

Income Tax Programs--Part 3

Contents

• Charitable Contributions
• Contributions of Computers and Scientific Equipment to Educational Institutions
• Employee Business and Miscellaneous Expenses
• Amounts in Excess of Straight-Line
• Pollution Control Equipment
• Reforestation Expenditures
• Property Used in Economically Depressed Areas
• Agricultural Costs
• Employer-Provided Ridesharing Program Costs
• Exploration, Development, Research, and Experimental Costs
• Circulation Costs for Periodicals
• Small Business Expensing
• Carryforward of Net Operating Losses
• Percentage Resource Depletion Allowance
• Reserve Allowance for Bad Debts
• Employee Stock Ownership Plans
• Personal Exemption

Deduction:

Charitable Contributions

Description

This program allows taxpayers to deduct cash and specified noncash contributions to charities, religious organizations, governmental bodies, and other qualifying nonprofit organizations. The itemized deduction for PIT taxpayers is generally limited to 50 percent of adjusted gross income (AGI). The deduction available under BCT law may not exceed 10 percent of California taxable income. Contributions that exceed these percentage limitations may be carried forward for use in future tax years for up to five years.

Rationale

This program provides an incentive for taxpayers to donate cash, property, or services to qualifying charitable organizations. It does this by reducing the net after-tax cost to the giver making a contribution. The underlying rationale for the program is that qualifying charitable organizations provide socially beneficial services which are viewed as being worthy of indirect state financial support.

Distribution of Benefits

Charitable contributions are a flexible expenditure for many taxpayers, especially those in the higher-income categories. The concentration of the benefits of this program in the over 40 percent of the deductions claimed are by those taxpayers earning at least $150,000 per annum, with over 20 percent by those earning $500,000 or more. The average deduction for those in the highest income class is more than four times as large as that for the next highest income class.

Charitable Contributions Deduction
1998 Tax Year
Adjusted Gross Income ($000)	Percent of		Average Amount Claimed
	Total Taxpayers Benefitting	Total Amount Claimed
$0-20	1.8%	0.3%	$31
20-40	12.0	3.4	67
40-60	21.8	9.4	101
60-80	21.4	13.1	143
80-100	14.5	12.5	201
100-150	16.4	18.9	268
150-200	4.9	7.7	364
200-250	2.4	4.5	440
250-500	3.2	9.7	699
Over 500	1.7	20.5	2,879

Comments

One effect of this program is that, for PIT taxpayers, the state government provides donors with a subsidy that, per dollar of donation, increases in value as the donor's marginal income tax bracket rises. Economists widely agree that permitting a deduction for charitable contributions tends to stimulate the volume of charitable donations, although there are differences of opinion regarding the exact nature and magnitude of this response.

Deduction:

Contributions of Computers and Scientific Equipment to Educational Institutions

Description

This program allows corporations to claim a larger-than-normal deduction for contributions of computers, software, and scientific equipment to institutions of higher education. The deduction is equal to the lesser of: (1) the taxpayer's "basis" in the equipment, plus one-half of the difference between this basis and the equipment's market value; or (2) twice the taxpayer's basis in the equipment. For example, if a computer manufacturer donated two computers and a printer to a community college with a total production cost of $500,000 and a market value of $800,000 under this program, the company could have claimed a deduction of $650,000 ($500,000 for the depreciable basis plus one-half of $300,000). Without this program, the deduction would have been limited to $500,000.

Rationale

This program provides companies with an incentive to donate computers, computer software, and other scientific equipment to colleges and universities. The view was that these donations would enhance student performance at less cost than if the equipment was directly provided by the government.

Comments

This program, which was originally scheduled to sunset was continued in conformity with federal tax provisions pursuant to Chapter 322, Statutes of 1998 (AB 2797, Cardoza).

Deduction:

Contributions Made Through Tax Return "Checkoffs"

	Program Characteristics			Estimated Revenue Reduction
	Tax Type: Personal Income Tax (PIT) Authorization: California Revenue and Taxation Code Sections 18711 through 18444.			(In Millions)
				Fiscal Year	Amount
				1996-97	Minor
				1997-98	Minor
				1998-99	Minor

Description

This program allows taxpayers to make certain tax-deductible contributions simply by designating a specific contribution amount for one or more specified purposes on their state income tax return.

The recipient programs to which such tax deductible "check-off" contributions may be designated under this provision include:

• California Fund for Senior Citizens.

• California Seniors' Special Fund.

• Endangered and Rare Fish Fund.

• Wildlife and Plant Species Conservation and Enhancement Account (in the Fish and Game Preservation Fund).

• State Children's Trust Fund.

• Alzheimers' Disease and Related Disorders Research Fund.

• California Breast Cancer Research Fund.

• California Public School Library Protection Fund.

• California Firefighters' Memorial Fund.

• California Drug Abuse Resistance Education Fund (D.A.R.E.).

• California Military Museum Fund.

Rationale

his program provides an incentive for taxpayers to make donations to specified programs. The underlying rationale for this is that these programs are socially beneficial, and viewed as deserving of governmental encouragement and financial support.

Comments

These check-off contributions on state tax returns are deductible on federal income tax returns as itemized charitable deductions because they are contributions to a state government. For state income tax purposes, this program provides that they are deductible charitable contributions on the income tax return for the year in which the check-off contributions were made.

Deduction:

Employee Business and Miscellaneous Expenses

Description

This program allows a taxpayer to deduct from gross income a portion of certain unreimbursed expenses. These include:

• Business expenses, including travel, meals, entertainment, and lodging.
• Miscellaneous expenses related to: (1) producing or collecting taxable income; (2) management, conservation, or maintenance of income-pro-ducing property; and (3) tax return preparation fees.

Generally, a taxpayer may claim a deduction for 50 percent of meal and entertainment expenses to the extent that this 50 percent amount exceeds 2 percent of the taxpayer's federal adjusted gross income (AGI). Prior to 1995, taxpayers could deduct 80 percent of meals and entertainment expenses--a percentage that was reduced pursuant to Chapter 881, Statutes of 1993 (SB 671, Alquist).

Rationale

This program provides tax relief to employees on the grounds that qualifying expenditures are a direct cost of earning income and, therefore, should be deductible.

Distribution of Benefits

This program is used by all income groups, but most heavily by those in the middle-income categories. Over three-quarters of taxpayers benefitting from the deduction earn $100,000 annually or less. In terms of benefit dollars, however, these taxpayers receive only about half of the deductions claimed.

Employee Business and Miscellaneous Expense Deduction
1998 Tax Year
Adjusted Gross Income ($000)	Percent of		Average Amount Claimed
	Total Taxpayers Benefitting	Total Amount Claimed
$0-20	2.1%	0.4%	$77
20-40	12.5	5.1	153
40-60	24.1	15.1	235
60-80	22.7	18.1	298
80-100	14.6	15.4	393
100-150	15.5	22.6	546
150-200	3.9	7.9	755
200-250	1.7	3.4	762
250-500	2.2	6.2	1,074
Over 500	0.9	5.8	2,455

Comments

This program provides an incentive for employers to require, and employees to be willing to incur, certain job-related expenses. For example, the program increases the likelihood that an employee will be willing to pay his/her own way to a business conference, particularly if the conference is of personal interest because of its location or the professional opportunities it offers.

Federal and California tax law place additional limitations on the aggregate amount of deductions, such as this one, which can be claimed by a taxpayer with AGI over a specified amount. These income limits are discussed under the section regarding the deduction for "Certain Taxes Paid."

Deduction (Accelerated Depreciation):

Amounts in Excess of Straight-Line

Description

Depreciation deductions enable taxpayers to recover their investments in income-produc-ing assets, such as equipment and buildings, over specified periods of time. This program allows taxpayers to claim depreciation deductions in excess of "straight- line" depreciation on physical assets that are used in the production of income. Under the traditional straight-line depreciation method, a property's value is depreciated evenly over its useful economic life span.

Under this program, several more-generous accelerated depreciation methods are allowed. The permitted methods vary, depending on the type of property involved and when it is placed in service. These alternative methods include: (1) 200 percent, 150 percent, and 125 percent declining-balance methods; (2) the sum-of-years-digits method; and (3) other methods, such as the sinking-fund method.

Accelerated depreciation methods enable taxpayers to recover the costs of replacing their income-producing capital assets sooner than they otherwise would, through the deferral of tax liabilities, and thereby realize an increased rate of return on investments. For example, if a machine purchased for $20,000 had a useful life of 20 years and a salvage value of $2,000 after this period of time, under the straight-line method, the taxpayer could claim a depreciation deduction of $900 per year.

In contrast, under the 200 percent declining balance method, the taxpayer could claim an annual depreciation allowance twice the percentage amount permitted under the straight-line method. Thus, the first year's depreciation allowance for this property would be $1,800.

Rationale

By enabling taxpayers to defer some of their tax liabilities, the program provides an incentive for taxpayers to invest in income-produc-ing assets. This is due to the fact that the deferral of tax liabilities amounts to an interest-free loan from the government, which increases the rate of return on capital investments. In addition, such tax deferments reduce investment payback periods, thus improving the financial liquidity of investors. Another rationale for the program is that it compensates property owners for the failure of the tax code to adjust the depreciable basis of property upward over time for the effects of inflation.

Comments

Estimated revenue reductions for PIT under the accelerated depreciation program are for equipment and property (including rental property) and are based on federal estimates adjusted for California. The BCT estimates are not provided since comparable federal data are not available and since California has not fully conformed to the modified accelerated cost recovery system (MACRS) for depreciation.

In theory, depreciation allowances are intended to permit taxpayers to deduct the true economic costs of using assets that are incurred in the production of their income. Another way of looking at this is that depreciation allowances compensate taxpayers for the loss in productive capability of their income-producing property as it ages, so that, at the end of the property's life, the accumulated depreciation benefits permit it to be replaced. The revenue reductions associated with this program are based on the cost of allowable depreciation above and beyond that allowed under the straight-line method.

From a pure economic perspective, however, the technically correct measure of depreciation-related tax expenditure costs is the amount by which actual depreciation claims (however computed) exceed pure economic depreciation (that is, the decline in physical productivity of an asset) over time. This technically correct tax expenditure amount is likely to be less than that reported above, because the tax code does not adjust the depreciable basis of property for inflation. Many view the mid-point asset depreciation range (ADR) system based on 150 percent declining balance depreciation as a reasonable approximation of the economic life of corporate capital investment. The ADR system was used for federal purposes between 1971 and 1980, and assigned particular classes of assets with a prescribed useful life.

Deduction (Accelerated Depreciation):

Pollution Control Equipment

Description

This program allows taxpayers to depreciate the cost of pollution control facilities over a 60-month period, as opposed to a 10-year period which would otherwise apply. Qualifying facilities must be located within California and be appropriately certified by the California Air Resources Board or the State Water Resource Control Board.

Rationale

This program provides tax relief for businesses that are required by federal, state, and/or local regulations to install pollution control equipment. This tax relief takes the form of allowing taxpayers to, in effect, defer some of their tax liabilities by giving them larger depreciation write-offs during the early years following an investment in qualifying pollution control equipment. This tax deferral amounts to an interest-free loan from the government, which, in turn, increases the financial ability of taxpayers to make such required investments.

Comments

Revenue estimates for this program are based on federal sources. The PIT revenue reductions stemming from this program are included in the revenue reduction estimates in the earlier section "Amounts in Excess of Straight-Line." The BCT estimates are not provided due to the absence of comparable federal data upon which to base the estimates.

Deduction (Accelerated Depreciation):

Reforestation Expenditures

Description

This program allows PIT and BCT taxpayers to amortize over a seven-year period up to $10,000 per year of certain qualifying reforestation expenditures. Qualifying expenditures include the direct costs of forestation and reforestation, including site preparation, seeds or seedlings, labor, and equipment costs.

Rationale

This program apparently is intended to give taxpayers an incentive to reforest private lands where logging and timber-related activities have depleted available stocks of timber. Thus, the program provides an incentive for increasing the future supply of harvestable timber. It accomplishes this by permitting taxpayers to recover their capital costs more quickly, thereby deferring tax liabilities. The tax deferral amounts to an interest-free loan from the government, which, in turn, increases the rate of return on such investments. Rapid amortization for activities with lengthy payoff periods, such as reforestation, also dramatically improves the cash-flow position of investors, and thus, their financial liquidity.

Comments

California law is the same as federal law with the following modification: effective for taxable years beginning after 1996, California law limits the tax deduction to expenses associated with qualified timber located in California. In contrast, for income years beginning before 1997, there was no limitation as to where the timber property had to be located.

Deduction (Accelerated Depreciation):

Property Used in Economically Depressed Areas

Description

This program allows taxpayers to claim accelerated depreciation write-offs for certain qualified business property used in designated economically depressed areas of the state, including an Enterprise Zone, Local Agency Military Base Recovery Area (LAMBRA), Targeted Tax Area, and the Los Angeles Revitalization Zone (LARZ). In general, the program permits a taxpayer to "expense" (that is, immediately deduct as a current business-related expense) a certain portion of the costs of these types of property. Sunset dates under two components of the program are January 1, 1998 (LARZ) and January 1, 2003 (LAMBRA).

Rationale

This program provides an incentive for taxpayers to make business investments in economically depressed areas of the state. It does this by enabling taxpayers to use expensing to defer tax liabilities. This deferral amounts to an interest-free loan from the government, which, in turn, increases the rate of return on taxpayers' investments and improves their cash-flow position. The underlying rationale for this program is that the stimulation of investments in economically depressed areas can lead to improved economic conditions. This in turn, can result in various social benefits, including reduced state costs for unemployment and welfare benefits.

Comments

Taxpayers are permitted to expense a certain portion of the cost of qualified property under this program, depending upon the type of area. In the case of property located in a Targeted Tax Area (for taxable years beginning after 1997), or Enterprise Zone (for taxable years after 1996), a taxpayer can expense 40 percent of the cost of the property subject to a dollar limit of $100,000 in years one and two of the area's designation, $75,000 in years three and four, and $50,000 thereafter. The remaining 60 percent of a property's depreciable basis is subject to being written-off using standard depreciation options.

In the case of property located in a LAMBRA, for taxable years beginning after 1994 but before 2003, taxpayers may elect to expense a portion of the cost of qualifying property. The cost that may be taken into account is $5,000 for the first two years following designation as a LAMBRA, $7,500 for the second and third taxable years after designation, and $10,000 for every year thereafter.

In the case of property located in LARZ, for taxable years beginning after 1991 and before 1998, the taxpayer may elect to expense property purchased for exclusive use in a trade or business located within the zone.

In each case, the expensing deduction is recaptured (included in income) if the property ceases that is, to be used in the designated area at any time before the close of the second taxable year after the property was placed in service.

Deduction (Accelerated Depreciation):

Agricultural Costs

Description

This program allows taxpayers to "expense" (that is, immediately deduct as a current business-related expense) soil, water conservation, and fertilizer expenditures, up to a maximum of 25 percent of their gross income from farming. Any qualified expenses in excess of the 25 percent limitation, however, may be carried forward and expensed in future years. In the absence of this program, the qualifying expenditures would be considered capital expenditures to be written off.

Rationale

This program provides a tax incentive to encourage certain types of farming-related conservation investments, particularly those with lengthy developmental and payback periods. The program accomplishes this by allowing very rapid cost write-offs that, in effect, permit the deferral of taxes on farming income. This amounts to an interest-free loan from the government, which in turn, raises the rate of return on qualifying investments and shortens their payback periods. The program also has been rationalized as a way of simplifying record-keeping for small farming businesses.

Comments

Qualifying expenditures include those for: the treatment or moving of earth (including leveling, grading, furrowing, and other improvements); the fertilization of land; the construction of water channels, drainage ditches, and similar water conservation projects; the eradication of brush; and the planting of windbreaks.

The federal 1986 Tax Reform Act restricted a taxpayer's ability to expense agricultural costs for federal tax purposes to those expenditures which are consistent with a soil conservation plan approved by the Soil Conservation Service of the Department of Agriculture. California has adopted these limitations as well.

Deduction (Accelerated Depreciation):

Employer-Provided Ridesharing Program Costs

Description

This program allows taxpayers to "expense" (that is, immediately deduct as a current business-related expense) costs associated with providing ridesharing programs for employees. The deduction covers a taxpayer's expenses to provide for: company commuter vans or bus service to employees; subsidizing employee commuting expenses in third-party vanpools, private commuter buses, or subscription taxipools; free parking facilities for carpools; and certain other ridesharing programs. In addition, taxpayers are allowed an accelerated (36-month) depreciation deduction for costs of facility improvements for employee ridesharing, bicycling, and walking programs.

Rationale

This program provides an incentive for employers to establish ridesharing programs for their employees. It does this by allowing employers to partially offset their costs for sponsoring such programs by deferring tax payments. The program is based on the argument that state tax incentives are needed to encourage employees and employers to use ridesharing programs so as to alleviate traffic congestion, reduce air pollution, and reduce gasoline consumption.

Comments

It is possible that certain noncapital ridesharing expenses, such as subsidies for monthly transit passes, may be deductible by the employer as a business expense, even without this program. This is because an employer may consider such expenses to be "ordinary and necessary" in some situations and therefore deductible as a regular business expense. Thus, in some cases, employers benefit from the program only to the extent that it allows them to recover their costs for capital-related ridesharing expenditures (such as for vehicles and facilities) over a shorter- than-normal time period.

The argument traditionally put forth in explaining this type of program revolves around achieving the optimal amount of driving by individuals. Because of the social costs associated with car travel (like air and noise pollution), individuals do not bear the entire costs of car transportation. As a result, an over-consumption of car travel by individuals may occur. By lowering the costs of ride-sharing and other related policies, this program makes alternative forms of transportation more attractive, leading to an increase in participation. Proponents argue that the result of such intervention is a decrease in congestion and a more efficient deployment of transportation-related economic resources.

Deduction (Accelerated Depreciation):

Exploration, Development, Research, and Experimental Costs

Description

This program allows taxpayers to either "expense" (that is, immediately deduct as a current business-related expense) or amortize more rapidly the costs of (1) research or experimental activities, and (2) qualified mining-related exploration and development costs for mines and mineral deposits.

Qualified expenditures associated with research and experimental activities may be either deducted currently or amortized over a 60-month period at the election of the taxpayer. The option to immediately deduct versus amortize research and experimental expenditures applies only to expenditures that are deemed reasonable.

Qualified exploration and development activities may be either expensed or, for development activities only, amortized at the taxpayer's election. Exploration expenses are those paid prior to the development period. Development expenses are those that are incurred after the existence of ores or minerals in commercially marketable quantities has been established. If amortization is chosen over expensing, this must occur over a 10-year period.

Rationale

This program provides an incentive for taxpayers to undertake research and experimental projects, and to locate and recover minerals from the earth, by enabling them to more-quickly deduct their associated costs. This faster deduction, in effect, enables taxpayers to defer their taxes. The tax deferral amounts to an interest-free loan from the government, which, in turn, raises the real rate of return on qualifying expenditures and improves the taxpayer's cash-flow position.

The underlying rationale for the program is that research and experimental projects, and exploration and development activities--while often of great long-term importance to the state and its citizens--are inherently risky, and often do not generate any income for the taxpayer until a considerable period of time has passed.

Deduction (Accelerated Depreciation):

Circulation Costs for Periodicals

Description

This program allows taxpayers to "expense" (that is, deduct immediately as a current business-related expense) costs for establishing, maintaining, or increasing the circulation of a periodical. Alternatively, the program allows such costs to be amortized over a three-year period. In the absence of this program, these costs would have to be capitalized, and then amortized over whatever period of time the taxpayer was able to determine that the expenditure resulted in increased income.

Suppose for example, that a taxpayer spends $100,000 for advertising and promotional activities during the current year in order to increase over the next five years the circulation of a magazine the taxpayer publishes. This program allows the taxpayer to deduct the entire $100,000 as an expense on his or her current-year tax return or, if the taxpayer prefers, deduct it over a three-year period-- as opposed to having to spread the $100,000 deduction over five years.

Rationale

The rationale for this program appears to be administrative in nature, and relates to the difficulty of identifying exactly when the benefits of circulation-related expenses are realized. In principle, these costs should be deductible when the benefits they generate are experienced in the form of increased income. In practice, however, it often is difficult to determine which individual periodical subscriptions result from advertising or promotional expenses, including how to treat multiple renewals of subscriptions over time. For this reason, it is simpler from a tax administration perspective not to require taxpayers to capitalize their costs, but rather to allow taxpayers to deduct them either immediately or over a fairly moderate, specified time period.

Deduction (Accelerated Depreciation):

Small Business Expensing

Description

This program permits small businesses to expense rather than depreciate up to a specified amount of business personal property acquired each year. For 1997, the maximum expensing allowed was $13,000. This amount will increase to $16,000 for 1998 and incrementally thereafter until it reaches $25,000 in 2003. However, the expensing deduction cannot exceed the taxable income derived from the associated trade or business during the tax year involved. This program does not apply to C corporations, but does apply to most small businesses (partnerships, proprietorships, limited liability corporations, and S corporations).

Rationale

This program provides tax relief to small businesses for the purchase of business personal property (such as adding machines, furniture, and computers). It accomplishes this by allowing businesses to offset their costs by deferring tax payments. The tax deferral amounts to an interest-free loan from the government, which in turn improves the taxpayer's cash-flow situation and rate of return.

Comments

For 1997, the federal government allowed taxpayers to expense up to $18,000 of business personal property. Beginning in 1998, this amount is scheduled to incrementally increase until the year 2003, when the annual expensing limit will be $25,000. For both federal and California purposes, the deduction under this program is reduced (but not below zero) by the excess of the total investment in qualified property over $200,000 in a given tax year. The excess of the deduction over otherwise-allowable depreciation is recaptured if the property ceases to be used predominantly in the particular trade or business before the end of its recovery period.

Deduction:

Carryforward of Net Operating Losses

Description

General Provisions. This program generally allows taxpayers to carryforward, for up to five years, a portion of their net operating losses (NOLs). Generally, most businesses may carryforward 50 percent of their "excess" net operating losses in any given year (that is, the unrecovered losses that exceed their taxable incomes in that year) to offset their income in the following five years, and thereby reduce their cumulative state tax liabilities. For an NOL incurred prior to August 6, 1997, a 15-year carryover is permitted.

Extensions to the carryover period are available for NOLs incurred prior to or during 1991 and 1992, when NOL deductions were temporarily suspended due to state budgetary problems associated with the early-1990s' recession. Additional restrictions on NOL deductibility apply to water's-edge corporations and those taxpayers subject to income allocation and apportionment. California does not allow NOL carrybacks (that is, the application of deductions to a previous year's income), unlike treatment under the parallel federal program.

Special Provisions. Special rules apply to NOLs incurred by small businesses, new businesses, bankrupt taxpayers, and businesses operating in an Enterprise Zone, the Los Angeles Revitalization Zone (LARZ), or a Local Agency Military Base Recovery Area (LAMBRA). Businesses operating in Enterprise Zones, the LARZ, or LAMBRAs may carryforward 100 percent of their net operating losses for 15 years, and use them to offset income earned in future years attributable to those designated areas. Under certain circumstances, 100 percent carryover also is available to small and new businesses, but with truncated carryover periods. For bankrupt taxpayers, a ten-year carryover period applies.

Example. Consider a business that incurs an excess net operating loss of $70,000 during one tax year. If the business earns a net profit of $25,000 in the second year and $40,000 in the third year, under this program using a 50 percent carryforward, the taxpayer can apply $25,000 in losses to the second-year profits, thus completely eliminating his tax liability in that year. In addition, the $10,000 in net operating losses "left over" can be applied to the third-year profits, reducing his taxable income in that year to $30,000.

Rationale

This program is intended to provide tax relief for businesses that incur operating losses. In addition, it is an attempt to recognize that a taxable year is an arbitrary period of time with respect to measuring income and losses. For example, a firm might incur expenses in an early year (that result in net operating losses), in order to produce income (resulting in profits) in a later year. From an economic perspective, these losses and profits are related, and basing the firm's tax only on its reported net profits in individual years, but not accounting for loss years, overstates the net economic income resulting from the investment for the period as a whole.

The tax benefits associated with carryforward of net operating losses is heavily weighted towards smaller business in terms of the proportion of those claiming the deduction. Figure 1 below indicates that almost three-quarters of those claiming the deduction are from businesses with total receipts of less than $1 million. Total benefits are more evenly distributed across all sizes of industry, although a large proportion goes to businesses with total receipts of $1 billion or more. Figure 2 shows the distribution of benefits according to type of industry.

Distribution of Benefits

The tax benefits associated with carryforward of net operating losses is heavily weighted towards smaller business in terms of the proportion of those claiming the deduction. Figure 1 below indicates that almost three-quarters of those claiming the deduction are from businesses with total receipts of less than $1 million. Total benefits are more evenly distributed across all sizes of industry, although a large proportion goes to businesses with total receipts of $1 billion or more. Figure 2 shows the distribution of benefits according to type of industry.

Figure 1
Carryforward of Net Operating Losses Deduction by Receipt
1998 Income Year
Total Receipts (In Millions)	Percent of
	Total Taxpayers Benefitting	Total Amount Claimed
Under $1	73.0%	10.6%
1-10	20.9	17.5
10-50	4.1	15.1
50-100	0.4	7.2
100-500	1.2	18.3
500-1,000	0.2	5.0
Over 1,000	0.3	26.3

Comments

For federal tax purposes, a 100 percent carryforward of NOLs for 20 years is permitted along with a two-year carryback. The carrybacks must be applied, when possible, before any carryforward is allowed.

Deduction:

Percentage Resource Depletion Allowance

Description

This program allows taxpayers to claim a fixed percentage deduction for resource depletion, which generally proves to be in excess of the deduction amount that otherwise would be allowed under the normal cost-depletion method. Under the program, a specified percentage of gross income (depending on the type of resource involved) may be deducted as a depletion allowance, except that this depletion amount cannot exceed 50 percent of a taxpayer's related net income before applying the depletion deduction, or 100 percent in the case of oil and gas properties.

California conforms to federal tax law regarding the percentage depletion for oil and gas wells, and for geothermal deposits. Depletion rates are limited to: (1) 22 percent for regulated domestic natural gas; (2) 10 percent for natural gas from geopressurized brine; (3) 15 percent for domestic crude oil and natural gas from certain independent producers; and (4) 15 percent for geothermal deposits located in the U.S. California also adopts federal percentage depletion provisions for depletable assets other than oil, gas, and geothermal deposits, and with regard to natural resources located in continental shelf areas.

Under this program, a taxpayer who owns and operates a natural gas well that produces, for example, $100,000 in gross income, is allowed to claim a deduction for 22 percent of this amount ($22,000). This deduction is intended to offset the physical and economic resource costs associated with depleting the oil reserves in the well.

Rationale

This program provides an incentive for taxpayers to explore for and develop oil, gas, and other mineral resources. The underlying rationale for the program is that such activities can be extremely costly and inherently risky.

Comments

The term "percentage depletion" differs from "cost depletion." Cost depletion allows for the recovery of the initial costs of discovering, purchasing, and developing mineral reserves over the period during which a reserve produces income. Each year the taxpayer deducts the portion of the cost that is proportional to the fraction of the resource reserve that has been depleted in that year. Thus, under cost depletion, the amount of cost recovered through depletion allowances cannot exceed the original cost of acquiring and developing the reserve.

In contrast, under the percentage depletion method, a taxpayer deducts a fixed percentage of gross income from the reserve as a depletion allowance, regardless of the amount actually invested.

Deduction:

Reserve Allowance for Bad Debts

Description

This program allows financial institutions to elect to use the "reserve allowance" for deducting their losses from bad debts. Under this method, a deduction is allowed for a reasonable addition to what is known as a "bad debt reserve account." These are accounts set up by the taxpayer as an allowance against the possibility that some debts may be uncollectible. The amount allowed in the account is generally based on the taxpayer's past experience with bad debts.

During a given year, debts that become uncollectible are charged against a taxpayer's bad debt reserve, which reduces the balance in the reserve. The taxpayer makes additions to the reserve account to (1) offset the amount of bad debts which have been charged off and (2) allow for future bad debt charge-offs (attributable to increases in accounts receivables). The deduction is allowed for both of these kinds of additions to a bad debt reserve. In the absence of the program, the taxpayer would be required to use the "specific charge-off method," under which the taxpayer would deduct bad debts only when they are found to be uncollectible.

Rationale

This program provides tax relief to financial institutions that incur bad debts, to the extent that it allows them to claim a deduction for bad debt losses prior to the time the losses actually occur. The tax relief takes two forms. First, the early claiming of bad debt losses increases the "present value" of the deduction for bad debts to the taxpayer. Second, by "spreading out" deductions for bad debts, the program lessens the chance that a taxpayer will be unable to deduct the full amount of such debts, due to having insufficient offsetting income in any one year.

Comments

According to federal reports, the federal deduction (to which California generally has conformed) for bad debt reserves was first allowed in 1947, when there was fear of a postwar economic downturn. It was intended to reflect the banking industry's experience with bad debts during the depression period. The difference in annual bad debt deductions between the reserve and specific charge-off methods could be a gain or a loss in any given year.

Deduction:

Employee Stock Ownership Plans

Description

This program allows California employers that provide employee stock ownership plans (ESOPs) to their employees a PIT and BCT deduction for dividends paid to an ESOP, when those dividends are paid by the ESOP to participants or used to retire ESOP debt. It also allows the deferral of capital gains on the sale of stock to an ESOP if the proceeds are used to acquire a similar type security.

Rationale

This program conforms California ESOP provisions with federal law, thereby simplifying tax administration and compliance. It also gives an incentive to employers to provide their employees with this form of compensation as an option.

Comments

Effective for income years beginning after 1997, this deduction is unavailable to Sub-chapter S corporations under both California and federal law.

Credit (Person Specific):

Personal Exemption

Description

This program allows all individual taxpayers to claim a personal exemption tax credit. The amount of the credit depends on the taxpayer's filing status. The credit is indexed annually, based on the California Consumer Price Index. For 1998, the credit amounts are $70 for single taxpayers and $140 for married couples filing jointly. Nonresidents who are required to file a California tax return are allowed partial personal exemption credits, based on the ratio of their California adjusted gross income (AGI) to their total (multistate) AGI.

The exemption credits are phased out for taxpayers whose AGI exceeds a threshold amount. For 1998, for single taxpayers the credit is reduced by $6 for each $2,500 or fraction thereof by which the taxpayer's AGI exceeds $116,777; for married taxpayers filing jointly, the credit is reduced by $12 for each $2,500 or fraction thereof by which the taxpayer's AGI exceeds $233,556.

In addition, California's personal exemption credits may be reduced or eliminated altogether under the state's Alternative Minimum Tax (AMT).

Rationale

This program provides broad-based tax relief to California taxpayers. The rationale for the program is that taxpayers have a certain minimum amount of expenses and this program provides assistance through the tax system in meeting those expenses.

Distribution of Benefits

The personal exemption credit is a program which benefits primarily lower- and moderate-income groups. As shown in the accompanying table (see next page), almost 70 percent of tax returns receiving benefits and over 60 percent of the total benefits received go to taxpayers earning $60,000 or less annually. As indicated above, there are income limits placed on the program, making its use more infrequent in the higher-income categories. Average benefits are quite similar across income groups except in the lowest category, where low tax liabilities can keep the entire credit from being utilized (the credit is not refundable).

Personal Exemption Credit
1998 Tax Year
Adjusted Gross Income	Percent of		Average Amount Claimed
	Total Taxpayers Benefitting	Total Amount Claimed
$0-20	22.8%	14.2%	$57
20-40	26.9	24.1	82
40-60	19.9	21.9	101
60-80	12.5	16.0	117
80-100	7.3	9.8	124
100-150	7.5	10.2	124
150-200	2.0	2.8	130
200-250	1.0	1.2	122
250-500	0.1	0.1	NA
Over 500	--	--	--

Comments

Federal law allows exemptions in the form of deductions from AGI, as opposed to the use of tax credits, as under this program. The federal exemption amount for 1998 is $2,700 per taxpayer, taxpayer's spouse, and for each dependent.

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