Budget and Policy Post
October 17, 2019

The 2019‑20 Budget: California Spending Plan

Changes to Individual and Business Tax Provisions (Partial Tax Conformity)


The 2019‑20 budget package included legislation that amended the state’s personal income tax (PIT) and corporation tax (CT) tax laws to, in general, adopt—or “conform” to—some 2017 changes to federal tax laws. (For a description of federal tax conformity, please refer to our analysis of the Governor’s January tax conformity proposal.) Figure 1 lists the tax conformity provisions and their estimated revenue effects. In all, the conformity provisions are estimated to increase General Fund revenue by about $1.6 billion in 2019‑20.

Figure 1

Individual and Business Tax Provision Changes (Partial Tax Conformity)

(In Millions)

Tax Provision

Estimated Change in Revenue



Limits noncorporate business losses



Eliminates like-kind exchanges of personal and intangible property for single filers earning more than $250,000 ($500,000 for joint filers)



Eliminates net operating loss carrybacks



Limits deductions of Federal Deposit Insurance Corporation premiums paid by banks



Eliminates differences between state and federal law regarding the tax treatment of corporate mergers and acquisitions (Section 338 election)



Eliminates the performance-based compensation exception from existing limits on business deductions of executive pay



Repeals “technical termination” of partnerships



Modifies rules regarding contributions to Achieving Better Life Experiences (ABLE) accounts



Allows individuals to convert an educational savings account (529 plan) to an ABLE account without incurring a penalty



Excludes the discharge of student loan debt in case of death or disability from taxable income



Increases to $25 million the annual revenue threshold for certain simplified tax accounting rules for small businesses



Net Change in Revenue



aEstimated revenue reduction of less than $1 million.

This post explains how each of the tax conformity provisions changes the state’s tax laws. The administration coupled tax conformity with an expansion of the state’s Earned Income Tax Credit (EITC). We describe the expansion of the state EITC in a companion post.

Tax Conformity Provisions

Limits Deduction of Business Losses to $250,000 Per Year for Individuals, $500,000 for Joint Filers. Individuals and married couples filing jointly may have various sources of income, including business income. The costs of running a business—such as wages paid and asset depreciation—may in some years exceed the business’ gross income, resulting in a loss. PIT filers generally can deduct business losses from their other sources of personal income like wages, dividends, and interest.

The change in state tax law limits the amount of business losses that filers may deduct to $250,000 for single filers and $500,000 for married couples filing jointly. Business losses in excess of that amount are carried over to the following year and may be deducted from future income. Business loss deduction claims—whether from the current tax year or carried over from prior years—may never exceed $250,000 for individuals or $500,000 for married couples filing jointly. For example, a single filer who earned $400,000 in wages in 2019 and had business losses of $300,000 may reduce their income by $250,000 and carry the balance of $50,000 forward to deduct from 2020 income. Under prior law, this filer would have been allowed to deduct the entire $300,000 in 2019. The administration estimates this change will increase CT revenue in 2019‑20 by $1.3 billion ($900 million ongoing). This change has no effect on how the losses of corporations are treated for CT filers.

Eliminates Some Like-Kind Exchanges. The like-kind exchange provision allows PIT and CT filers to defer paying taxes on capital gains from the sales of certain types of property if they purchase a similar type of property within 180 days. For example, if a corporation sells an apartment building for an amount above the original purchase price, less any deductions for depreciation the corporation had previously claimed, it may defer paying tax on that gain if it invests all of the profits in another apartment building within 180 days. Filers may defer paying taxes indefinitely by continuing to reinvest gains in like-kind property. However, when property is eventually sold and not exchanged, tax is owed on the entire amount of the accumulated gains.

The change in state tax law eliminates like-kind exchanges of personal and intangible property. Personal property includes movable physical assets such as vehicles and machinery. Intangible property is an asset like a patent or a copyright. (For example, it was previously possible to exchange the ownership of a copyright on a piece of music for the copyright on a different piece of music.) Like-kind exchanges for real property, such as land and buildings, are still allowed for all CT and PIT filers. In addition, unlike the change in federal law, single PIT filers with adjusted gross income of up to $250,000 ($500,000 for married couples filing jointly) will still be allowed to defer capital gains for qualified like-kind exchanges of personal and intangible property. The administration estimates this change will increase state tax revenues by about $200 million annually.

Eliminates Net Operating Loss (NOL) Carrybacks. The revenues and expenses of businesses may fluctuate significantly from year to year. When business expenses exceed revenue in a particular year, a corporation has a NOL in the amount by which allowable expenses exceeded revenue. The corporation can then deduct the NOL from its taxable income the following year, reducing that year’s tax liability. Corporations can carryforward NOLs—apply them to a future year’s earnings—for up to 20 years. Overall, NOLs allow corporations to smooth profits and losses over time. In 2013, state law was changed to also allow businesses to “carryback” NOLs—apply them to a previous year’s earnings—for up to two years and receive a refund.

The change in state tax law eliminates NOL carrybacks. The largest fiscal effect of this change will be to increase 2018‑19 revenues by $360 million because, under the state’s accrual accounting rules, refunds from NOL carrybacks are assigned to the previous fiscal year. For 2019‑20, the administration estimates this change will increase revenue by $200 million.

Limits Banks’ Deductions for Deposit Insurance. The Federal Deposit Insurance Corporation (FDIC) protects consumers from financial losses in the event a bank fails. Banks pay insurance premiums to the FDIC and are generally allowed to deduct these as a business expense. The change in state law limits the amount that banks may deduct based on their assets. Banks with under $10 billion in assets are unaffected. Banks with more than $50 billion in assets may not deduct these premiums at all. Banks with between $10 billion and $50 billion in assets may deduct a portion of their FDIC premiums. About 40 U.S. banks have more than $50 billion in assets. The administration estimates this change will increase CT revenue in 2019‑20 by $65 million.

Eliminates Separate Section 338 Election. When one business purchases stock in another business, it has some flexibility under federal tax law (specifically, Section 338) about whether to treat the purchase as an asset purchase or a stock purchase. The budget package changes state law so that corporations are required to make the same choice about the purchase for state tax purposes as they elected to do for federal tax purposes. The change to state law ends the ability for some corporations to treat the purchase as an asset purchase for federal tax purposes, for example, and as a qualified stock purchase for state tax purposes. The separate Section 338 election previously had allowed some corporations to reduce their state taxes by taking advantage of certain income sourcing rules. The administration estimates this change will increase CT revenue in 2019‑20 by $38 million.

Eliminates Performance-Based Pay Exception From Executive Pay Limits. Publically traded corporations are not allowed to deduct more than $1 million of the compensation of the principal executive officer, the principal financial officer, and the three other most highly compensated executives at the corporation. The change to state law removes exceptions to these limits that had previously allowed the corporations to deduct compensation over $1 million that was from sales commissions or based on attaining certain performance goals. The change also conformed to other changes in the law made in 2016 related to the number and definition of the executives whose pay was subject to these limits. The administration estimates this change will increase CT revenue in 2019‑20 by $32 million.

Ends “Technical Termination” of Partnerships. The budget package repeals a rule that previously terminated partnerships when more than 50 percent of the partnership was sold or exchanged. This technical termination did not end the existence of the partnership but, rather, deemed a transfer of the partnerships assets from the “old” partnership to a “new” one. In addition, the technical termination closed the taxable year and started a new one. The change to state law prevents partnerships from using such technical terminations to reduce their taxes by changing various tax accounting rules that would have otherwise not been allowed, such as their methods of accounting and depreciation. The change also simplifies tax reporting for small partnerships that could have been unaware of the additional filing consequences of technical terminations. The administration estimates this change will increase revenue in 2019‑20 by $10 million.

Modifies Achieving a Better Life Experience (ABLE) Account Rules. ABLE accounts are tax-advantaged savings accounts that allow the families of individuals with disabilities to save money for their future care. Contributions to ABLE accounts are not tax deductible but the earnings are excluded from income for state and federal tax purposes. This tax treatment is similar to educational savings (Section 529 plan) accounts. The budget package made two changes to ABLE account rules to conform to 2017 changes in federal law. The first change was to allow beneficiaries of ABLE accounts that have their own income to contribute amounts up to the federal poverty level to their own ABLE accounts. The second change allows beneficiaries of existing Section 529 plan accounts to roll over those accounts to an ABLE account if they have a qualified disability. The administration estimates that each of these changes will reduce PIT revenue by several hundred thousand dollars.

Excludes the Discharge of Student Loan Debt on Account of Death or Disability From Income. Federal student loans are “discharged” (do not have to be repaid) under certain circumstances. If an accredited college closes, for example, those students enrolled there may be able to obtain a discharge of their associated student loan debt. Student loans also are generally discharged in the event of the borrower’s total and permanent disability or death. The change to state law excludes from income any amount of student loan debt that was discharged on account of the borrower’s death or disability. The administration estimates this change could affect about 100,000 filers annually and reduce PIT revenue in 2019‑20 by $700,000.

Simplifies Tax Accounting Rules for Small Businesses. State and federal tax laws include specific accounting rules businesses must use to calculate their income and deductions. However, small businesses are exempt from following many of these rules. For example, corporations are required to use an “accrual” method of accounting. Under accrual accounting, the business recognizes income when the work was performed, even if it will not be paid for that work until a later date. Small businesses can instead use the simpler cash accounting method. Under cash accounting, businesses recognize revenue and expenses as they occur. Federal CT laws define a small business as a corporation or a partnership with a corporate partner that has annual gross receipts under $25 million.

The changes in state law conform to federal changes regarding the definition of a small business made in 2017. Under prior state law, the exclusions for small businesses were narrower than the federal government. Consequently, an estimated 60,000 business filers were allowed to use a simpler rule for their federal taxes but had to use a more complex rule for their state taxes. Under the new statute, the affected businesses may choose to use some simpler accounting rules. The administration estimates that this flexibility will allow affected businesses to reduce their taxes by $280 million in 2019‑20. The changes also are retroactive to the 2018 taxable year.