California Residents Might Be Smiling Now but Will They Suffer A Hangover Come Tax Filing Season?
California has always had a bit of a reputation for having a complicated and expensive tax system, so residents could be forgiven for smiling when the legislature adjourned on September 1st without an agreement on the new tax laws. In layman’s terms, this means California state income taxes currently will not conform to any aspect of the Republican federal tax law which was passed last December.
What Does This Actually Mean for California Residents?
When it comes to working out how much money Californians have to pay in state income tax for 2018, technically speaking the federal tax law won’t have any bearing on the calculations. However, as with all tax legislation and predictions, nothing is ever as simple as it might seem. Filing your tax returns this year could be a little more complicated than usual, and consulting a tax professional might be advisable.
For instance, those who decide to take the new higher standard deduction on their federal return can still claim itemized deductions on their state return. In effect, the status quo remains the same, whatever was deductible last year, is also deductible this year. Many California residents were understandably concerned, that their tax bills would increase, particularly if the legislature did nothing. Their thinking was that they would no longer be able to claim deductions, but there would be no corresponding cuts in state rates to balance out those changes.
California, however, has a history of not conforming to federal law, unless their lawmakers make an executive decision to conform. In other words, unlike some states who choose to accept and implement federal changes automatically, California takes the opposite approach. California’s legislature did not introduce or agree to any new bills last year, which would have conformed to the new federal law.
The New Federal Changes Are Perceived as Being Bad for The Golden State
New Federal changes are perceived as bad by the California legislators because most Californian’s will pay less in taxes this year. Due to the new federal tax cuts, fewer people are now subject to the alternative minimum tax. This is bad news for Californian’s, because those with higher-incomes tend to get hit with higher-state taxes.
There is a lot of confusion among California residents, with some worried that if they opt to take the higher standard deduction on their federal return, that they would then be penalized and forced to take the rather trivial standard deduction on their state return. However, this is one area where living in California benefits residents because California does not require residents to take the standard deduction on their state tax return if they have taken it on their federal return.
In fact, in California deducting state income taxes was never an option, but you could and still can deduct property taxes, as well as miscellaneous deductions provided that you itemize correctly. And the good news is that it doesn’t stop there, on a Californian tax return you can still deduct interest on up to $1,000,000 in mortgage debt, but only if it was used to buy or improve a first or second residence, as well as $100,000 in home equity debt that was not used to purchase or improve a home. This is one area where the rules in California differ drastically from the new federal regulations. Under federal returns, the limits have been cut rather drastically to $750,000 in interest on mortgage debt taken out after Dec 14th, 2017, and there is now zero interest on the home-equity debt.
As if all of this was not complicated enough, Californians are still allowed to claim an exemption credit, for themselves and any dependents. This exemption is claimed on their state return and is entirely separate from the personal exemption which Congress removed.
How to Figure Out All of These Changes and Exemptions When Completing Your Tax Return
Having read all of the above you would be forgiven for thinking that working out your tax return could be a potential minefield for a California resident this year; you would be right! Indeed, the Franchise Tax Board is currently in the process of trying to figure out how to incorporate all of these differences between state and federal tax law on 2018 California Tax returns. There have been numerous draft versions shown to tax professionals, but an official public release will not be made available to the public before November 15th. One thing that is certain is that there will be significant changes to Schedule CA 540, the state tax form which people complete to adjust for differences between federal tax and state tax law, which is hardly a surprise given the sweeping changes that have been implemented.
What Will Happen to People Who Use Software to Calculate Their Tax Returns?
With so many changes and alterations, it will require some significant updates to personal computer tax software systems to reflect the new changes accurately. At the time of writing this, there is no way to know how quickly the various providers will be able to update their systems to provide an accurate estimate of taxes California residents will have to pay. These drastic changes could potentially cause a lot of hassle to individuals doing their own returns, which is why it might be advised to contact a tax expert, sooner rather than later. The demand for tax professionals in 2018 could exceed the supply, as more people may consult professionals to help with the new tax changes.