California enacted several tax law changes related to its most recent budget. The changes most likely to be applicable for high net worth families include:

Net Operating Losses. Net operating losses (NOL) and carryovers may not be deducted in the 2008 and 2009 tax years. An equivalent number of years is added to the carryover period. For losses incurred beginning January 1, 2008, the carryover period is extended to twenty years, although losses incurred in 2008 and 2009 cannot be deducted until 2010. Losses incurred in years beginning on or after January 1, 2011, may be carried back two taxable years. However, the amount of the NOL carryback will be limited to 50% of the NOL for losses incurred in 2011 and 75% of the NOL for losses incurred in 2012. Beginning in 2013, the entire loss may be carried back.

Limited Liability Company Fee is Accelerated. Limited liability companies will no longer be able to pay the fees they owe by April 15 of the following year. From now on, the amount of the fee for the year must be estimated and paid by the 15th day of the sixth month of the tax year and underpayment penalties will be imposed. However, no penalty will be imposed if the estimated fee equals or exceeds the amount of the fee paid by the company in the preceding taxable year.

Automobiles, Boats and Aircraft Must Be Kept Outside of California for Twelve Months to Avoid Payment of Use Tax. If you purchase an automobile, boat or aircraft out of state, the period for which you must use it outside of California to avoid California use tax has been increased from 90 days to one year, although the interstate commerce exception, discussed in a prior article, continues to apply.

Individuals with Income over $1,000,000 Can No Longer Use 110% of Prior Year Tax Exception to Underpayment of Estimated Tax Penalties. To accelerate collection of tax revenue, beginning in 2009, if your adjusted gross income is $1,000,000 or more, you can no longer avoid California underpayment penalties by paying in quarterly installment equal to 110% of your previous year tax liability. This will force taxpayers to do their tax accounting more in real time. The quarterly payments have also been front-loaded in that instead of paying in 25% of the estimated tax amount each quarter, the first two quarterly payments must be 30% and the last two payments will be 20%.

Expanded Withholding on Sales of Real Property. California law currently requires the withholding of 3 1/3% of the gross sales price on the sale of California real property by individuals (whether resident or non-resident) and corporations without a permanent place of business in California. Sales of principal residences are exempted from the withholding requirements. Since 3 1/3% of the gross sales price will result in over-withholding in many cases, a seller may elect to instead have an amount equal to 9.3% of the taxable gain on the sale withheld.

Beginning in 2009, withholding will also be required on sales by non-California partnerships. In the case of non-California S corporations, withholding is currently required but only at the rate of 1.5% of the gain incurred by the S corporation on the sale. Beginning in 2009, the rate will be 10.8% which is the sum of the corporate rate of 1.5% and the individual shareholder rate of 9.3%.

Changes are also made to the way withholding is done in connection with installment sales where the seller is not a California resident. Through 2008, the buyer was required to withhold the entire tax out of the payment made at the time of the sale unless the buyer consented to withholding out of each subsequent installment payment. Beginning in 2009, the withholding out of each installment payment will be mandatory. It is expected that the Franchise Tax Board will provide additional information prior to the end of the year.

General California Caution. As our next president and the Congress look for ways to stimulate the economy, a variety of tax subsidies designed to increase consumer spending, business capital investment, and jobs growth may be enacted. While the Federal government has a virtually unlimited ability to borrow money, the states do not. California is facing especially troublesome budget problems and has a real need for increased revenue. It is entirely likely that California, and probably many other states as well, will not conform to many of the coming Federal subsidies for purposes of their tax law. This is something of which you must be mindful. We will also try to keep your apprised of these developments.