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Steve Sims, Taxpayers' Rights Advocate.

Should California Have a Stand-Alone Return?

On December 2, 2010, we held the Taxpayers’ Bill of Rights Hearing and we received a lot of good feedback as well as comments and suggestions on how we could improve our services. This month, I would like to share one of the suggestions received and our response to it. This suggestion is one of many we have heard given the recent election results and the current situation regarding the lack of conformity between California and Federal tax law.

Suggestion: In light of Proposition 26’s two-thirds vote requirement for conformity bills, we request that the FTB once again review the idea of going back to a stand-alone return similar to the federal return.

Response: This proposal discusses the history of California adoption of a tax return that currently uses federal AGI as a starting point to complete the California tax return. Our 2009 Bill of Rights’ Hearing response to a similar proposal includes additional discussion on the history and benefits of the current format of the California tax return.

To revisit the benefit of the current tax return format, we have looked to the types of state adjustments that are commonly reported by taxpayers who filed a 540/540A/540NR tax return. Our research finds that about one-half of these taxpayers do not show a California adjustment to federal AGI. Furthermore, of those that have a California adjustment to federal AGI, a total of 58 percent are related to the following three common items of income that are not taxable for California purposes: state tax refunds (33 percent), social security benefits (15 percent), and unemployment compensation (10 percent). Any other type of adjustment accounts for five percent or less of all state adjustments to federal AGI. Looking further at state adjustments to federal itemized deductions, 52 percent of the taxpayers report the deduction for state taxes as the only state and federal difference. An additional 38 percent of taxpayers report no state and federal difference to itemized deductions.

We believe the taxpayer’s burden to file is simplified by using the current format to allow the taxpayer to begin with a completed federal return, and then only report adjustments for differences in federal and California law on the Schedule CA of the California return. This is supported by our research findings that the majority of taxpayers have either no adjustment or one of the three most common adjustments. Using a stand-alone return format would require taxpayers to report every line of income and expense on both their federal and state return, including the majority of tax return lines where the reported amounts are identical. Under both the current return and the stand-alone return, the taxpayer must account for differences between federal and California tax law.

The majority of taxpayers use software which computes state and federal income and deductions. A side by side comparison is currently available to all taxpayers by reviewing the Schedule CA, which replicates the current Federal 1040, with corresponding state adjustment columns for each federal line number. Tax professionals may suggest to software companies their desire for an additional software product that includes an analysis of state and federal differences.

The proposal also points out that much effort would be required to revert to a stand-alone return. We agree significant resources and costs would be necessary to redesign the tax return, return processing, and system programming to revert to a stand-alone tax return. Devoting resources to such an effort at this time would impact our ability to implement the current Enterprise Data to Revenue (EDR) project. EDR deliverables include reduction to the $6.5B tax gap, improved processes, and providing more taxpayer data to our customers.

Finally, this proposal highlights the potential impact of Proposition 26 in relation to federal conformity. We agree that a lack of updated federal conformity affects taxpayer’s burden to file, and we continue to support and encourage federal conformity in order to simplify taxpayer’s burden to file. While the number of state and federal differences will continue to increase without updated federal conformity, our findings show that the majority of taxpayers are able to complete their California tax return with few, if any, state adjustments.

For the reasons stated above, we do not believe reverting to a stand-alone return will result in an overall reduction in taxpayer’s burden to file. We also continue to earnestly support updated federal conformity. We will continue to monitor the reporting of state adjustments, federal non-conformity, and the related impact on the taxpayer’s burden to file.

Steve Sims, EA
Taxpayers’ Rights Advocate

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