HIGHLIGHTS OF STATE INCOME TAX REVISION

The Legislature has passed and sent to Gov. Deukmejian a major revision of state income tax laws to take effect in the 1987 tax year. The legislation is intended to bring California income taxes into selective conformity with last year’s overhaul of the federal income tax system. Authors of the legislation predict that taxes will be reduced for 71% of California families, mainly those earning $50,000 or less. However, the amount of tax relief, or tax increase, depends on the individual taxpayer’s use of deductions and credits that are affected by the tax revision. Generally, a greater reliance on deductions and credits would mean a higher new tax liability.

Personal Income Tax Provisions

Rates and Brackets: Reduces top personal income tax rate from 11% to 9.3% and shrinks number of brackets from 11 to 6.

Deductions Eliminated: State and local taxes, adoption expenses, handicapped remodeling expenses, ride-sharing expenses no longer deductible.

Consumer Loan Interest: Interest deductions for consumer loans, including credit card interest, phased out in four years: 65% deductible in 1987, 40% in 1988, 20% in 1989 and 10% in 1990.

Employee and Miscellaneous Expenses: Deductions for employee business, miscellaneous and moving expenses limited to amounts above 2% of adjusted gross income.

Medical Expenses: Deductions for medical expenses limited to amounts exceeding 7.5% of adjusted gross income.

Entertainment: Write-offs on business meals and entertainment limited to 80% of cost.

Mortgage Interest: Allows mortgage interest deductions for first and second homes, up to the original purchase price plus cost of improvements, and for certain motor homes and boats with overnight facilities.

Charity: Deductions for charitable contributions limited to 50% of adjusted gross income.

Personal, Dependent and Senior Credits: Increases the personal credit from $45 to $51; increases dependent and blind credit from $14 to $51; repeals current $1,000 income exclusion for low-income seniors and replaces it with a $51 credit for those 65 and older.

Standard Deduction: Increases the standard deduction for those not itemizing from $3,540 to $3,760 for joint returns, and from $1,770 to $1,880 for single filers.

Social Security and Unemployment: Continues California’s practice of exempting Social Security and unemployment compensation from taxation.

Military Pay: Repeals $1,000 exclusion for certain military pay and pension payments and substitutes a new credit of up to $40.

Child Care: Raises child care credit, currently 1%-3% of costs, to 6%-9% of costs. The state tax credit is equal to 30% of the credit allowed by federal law.

Renters’ Credit: Retains the present renters’ credit of $60 for single filers, $137 for married couples and heads of households, and $99 for joint custody heads of households.

IRAs: Adopts the more liberal federal limitations on deductions for Individual Retirement Accounts. IRAs remain fully deductible for those not covered by a company pension plan. For those who are, the deduction is phased out between $25,000 and $35,000 of adjusted gross income for single filers and between $40,000 and $50,000 for married couples filing jointly. Previously, state law barred deductions for anyone with a company pension plan.

401(K) Plans: Employees in these company-sponsored retirement plans would be able to defer up to 20% of salary or $7,000, whichever is less. Previous law allowed maximum tax deferral of up to $30,000 or 20%, whichever is less.

Political Contributions: Enacts a new credit for political contributions equal to 25% of the gift with a maximum of $25 for singles and $50 for joint filers.

Capital Gains: Conforms to new federal rules that fully tax capital gains. For residential rental and farm properties, an exception is made from 1987 through 1991 during which a tax credit equal to 4 1/2% of the gain would be substituted.

Minimum Tax: Enacts a new alternative minimum tax at a flat 7% rate for those taxpayers who otherwise would be able to shelter all their income with certain credits and deductions.

Corporate Income Tax Provisions

Rates: Reduces bank and corporation tax rate from 9.6% to 9.3%

Losses: Allows companies to carry 50% of their losses from 1985 and 1986 and deduct them in future years through 1989. Losses incurred in 1987 or later can be deducted at the same 50% level over a 15-year period. The provisions are repealed in 1992.

Small Corporations: Allows firms with 35 or fewer stockholders to register as “Subchapter S” corporations, allowing profits and losses to be passed on to stockholders. The corporations would still be taxed on their net income, however, at a rate of 2.5%.

Oil: Requires oil companies to spread their deductions for overhead and other costs over a longer period, in line with the federal tax revision.

Minimum Tax: Beginning in 1988, repeals existing add-on preference tax for corporations that shelter the bulk of their income and substitutes a new alternative minimum tax at a 7% rate. Also increases the current $200 minimum yearly tax charged to all corporations to $300 in 1987, $600 in 1989 and $800 in 1990. Also extends that tax to all limited partnerships beginning in 1988.

Solar: Sets tax credits for commercial solar projects at 12% of costs in 1987 and 10% of costs in 1988.

Housing: Sets aside up to $35 million annually for owners of low-income rental housing, provided the housing remains low-income for 30 years.

Research and Development: Allows 8% tax credits for research and development by private firms and 12% for basic and applied research conducted at universities or by certain nonprofit organizations.

Drugs: Sets up a special 15% credit for firms that manufacture drugs for certain rare diseases, commonly known as “orphan drugs.”

Depreciation: Retains current California method of depreciating assets.

Comparing Current and Proposed Tax Rates and Brackets

Top rate dropped to 9.3% from previous 11%. Number of brackets reduced to 6 from 11. Figures are for joint returns.

1987 Taxable Income and Rates

Taxable Income Rates Under $7,260 1% $7,260-$12,640 2% $12,640-$18,060 3% $18,060-$23,560 4% $23,560-$29,020 5% $29,020-$34,440 6% $34,440-$39,820 7% $39,820-$45,280 8% $45,280-$50,700 9% $50,700-$56,120 10% Over $56,120 11%

Proposed Rates

Taxable Income Rates Under $7,300 1% $7,300-$17,300 2% $17,300-$27,300 4% $27,300-$37,900 6% $37,900-$47,900 8% Over $47,900 9.3%