YOUR TAXES : TAX REFORM : Affairs of State : California rules have been overhauled to conform more closely with federal returns. But there are differences.

California tax law once varied so much from federal provisions that even Gov. George Deukmejian got tripped up in 1985. The governor inadvertently deducted part of his IRA contribution in violation of a state law that prohibits members of qualified pension plans from claiming IRA deductions.

Some 200,000 Californians made the same mistake that tax year, according to Jim Reber, a spokesman for the state Franchise Tax Board. And errors plagued at least 1 million of the 13 million returns submitted in 1987, he said.

But today, in the wake of the state Legislature’s overhaul of the California tax laws in 1987, most California taxpayers with relatively uncomplicated financial lives will find that filing a state income tax return is greatly simplified.

But if you are depreciating certain assets or have a home equity loan, you had better not wait until the last minute to do your taxes, because California requires old federal forms that can be difficult, if not impossible, to get quickly.

“We did not intend to have complete conformity with the federal government--California often views the world differently than Washington,” said state Sen. John R. Garamendi (D-Walnut Grove), who co-chaired the Legislature’s tax-writing conference committee.

“Our notions of fairness and equity are sometimes different from the federal government. In order to balance our state budget we are not allowed to run a deficit, for example. But I think taxpayers will find a much simpler process” doing their taxes today, Garamendi said.

While state law once required California taxpayers to fill out a form equal in size and complexity to the federal returns, state lawmakers passed new rules two years ago that eliminated 30 different state tax schedules and some 20-odd tax form entries. Today, the majority of the 13 million individuals and couples filing state income tax returns may use the two-page Form 540A California short form.

Taxpayers who must file the long form will find that it’s only four pages long and allows filers to transfer their taxable income from the federal forms to a line on their state return and then add in most of their tax credits and certain deductions without major additional calculations.

The sweeping overhaul of the state tax code in 1987 now follows IRS rules. Popular deductions for interest on home mortgages were retained, and writeoffs on credit cards and consumer loans are being phased out in line with changes made at the federal level.

The state law also mimics the federal limitations on deducting employee business expenses and medical costs. Finally, Deukmejian and other state taxpayers should find accounting for IRA contributions a breeze. The state and federal tax rules are now nearly identical.

But unlike the federal government, which counts unemployment compensation as taxable income, California still excludes such compensation from gross income. California also retains its full exemption for Social Security benefits and, unlike the federal government, grants tax credits of $60 to single renters and $137 to married couples.

Another variation between federal and state law is that the state income tax deduction on federal returns is not deductible on California returns. This difference often means that taxpayers will end up showing more taxable income on their state returns.

But two major remaining differences between state and federal returns are likely to confound hundreds of thousands of Californians, if they aren’t prepared for the arcane paper work.

First, California has different rules from the federal government regarding interest deductions on a home equity loans. Second, if you have capital gains income from the sale of a rental, business property or other asset, you probably had different depreciation or amortization allowances for federal and state taxes in prior years, which can give you a different cost base on your state return.

The differences in depreciation rules will most likely increase the taxable income on your state return, since California has been more stringent than the federal law. The IRS permits use of the so-called accelerated cost recovery system or ACRS in computing depreciation allowances, said Harvey A. Bookstein, managing partner of the Los Angeles accounting firm of Roth Bookstein & Zaslow.

For example, say you purchased new real property for $20,000 on Jan. 1, 1986. Federal depreciation for 1988, the current tax year, would amount to $1,520 under the regular ACRS method of computing depreciation and $1,053 if you are subject to the alternative minimum tax, Bookstein said. Under state law, assuming you’ve been using a 200% declining balance depreciation method for the 25-year accounting life of the property, regular depreciation would amount to $1,355 and only $800 under the alternative minimum tax.

The alternative minimum tax is aimed at making sure certain high-income taxpayers do not escape paying income taxes altogether. It is usually triggered by excessive itemized deductions or large tax shelters.

If your capital gain is from property on which you never claimed depreciation, such as your principal residence, you still have to go through one of the supplemental schedules on the state return but will probably find that the taxable income is the same as your federal return. However, sale of principal residence is exempt from taxes under most circumstances.

“It basically requires two sets of books, one for the feds and one for the state,” said Jim Reber of the Franchise Tax Board. “But we are not talking about something the little guy would encounter on his return. This problem affects (mostly) wealthy people whose returns are prepared by accounting firms.”

Perhaps the worst news, in terms of complicating the job of filing, is a rule change that affects a half-million or more California homeowners who took out a second mortgage or established a home equity line of credit last year.

In 1987, the federal and state laws on deducting the interest paid on home equity loans were nearly identical. But the federal law was changed for 1988, while state law remained the same.

The federal government now allows homeowners to deduct all the interest paid on a loan secured by their principal or second residence, to the extent that the amount of the loan didn’t exceed the original cost of the house, Bookstein explained.

Generally, the proceeds must be used for the purchase or improvement of the home. But up to $100,000 can be used for any purpose and still be deductible. There are special rules for loans made prior to Aug. 16, 1986.

But on state returns, California residents may deduct interest on home equity loans only if the principal was used to pay for home improvements or educational or medical purposes. What’s more, the loan amount cannot exceed the original cost of the home plus improvements.

Thus, if you used the home equity loan to pay off the balance on your credit cards, that interest isn’t deductible on your state taxes except in cases in which you have records indicating that the original credit card expenditure was for a home improvement or for a medical or educational purpose.

Complicating matters, the state doesn’t have any forms or instructions to help you through this maze. And since the federal form eliminated the distinctions, current IRS forms won’t help.

The proper way to complete the part of your state return that deals with home equity loans is to get the 1987 version of federal Form 8598 and the four-page instruction booklet that goes with it from the Internal Revenue Service or the state Franchise Tax Board.

The chances of finding the form at the counter of IRS offices are slim. Fortunately, the state maintains a toll-free number for information and ordering the old federal forms: (800) 338-0505. The line is often busy. However, the form can also be ordered from the IRS. It takes about 10 days to two weeks to get the forms after you request them.