BILL ANALYSIS
AB 1806
Page 1
Date of Hearing: April 12, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
AB 1806 (Hagman) - As Amended: March 15, 2010
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Personal income tax: sale of principal residence:
surviving spouse.
SUMMARY : Conforms to Internal Revenue Code (IRC) Section
121(b)(4), relating to an exclusion from income for capital
gains recognized by a surviving spouse upon the disposition of
his/her principal residence. Specifically, this bill :
1)Allows, by reference to IRC Section 121(b)(4), a surviving
spouse to exclude from gross income up to $500,000 (instead of
$250,000) of the gain from the sale or exchange of the
principal residence owned jointly with a deceased spouse,
provided that the sale or exchange occurs within two years of
the death of the spouse.
2)Requires the surviving spouse to be an unmarried individual.
3)Specifies that all of the special ownership and use
requirements otherwise applicable to married couples filing a
joint tax return must be met.
4)Applies to sales or exchanges that occur on or after January
1, 2010.
5)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW:
1)Allows an individual taxpayer to exclude up to $250,000
($500,000 if married filing a joint return) of gain realized
on the sale or exchange of a principal residence. To be
eligible for the exclusion, the taxpayer must have owned and
used the residence as a principal residence for at least two
of the five years ending on the sale or exchange. A taxpayer
who fails to meet these requirements by reason of a change of
place of employment, health, or unforeseen circumstances, to
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the extent provided under regulations, is able to exclude an
amount equal to the fraction of the $250,000 ($500,000 if
married filing a joint return).
2)Limits the exclusion to account for periods of "nonqualified
use," e.g. when the property is rented out or otherwise does
not qualify as a principal residence, for sales occurring
after December 31, 2008.
3)Provides that, for sales after December 31, 2007, if a married
couple was otherwise eligible for the $500,000 maximum
exclusion with respect to a principal residence immediately
prior to the death of one of the spouses, then the unmarried
surviving spouse is eligible for a maximum exclusion of
$500,000 on the sale of the residence if such sale occurs not
later than two years after the date of death of such spouse.
[The Mortgage Forgiveness Debt Relief Act of 2007, Public Law
110-142 (MFDRA)].
EXISTING STATE LAW conforms to federal law relating to the
exclusion of gain from the sale of a principal residence by
reference to IRC Section 121 as of the "specified date" of
January 1, 2005. (Revenue and Taxation Code Section 17152).
The MFDRA increased the amount of the gain exclusion on the sale
of a principal residence by a surviving spouse to $500,000.
However, because the federal change was made after January 1,
2005, California has not conformed to these provisions.
Therefore, under existing California law, a surviving spouse may
exclude only up to $250,000 of capital gain recognized on the
sale of his/her principal residence.
FISCAL EFFECT : The Franchise Tax Board staff estimates that
this bill will result in an annual loss of $300,000 in fiscal
year (FY) 2010-11, $200,000 in FY 2011-12, and $300,000 in FY
2012-13.
COMMENTS :
1)Author's Statement . The author states that, "This measure
received bi-partisan support in Washington DC; it deserves the
same here in Sacramento. AB 1806 would greatly benefit
Californians who have lost spouses by providing tax relief in
compliance with federally enacted laws."
2)Arguments in Support . The proponents of this bill state that
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this bill would lessen the burden placed on a surviving spouse
to sell his/her principal resident in the year in which
his/her spouse dies in order to qualify for the $500,000
capital gain exclusion. The proponents argue that, nowadays,
a grieving surviving spouse may be unable, or at least, find
it difficult, to sell the principal residence in the year of
his/her spouse's death. They further assert that a surviving
spouse is advised not to make major decisions in the first
year of the spouse's death, and that, by extending the time
period within which a sale of the principal residence can
still qualify for the $500,000 exclusion to two years, this
bill would provide tax relief to the surviving spouse, in
compliance with federally enacted laws.
3)Tax Relief for Surviving Spouses . Under existing California
law, an individual taxpayer may exclude up to $250,000 of gain
realized on the sale or exchange of a principal residence. To
be eligible for the exclusion, the taxpayer must have owned
and used the residence as a principal residence for at least
two of the five years ending on the sale or exchange. A
husband and a wife who file a joint return for the taxable
year in which they sell their principal residence may exclude
up to $500,000 of gain, provided that at least one of the
spouses owned it and both spouses have used the property as
their principal residence for the required period of time. In
the case of a surviving spouse, only up to $250,000 of capital
gain realized on the sale of his/her principal residence is
eligible for the exclusion, unless the surviving spouse sells
the residence in the year in which his/her spouse died.
Often, the surviving spouse is unable to sell the property
within the same year that the spouse died, especially when
this circumstance occurs late in the year.
In most cases, because of the so-called "basis step-up" rules, a
surviving spouse does not need the protection offered by this
bill as long as the surviving spouse has inherited the
deceased spouse's half of the principal residence. Although
they are not specific to housing, the rules on asset "basis
step-up" at death benefit housing. When an heir sells a
house, the capital gain on the sale is calculated from the
home's value at the time of inheritance rather than from its
value at the time it was originally purchased. Thus, any
appreciation in the property's value that occurred prior to
the decedent's death is exempted from capital gains taxation.
While the existing "basis step-up" rules already provide tax
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relief to most surviving spouses, some surviving spouses still
realize more than $250,000 on the sale of their principal
residences. Furthermore, some spouses do not hold their
principal residences in joint ownership. Consequently, if the
deceased spouse had no ownership interest in the principal
residence, the surviving spouse receives no step up in basis
on the half of the property and, under existing law, would be
eligible only for an exclusion of $250,000, unless he/she
sells the property in the year of his/her spouse's death. In
contrast, had the home been sold during the deceased spouse's
lifetime, the full $500,000 exclusion would have applied, so
long as the spouses filed a joint tax return in the year of
sale. This bill ensures that a surviving spouse may claim the
full $500,000 exclusion not only in the year of his/her
spouse's death, but also during the two years thereafter.
4)Tax Relief for Registered Domestic Partners . The federal law
does not recognize same-sex couples who are married under
state law. Thus, under federal law, registered domestic
partners will not benefit from the tax relief granted to
surviving spouses pursuant to IRC Section 121 (Section 121).
However, existing California law treats a domestic registered
partner as a spouse for purposes of the Personal Income Tax
Law. The term "domestic partner" means an individual partner
in a domestic partner relationship within the meaning of
Family Code Section 297. Therefore, if this bill is enacted
into law, it will provide tax relief to surviving spouses as
well as registered domestic partners.
5)Conformity Item . This bill provides partial conformity to
federal tax laws by allowing the specified tax relief to a
surviving spouse by reference to Section 121. The last
California-federal conformity bill was enacted in 2005 [AB 115
(Klehs), Chapter 691, Statutes of 2005]. The provisions of AB
1806 have been part of a number of state conformity bills,
including the most recent one, SBx8 32 (Wolk), since Congress
enacted the MFDRA. Despite the fact that SBx8 32 incorporates
this bill's provisions, the proponents are pursuing this
stand-alone measure in the hopes that the individual provision
conforming California law to federal law authorizing a special
tax relief for surviving spouses is more likely to be enacted
than the conformity bill. However, an enactment of just this
one provision to the exclusion of other changes made to
Section 121 by Congress since 2005 will result in a creation
of additional benefits for surviving spouses without a
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corresponding burden of new limitations imposed by Congress on
the amount of capital gain exclusion.
In 2008, Congress amended Section 121 to provide that gain from
the sale or exchange of a principal residence allocated to
periods of "nonqualified use" is included in gross income [IRC
Section 121(5)]. A period of "nonqualified use" means any
period (on or after January 1, 2009) during which the property
is not used by the taxpayer or the taxpayer's spouse or former
spouse as a principal residence. For example, a time period
within which the taxpayer uses his/her principal residence as
rental property will be a period of "nonqualified use." The
amount of gain allocated to periods of nonqualified use equals
to the amount of gain multiplied by a fraction the numerator
of which is the aggregate periods of nonqualified use during
the period the property was owned by the taxpayer, and the
denominator of which is the period the taxpayer owned the
property. Without the limitations imposed under federal law
on the amount of gain exclusion, not only California will
still be out of conformity with the federal tax law, but the
surviving spouses residing in California will receive an
unrestricted tax relief. The Committee may wish to consider
amending this bill to incorporate all other changes made by
Congress to Section 121 since 2005.
6)How Important is Conformity? When changes are made to the
federal income tax laws, California does not automatically
adopt such provisions. Instead, state legislation is needed
to conform to most of those changes. Conformity legislation
is introduced either as individual tax bills to conform to
specific federal changes or as one omnibus bill to conform to
the federal law as of a certain date with specified
exceptions, a so-called "conformity" bill.
Since 2005, when the last California-federal conformity bill was
enacted, businesses, tax practitioners and state tax agencies
have been advocating for a new bill to conform state tax laws
to ever-changing federal tax laws. Businesses, generally,
prefer conformity to federal tax laws because it reduces their
state tax compliance costs. The tax practitioners have argued
that there are significant costs associated with federal
non-conformity. Failure to conform to federal law in some
areas may lead to improper tax reporting to California and
extra costs to the taxpayers. As an example, a taxpayer may
roll-over balances in an Archer Medical Savings Account to a
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new Health Savings Account without triggering liability at the
federal level, but will unknowingly face penalties for the
transfer since it constitutes a disqualified distribution for
state purposes. Finally, conformity legislation is also
important to state agencies. Conformity eases the burden, and
reduces the costs, of tax administration because the state may
rely on federal audits, federal case law, and regulations.
While state conformity to federal income tax provisions offers
certain advantages and reduces tax compliance costs, it can
also significantly impact state revenues. Thus, it would be
difficult to achieve complete conformity with federal income
tax rules.
In 2008, AB 1561, a conformity bill, required a 2/3 vote of the
membership in each house and did not advance from the Senate
Floor because it failed to secure 27 Senate votes. In 2009,
AB 1580, another conformity bill, was vetoed by the Governor.
In 2010, SB x8 32, which was nearly identical to AB 1580 was
also vetoed by the Governor. SB 401 (Wolk) represents that
most recent attempt to ease the hardship on taxpayers and tax
practitioners by bringing the federal and state tax codes
closer together. It incorporates all of the changes to IRC
Section 121 made by Congress since 2005 and, currently, is
pending with the Governor.
7)Related Legislation .
SB 401 (Wolk), introduced in the 2009-2010 Legislative Session,
in its final form, is a comprehensive California-federal
conformity measure that includes the provisions of AB 1806.
SB 401 was passed by both the Assembly and the Senate and now
is pending with the Governor.
SBx8 32 (Wolk), introduced in the 2010 8th Extraordinary
Session, was also a comprehensive conformity measure that
included provisions of AB 1806. SBx8 32 was vetoed by the
Governor.
AB 1580 (Charles Calderon), introduced in the 2008-09
Legislative Session, was also a tax conformity measure that
contained a provision identical to AB 1806. AB 1580 was
vetoed by the Governor.
AB 1561 (Charles Calderon), introduced in the 2007-08
Legislative Session, also contained a provision identical to
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AB 1806. AB 1561, in its final form, was a comprehensive
California-federal conformity measure that failed passage in
the Senate.
REGISTERED SUPPORT / OPPOSITION :
Support
Gray Panthers Sacramento
California Senior Legislature
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098