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SEPTEMBER/OCTOBER 2002

Big changes in store for nonresidents,


part-year residents, former nonresidents
The laws guiding California’s taxation You can also view this special feature on
of nonresidents, former nonresidents, our Webpage, Tax News Online, located
and part-year residents are changing at www.ftb.ca.gov/education/taxnews/
for taxable years beginning in 2002 as a Index.html.
result of California Assembly Bill 1115. Legislative update:
And there’s more. We are also preparing
The bill sets rules for calculating loss a new publication to provide additional Page 2
carryovers, deferred deductions, and guidance and examples. Please watch for
deferred income. Publication 1100 – Guidelines of
Nonresidents and Individuals Who
The changes in the California taxation Ask the Advocate
Change Residency. If you or your client
of income items as a result of AB 1115
changed residency, it is especially Page 3
need to be considered in determining
important that you request this
your clients’ estimated tax payments
publication. Since part-year residents are
for taxable year 2002. Tax forms for
taxed as residents for that period during
2002 will be revised to reflect the law
changes.
which they were residents and as Tax forms
nonresidents for the remaining period,
In this issue of Tax News we have a part-year residents are subject to a corrections
special feature on AB 1115, beginning combination of the rules set forth in this Page 3
on page 5. It contains definitions and article. The publication will have
examples to help you understand the examples illustrating the application of
changes resulting from the new law. AB 1115 to the part-year resident.
Continued on page 5 AB 1115
Online installment agreement tool Special feature
Page 5
simplifies application process
Beginning in October, we will have an authentication. Confidential information e-file news
online electronic installment agreement is protected through the use of Secure Page 18
application on our Website, Sockets Layer encryption. Here’s how it
www.ftb.ca.gov, that can simplify and works:
speed up the process of applying for an • The taxpayer completes and submits
installment agreement with us. an application for approval to pay an Missouri offers
amount due in installments. amnesty
The electronic installment agreement
also provides taxpayers the • We instantly send the taxpayer
confirmation that we received the Back page
convenience of applying for an
application.
installment agreement at any time.
Taxpayers are required to use their
customer service number for Continued on page 4
Page 2

Volume 00-5 September/October 2002


Legislative update
TAX NEWS is a bimonthly publication of
the Communications Services Bureau,
New laws affect taxpayers in military, limited liability
California Franchise Tax Board. Its
primary objective is to provide
companies, Lupus Foundation contributors
information to income tax practitioners
about state income tax laws, regulations,
Several legislative measures were than six percent on any liability
policies and procedures. recently enacted into law. Here are incurred by the service member prior
summaries of each. If you want to learn to their entry into active service,
Members of the Board:
more about any of the new laws, go to unless a court concludes that the
Kathleen Connell, Chair
State Controller
our Law and Legislation Webpage service member’s ability to pay a
John Chiang
located on our Website at higher interest rate is not materially
Chair, State Board of Equalization www.ftb.ca.gov. affected by their service.
B. Timothy Gage
You also can find comprehensive
• We will defer the collection of any
Director, Department of Finance income tax that is due prior to or
———————— information about all legislative measures
Executive Officer:
during the period of military service
on the Internet at www.leginfo.ca.gov,
Gerald H. Goldberg for a period of up to six months after
the Official California Legislation
Editor: the termination of active military
Marvin Meek Information Website.
service. Interest and penalties for
To update or correct your address or to AB 957 (Papan, Stats. 2002, Ch. 135) nonpayment of the tax will not accrue
subscribe to TAX NEWS (send $12 This act makes clarifying changes to the during the time we defer the liability.
for a one-year subscription), write: law that allows individuals to make Further, the running of the statute of
TAX NEWS voluntary contributions to the Lupus limitations against the collection of
PO Box 2708
Rancho Cordova, CA 95741-2708 Foundation of America on their tax any tax will be suspended for the
or call: (916) 845-7070 returns. This act clarifies that period of military service and for an
contributions shall be used by the additional nine months after the end
To view TAX NEWS on the Internet or to California-based operating chapters of of active service.
request an electronic mail subscription,
contact FTB on our website: the Lupus Foundation for lupus Further, this act allows a court to grant
www.ftb.ca.gov education, awareness, and for the following relief (after notice and
research grants. hearing) if a service member applies for
For information about a
client’s account, contact: The Lupus Foundation first appeared on the relief of any tax or assessment that is
Tax Practitioner Support Unit the 2001 tax return and will appear for five due prior to or during the period of
phone: (916)845-7057
fax: (916)845-6377 years, as long as it meets a minimum military service:
contribution amount. • A stay of the enforcement of the tax
For recorded answers to questions on during the period of military service.
California taxes, to order forms, AB 1433 (Horton, Stats. 2002, Ch. 60)
or to check on a refund, call: • The service member may pay the
This act provides various civil balance of any unpaid liability and
(800)338-0505 protections and relief to military service
From outside U.S. (916)845-6600 interest in equal periodic installments
members who are ordered to active for a period beginning on either the
To send a facsimile about a federal or state military duty by codifying date of the termination of service or
client’s account, transmit to: provisions that are generally similar to
Electronic Correspondence the date of application for relief. The
(916)845-6377 the Federal Soldiers’ and Sailors’ Civil time period will be equal to the period
————————— Relief Act. With respect to income taxes the member spent in military service.
Information Center and administration, this act requires:
(800)852-5711
From outside U.S. (916)845-6500 • We exclude the period of military When a court has granted the stay, no
service when computing any statute fines or penalties can accrue during the
Hearing Impaired
TDD (800)822-6268 period limited by law for bringing period of the relief outlined above.
————————— actions or proceedings in any court,
FTB on the Internet board, bureau, commission,
www.ftb.ca.gov
Printed on recycled paper
department, or other agency of the
government.
• We assess an interest rate of no more Continued on page 3

September/October 2002
Page 3

New law modifies Open Meeting Act;


Board of Equalization most impacted Ask the Advocate
Continued from page 2 AB 2791 (Migden, Stats. 2002, Ch. 169)
This act requires that:
Finally, this act states that the • The Secretary of State notify certain
Legislature’s intent is to allow service business entities about their
members to qualify for the benefits and obligation to pay an annual tax at the
protections under this act retroactive to time the entity is created or registered Debbie Newcomb
September 11, 2001. However, it is also in this state, and Taxpayer
the Legislature’s intent that the actual • We notify certain business entities Advocate
benefits and protections to service about their obligation to pay an
members will only apply on a prospective annual tax until the existence of the
basis after January 1, 2003, which is the business entity is properly ended or Q: My client wants to dissolve a
act’s operative date. Therefore, service the business entity’s registration is corporation. How do I compute
members that are in active service as of properly cancelled. the tax for the final year?
September 11, 2001, will qualify for the
income tax collection deferral, but the This act applies to domestic and foreign
A: I would need to know more
deferral will be effective only on or after limited partnerships, limited liability
about your client’s account
January 1, 2003. partnerships, and limited liability
before I could answer your
companies.
question definitively. However,
AB 1752 (Migden, Stats. 2002, Ch. 156)
there has been a noticeable
This act makes changes to the Bagley-
change in the law that affects final
Keene Open Meeting Act as it applies to Correction year returns for dissolving
the Board of Equalization. This act
generally requires that certain disclosable to tax form corporations. If you’re not careful
when completing the dissolution,
public records pertaining to an item on an
Please note the following your client could wind up paying
agenda for a meeting of the Board of
correction to the distributed 2001, additional taxes, penalties, and
Equalization that are prepared and
California tax forms, instructions, interest. Let me explain:
distributed by either a Board of
Equalization member or Board of and booklets. Should you have any In 2000, California enacted
Equalization staff to Board of questions about this clarification, Assembly Bill 1843, replacing the
Equalization members prior to or during a contact our Tax Forms term income year with taxable
Board of Equalization meeting must be Development and Distribution year. This law change made it
disseminated in three ways before the Section at (916) 845-3442. easier for corporations to
Board of Equalization takes any final CA Targeted Tax Area Business calculate their tax liability for their
action on that item to which the writing Booklet, Form FTB 3809 final year.
pertains. The public records must be: (1) (instructions)
made available for public inspection at AB 1843 replaced income year
the meeting, (2) distributed to all persons The error appears on page 4 of the with taxable year in all provisions
requesting copies of such writings, and instructions, third column, under of the Bank and Corporation Tax
(3) made available on the Internet. These the heading Credit Limitations. Law, the Administration of the
requirements do not apply to writings The third bullet should be deleted. Franchise and Income Tax Law,
pertaining to any item that involves a The bullet reads: and the Personal Income Tax Law.
named tax or fee payer. • The business must reduce any Revenue and Taxation Code
deduction for wages by the Section 23151(f)(1)(A) and (B)
This act is similar to Senate Bill 445 amount of the TTA credit. states:
(Burton, Stats. 2001, Ch. 670), which
applies to the three-member Franchise The error appears in the 2001
Tax Board. Package X and in the above
mentioned booklet. The Internet
version is correct. Continued on page 4
Page 4

Electronic installment agreement – faster, simpler


Continued from page 1 owed cannot exceed $10,000, and We are looking at expanding it to
• Later, the taxpayer goes online the total balance must be paid allow you to submit an installment
to check the status of the within 36 monthly installments. agreement request on your clients’
request. behalf. In the meantime, let your
Currently, our electronic installment
clients know about our new
To qualify for an installment agreement is for taxpayers’
paperless service.
agreement the maximum balance use only.

Ask the Advocate The current law requires dissolving


corporations to pay a measured tax
laws, your client may be required to file
another tax return, and pay additional
amount that is based on their net income, taxes, penalties, and interest. Here’s
Continued from page 3
but not less than the minimum tax ($800) an example:
With respect to taxable years beginning
in their final year. Note: Regarding
on or after January 1, 2000 (other than the Corporation A, filing on an annual basis,
prepayments made upon incorporation,
first taxable year beginning on or after submits documents to the Secretary of
there is no provision in the tax law to
that date), the tax for the taxable year State with the intention of dissolving on
apply prepayments made upon
(including the taxable year of December 12, 2002. It mails
commencement and the taxable the documents to the
year of cessation) shall be Secretary of State on
according to or measured by its More than ever before, it is critical that December 15, 2002. The
net income for the taxable year to Secretary of State
be computed at the rate you carefully follow the procedures for determines the documents
prescribed in Section 23151 the proper dissolution of a corporation. are incomplete and informs
{Emphasis added}. the corporation that it must
file additional forms.
As a result of AB 1843,
corporations now calculate their incorporation to the computation of the Corporation A delays in filing the
franchise tax using their net income from final year tax (applies to entities additional documents and as a result, the
the taxable year instead of using the net incorporated prior to January 1, 2000). documents do not reach the Secretary of
income of the preceding income year, State until February 5, 2003. The
Nowadays, many corporations wait until
which no longer exists. To make the Secretary of State completes the
the end of their normal year, to file for
change from income year to taxable year, dissolution process and informs us that
dissolution, withdrawal, or merger with
California made statutory changes to the the dissolution date is February 5, 2003.
the Secretary of State.
treatment of estimate payments.
Corporation A is now required to file an
More than ever before, it is critical that
Beginning with tax year 2000, we do not additional tax return, even though it did
you carefully follow the procedures for
treat an estimate payment made in a not conduct business or earn income, for
the proper dissolution of a corporation
current taxable year as payment for the the short period ending February 5, 2003,
(located in the California Corporations
franchise tax in the following taxable year, and it must pay at least the minimum tax
Code).
but we regard it as payment for the (We would also assess penalties and
taxable year in which the payment Pay particular attention to the timing of interest for a late return, if applicable).
is made. the filing, otherwise, under the current

September/October 2002
Page 5

Assembly Bill 1115


Table of Contents
Section 1 The New Computation Section 5 Compensation Section 9 Suspended Gains and Losses
Section 2 Installment Sales Section 6 Stock Options Section 10 Net Operating Losses and
Deductions
Section 3 Individual Retirement Section 7 Deferred Gains
Accounts (IRAs) (Section 1031 Exchanges) Section 11 Basis in Pass-through Entities
Section 4 Employer-sponsored Section 8 Capital Gains and Losses Section 12 Alternative Minimum Tax
Retirement Plans

Section 1: The New Computation

Prorated tax computation: This new law changes the computation The effective tax rate is the California tax
method to recognize those items. on all income as if the person were a
Prior California law was silent on the tax California resident for the current tax year
Beginning this year, your nonresident
treatment of loss carryovers, deferred and for all prior tax years for any
and part-year resident clients will
deductions, and deferred income that carryover items, deferred income
determine their California tax by
vested prior to the time individuals suspended losses, or suspended
multiplying their California Taxable
became part-year or non-California deductions, divided by that income. The
Income by an effective tax rate.
residents. computation is as follows:

California Taxable Income x Tax on Total Taxable Income = Prorated Tax


Total Taxable Income

How are the percentages calculated?


Calculate percentages for California deductions, tax, and credits as follows:

To Calculate the Percentage for CA Instruction


Itemized or Standard Deductions Divide the California AGI by the total adjusted gross income (not to exceed 1.0)
California AGI
Total AGI
Tax Rate Divide the tax on the total taxable income by the total taxable income.
Tax on Total Taxable Income
Total Taxable Income
Credits Divide the California taxable income by the total taxable income.
California Taxable Income
Total Taxable Income

(Note: This percentage does not apply to renter’s credit, other state tax credit, or credits that are conditional upon a transaction
occurring wholly within California.)
Page 6

any part of the taxable year during California deductions do not exceed what
Section 1 which the taxpayer was a resident. was actually incurred by the nonresident
The new computation • Any carryover items, deferred or part-year resident.
income, suspended losses or
Total Taxable Income is the entire taxable
suspended deductions are included
income of a nonresident or part-year
or allowable only to the extent they
Continued from page 5 resident determined:
were derived from California sources
California Taxable Income is for the period of nonresidency. Basis • As if the nonresident or part-year
California Adjusted Gross Income less adjustments, including the basis in resident were a California resident for
California itemized or standard tax-free exchanges, for all prior years the current taxable year; and
deductions. are determined under California law. • As if the nonresident or part-year
resident were a California resident for
California adjusted gross income is California Itemized or Standard all prior taxable years for any
Gross income and deductions derived Deductions are determined by applying carryover items, deferred income,
from California sources for any part of the ratio of California AGI to Total AGI to suspended losses, or suspended
the taxable year during which the all of the nonresident’s or part-year deductions.
taxpayer was a nonresident, plus: resident’s itemized deductions that are
• All items of gross income and all allowed to California residents. The ratio
deductions regardless of source for is limited to 1.00 so that the allowable
Continued on page 7

Example 1-1:
Tom lived in Washington until March 31, 2002. He became a CA Itemized Deductions: 24,000 (Total itemized deductions)
California resident on April 1, 2002. Tom earned and received wages x .8095 (CA AGI ÷ Total AGI)
of $15,000 in Washington while he was a Washington resident, and $19,428
he earned wages of $65,000 while he was a California resident. Tom
CA Taxable Income: $68,000 (CA AGI)
also earned $4,000 in interest income during 2002, $1,000 while a
- 19,428 (CA itemized deductions)
resident of Washington and $3,000 while a California resident.
$48,572
Tom is single and had the following itemized deductions in 2002:
Real estate taxes: $ 1,200 (CA house) Total Taxable
800 (WA house) Income (TI): $84,000 (Total AGI)
Mortgage interest: 17,000 (CA house) - 24,000 (Total itemized deductions)
3,500 (WA house) $60,000
Charitable
Tax on Total Taxable
contributions: 1,500 (NY Firefighters’ Fund)
Income: $3,733 (Tax table*)
$24,000
Prorated Tax: $48,572 (CA Taxable Income)
Calculation of Tom’s 2002 California Tax Liability: x .0622 (Tax on Total TI ÷Total TI)
CA AGI: $65,000 (CA wages) $3,021
+ 3,000 (Interest earned while a CA resident)
TT Prorated Exemption
$68,000
Credit: $ 79 (Personal exemption credit*)
Total AGI: $80,000 (Wages from all sources) x .8095 (CA Taxable Income÷Total TI)
+ 4,000 (Interest income from all sources) $ 64
$84,000
Tax Liability: $ 3,021 (Prorated tax)
- 64 (Prorated exemption credit)**
$ 2,957

* For purposes of this example, the 2001 Tax Table and personal exemption credit amounts have been used.
**Even though, under AB 1115, the proration of personal exemption credits was not really changed, since exemption
credits are figured after the prorated tax, the new computation makes the proration more explicit.

September/October 2002
Page 7

sourced to the recipient’s state of Jim’s capital gain income received on


residence. Residents are taxed on all June 1, 2002, because the property was
Section 1
income regardless of source. not located in California. California also
The New Computation
does not tax the interest income because
For those who were always nonresidents
Jim was a nonresident of California when
The repeal of section 17554 does not he received the proceeds.
change the taxation of California property
For California residents who were
installment proceeds for nonresidents
Continued from page 6 formerly nonresidents
who have always been nonresidents.
Credits: California taxes the installment proceeds Residents are taxed on all income
Renter’s credit, other state tax credit and received by a nonresident to the extent regardless of source. With the repeal of
credits that are conditioned upon a the income from the sale was from a section 17554, California now taxes
transaction occurring wholly within California source. installment proceeds received by a
California (e.g., the Manufacturer’s resident from the sale of property located
Investment Credit) are allowed in full. All Example 2-1: Bob is a nonresident of
outside California that was sold before
other credits are prorated using the ratio California. On March 1, 2001, he sold a
the taxpayer became a California resident.
of California Taxable Income over Total California rental property in an
Taxable Income. For prorated credits, the installment sale. During 2001 and 2002, Example 2-4: On July 1, 2001, Sue, while
ratio is not limited to 1.00. However, the Bob received installment proceeds a nonresident of California, sold her
actual prorated credit amount cannot comprised of capital gain income and Texas rental property in an installment
exceed the specific dollar limit applicable interest income. California taxes the sale. On May 15, 2002, Sue became a
to the credit. capital gain income in both 2001, and California resident and on August 1,
2002, because the property was located 2002, she received installment proceeds.
Once Tom, the taxpayer in Example 1-1, in California. California does not tax the California taxes Sue’s installment
(see page 6) becomes a California interest income, which has a source in proceeds received on August 1, 2002,
resident, he will pay taxes on all income, Bob’s state of residence. because she was a California resident
regardless of source. In addition, AB when she received the proceeds.
1115 provides that Tom should treat Example 2-2: Jane is a nonresident of
carryover items, suspended losses, etc., California. On June 4, 2001, she sold a Example 2-5: On September 1, 2000,
as if he were a California resident in the parcel of land located in Idaho on an Sandra, while a nonresident of California,
current year and all prior years. installment basis. California does not tax sold stock (intangible property) in an
the gain on the sale or any of the installment sale. On June 1, 2002, Sandra
If Tom decides to move out of California installment proceeds while Jane is a became a California resident and on
in the future, he will pay taxes on a nonresident because the source of the October 1, 2002, she received installment
source basis and calculate his carryover gain is Idaho. proceeds from the stock sale. California
items accordingly. taxes Sandra’s installment proceeds
For former California residents
received on October 1, 2002, because she
The repeal of section 17554 may reduce was a California resident when she
Section 2 taxes for some former California received the proceeds.
Installment sales residents. They will no longer be taxed
Continued on page 8
on installment proceeds received from
the sale of property located outside
California that was sold while the
AB 1115 repealed Revenue and Taxation
taxpayer was a resident.
Code section 17554, pertaining to income
accrual. Beginning this year, California Example 2-3: In June 1999, Jim, while a
taxes installment gains received by a California resident, sold a parcel of real
nonresident from the sale of tangible property located in Washington in an
property on a source basis. Real property installment sale. On March 1, 2002, Jim
is taxed based upon where the property became an Ohio resident and on June 1,
is located. Installment gains from the sale 2002, he received installment proceeds
of intangible property are generally comprised of capital gain income and
interest income. California does not tax
Page 8

distributions, qualified pension, profit


sharing, and stock bonus plans of a income, which includes IRAs.
nonresident. Accordingly, a former nonresident will be
Section 3
allowed a basis for contributions which
Individual retirement accounts Example 3-1: David, a nonresident of would not have been allowed under
California, lives and works in Wyoming. California law had the taxpayer been a
David’s Wyoming firm temporarily California resident.
assigned him to California for four
Continued from page 7 months to complete a project. David California did not conform to the $2,000
earns $5,000 per month. California taxes or 100% of compensation annual
AB 1115 sets rules for calculating contribution limit permitted under federal
$20,000 ($5,000 x 4) as compensation for
deferred income. The new laws do not law from 1982 through 1986. During these
services having a source in California,
affect the taxation of IRA income, income years, California limited the deduction to
the state where David performed four
from employer sponsored retirement the lesser of 15% of compensation or
months of his services.
plans, and compensation income of a $1,500 and denied a deduction altogether
nonresident, whether the nonresident For California residents who were to individuals who were active
was always a nonresident or was formerly nonresidents participants in qualified or government
formerly a California resident. However, plans. Any amounts an individual
they do affect California residents who Beginning this year, a former nonresident
no longer receives a stepped-up basis for contributed in excess of California
were formerly nonresidents. deduction limits during these years
annual contributions and earnings in an
For Nonresidents Individual Retirement Account (IRA) create a basis in the IRA.
simply because the individual was a Example 3-2: Mary became a California
Compensation received by a nonresident
nonresident when the contributions resident on January 1, 2001. The fair
for performance of services is taxed on a
were made. market value of her IRA on January 1,
source basis. If the services are
performed in California, the The new laws treat a former nonresident 2001, was $9,000. Her contributions in
compensation income is sourced to as though the taxpayer were a resident excess of California deduction limits
California. California does not tax the IRA for all prior years for all items of deferred during 1982-1986 were $2,500. Mary
received IRA distributions of $1,500 in
2001, and $3,000 in 2002.

Example 3-2
Section 4
Tax Year 2001 (pre-AB 1115): Employer-sponsored
California IRA basis, 1/1/01 $9,000 (Fair market value on 1/1/01) retirement plans
Less: IRA distribution $1,500
California IRA basis 12/31/01 $7,500
Tax Year 2002 (post-AB 1115):
IRA distribution, 2002 $3,000 California taxes qualified pension, profit
Less: California IRA basis sharing, and stock bonus plan income
Contributions in excess received by a resident for services
of California deduction limits $2,500 performed outside California while the
Less: California IRA basis taxpayer was a nonresident.
recovered in 2001 1,500 Example 4-1: Rick permanently moved
California IRA basis from Florida to California on January 1,
available in 2002 1,000 2002. He received pension income during
Taxable IRA income $2,000 2002 through a qualified plan from his
former Florida employer. California taxes
Rick’s qualified pension income because
he was a California resident when he
received the income.

Continued on page 9

September/October 2002
Page 9

and permanently moved to Texas. On


June 1, 2002, John exercised his Section 7
Section 5 nonstatutory stock options. California Deferred gains
Compensation taxes the income resulting from the (Section 1031 exchanges)
exercise of the nonstatutory stock as
compensation for services having a
source in California, the state where John
performed all of his services.
Continued from page 8 Gain from the sale or exchange of real or
For California residents who were tangible personal property located in this
Residents are taxed on all income formerly nonresidents state is sourced to California at the time
regardless of source. With the repeal of the gain is realized. (Note: See California
Revenue and Taxation Code section California taxes the wage income received
Code of Administration, Title 18,
17554, California now taxes compensation by a former nonresident from employee
Regulation 17951-3. Gains from the sale
received by a resident that accrued stock options because all the income is
of intangible property are generally
before the taxpayer became a recognized while the taxpayer is a
sourced to the recipient’s state of
California resident. California resident.
residence.)
Example 5-1: Jill lived and worked in New Example 6-2: On March 1, 1998, while a
If a nonresident taxpayer exchanges
York until April 30, 2002. She permanently Nevada resident, Fred was granted
property located within California for
moved to California on May 1, 2002. Her nonstatutory stock options. On April 1,
property located outside California, the
former New York employer pays its 2002, he retired and permanently moved
realized gain will be sourced to California,
employees on the 5th of every month. On to California. On May 1, 2002, Fred
although tax will not be assessed until
May 8, 2002, Jill received her last exercised his options. California taxes
the gain is recognized. This requires
paycheck of $3,000 in the mail from her Fred’s compensation resulting from the
nonresidents to keep track of their
former New York employer. California exercise of his nonstatutory stock
deferred gains sourced to California so
taxes the compensation of $3,000 options because Fred was a California
that they can be reported to California in
because Jill was a California resident resident when the income was
the year the gain is recognized. (Note: It
when she received the income. If Jill also recognized.
should be noted that gain from the sale
paid tax to New York on this California also taxes the capital gain of a principal residence after May 7,
compensation, she is allowed a credit income received by a former nonresident 1997, is no longer deferred. Rather, the
for taxes paid. from the sale of stock in a qualifying law provides for an exclusion of gain up
disposition of statutory stock options to a certain dollar limitation. The non-
because the stock is sold while the excluded portion of the gain will be
Section 6 taxpayer is a resident. taxable to California for a nonresident if
Stock options Example 6-3: On February 1, 1998, while
the residence was located in California.
Residents are taxed on the gain
a Texas resident, Nancy was granted
regardless of the location of the
incentive stock options. On February 1,
principal residence.)
2001, she exercised her options. On
AB 1115 does not affect taxation of December 1, 2001, Nancy permanently If out-of-state real property or tangible
employee stock options. moved to California and sold her stock personal property is exchanged for real
on March 1, 2002, for a gain. California property or tangible personal property
Nonresidents taxes the resulting capital gain because located within California and all the
California taxes the wage income received Nancy was a California resident when requirements under Internal Revenue
by a nonresident from employee stock she sold the stock. Code section 1031 have been met, when
options on a source basis, whether the the California property is disposed of
Get FTB Publication 1004, Stock Option
nonresident was always a nonresident or (assuming it is not disposed of in another
Guidelines, for additional information on
was formerly a California resident. deferred gain transaction), the gain will
the California taxation of stock options.
be sourced to California.
Example 6-1: On February 1, 1999, while
a California resident, John’s company
granted nonstatutory stock options to
him. John performed all of his services in
California from February 1, 1999 to May Continued on page 10
1, 2002, the date John left the company
Page 10

Out-of-state property exchanged for California because John is a resident at


California property the time of the sale. If Kansas taxes a
portion of the recognized gain because of
Example 7-2: Jane was a resident of
Section 7 the deferral of gain associated with the
Nevada when she exchanged Nevada
Deferred gains Kansas property, John may be able to
business property for like-kind California
(Section 1031 exchanges) take an Other State Tax Credit.
business property. Jane realized a $10,000
gain on the property that was properly
deferred under Internal Revenue Code
section 1031. Jane then sells the
Continued from page 9
California property while still a resident Section 8
California property exchanged for out- of Nevada. Jane recognizes $50,000 of Capital gains and losses
of-state property gain in a non-deferred transaction.
Because the property is located in
Example 7-1: Jim, a resident of Texas,
California, the $50,000 gain is sourced
owned a condominium in California. Jim
to California.
exchanged the condominium for like-kind Capital loss carryovers and capital loss
property located in Texas. There was no Example 7-3: John is a resident of limitations for nonresidents are
boot on the exchange that met all of the Kansas when he exchanges property determined based upon California source
requirements for Internal Revenue Code located in Kansas with property located income and loss items only for
section 1031 treatment. Jim realized a gain in California in a transaction that qualifies computation of California Taxable
of $15,000 on the exchange. Jim must for Internal Revenue Code section 1031 Income.
recognize the lesser of the deferred gain treatment. There is no boot on the
of $15,000 or the gain recognized at the transaction and John realizes $12,000 of Example 8-1: Mary, a resident of Oregon,
time Jim disposes of the Texas property, gain. John becomes a resident of has a $4,000 capital gain sourced to
assuming he does so in a non-deferred California and, while a California resident, California, a $2,000 capital loss sourced
transaction. he disposes of the California property in to California, a $1,000 capital gain
a non-deferred transaction. All of the sourced to Oregon and a $5,000 capital
gain recognized will be taxed by Continued on page 11

Example 8-1
Total Taxable Income California Taxable Income
CA Capital Gain $4,000 $4,000
CA Capital Loss (2,000) (2,000)
ORE Capital Gain 1,000
ORE Capital Loss (5,000)
Total $(2,000) $2,000

Example 8-2 - 2002 - Nonresident


Total Taxable Income California Taxable Income
CA Capital Gain $2,000 $2,000
CA Capital Loss (6,000) (6,000)
NY Capital Gain 5,000
NY Capital Loss (2,000)
Total $(1,000) $(4,000)
Loss Used in 2002 3,000
Carryover $(1,000)

September/October 2002
Page 11

Example 8-2 - 2003


Section 8
Resident
Capital gains and losses
California Taxable Income
Capital Gain $5,000
Capital Loss (4,000)
Total $1,000
Continued from page 10
As a resident, the source of the items does not matter because all income is taxed.
loss sourced to Oregon. For determining If Mike had been a nonresident, only the $4,000 capital loss would have been
California Taxable Income, Mary will net sourced to California.
her California capital gains and losses.
Mary has a $2,000 net capital gain that is Example 8-2 -2004
included in her California Taxable Income. Nonresident Capital Loss Carryover
Example 8-2 (see page 10)
2002 - Nonresident Carryover from 2002 $1,000
Carryover from 2003 1,000
In 2002, Mike, a New York resident, has a Total carryover to 2004 $2,000
$2,000 capital gain sourced to California,
a $6,000 capital loss sourced to
Example 8-3
California, a $5,000 capital gain sourced
to New York and a $2,000 capital loss
Total Taxable Income California Taxable Income
sourced to New York. For determining
CA §1231 Gain $3,000 $3,000
California Taxable Income, Mike will net
CA §1231 Loss (2,000) (2,000)
his California sourced capital gains and
WA §1231 Gain 4,000
losses. Mike will have a net capital loss
WA §1231 Loss (5,000)
of $4,000. He can take $3,000 of that loss
Total $0 $1,000
this year and carryforward $1,000 to 2003.
Example 8-2 Example 8-4- Nonresident
2003 - Resident
Total Taxable Income California Taxable Income
Assume Mike became a California
CA §1231 Gain $2,500 $2,500
resident beginning January 1, 2003.
CA §1231 Loss (3,000) (3,000)
Mike’s capital loss carryforward needs to
FL §1231 Gain 1,000
be restated as if he had been a resident
FL §1231 Loss (500)
for all prior years. Assuming that Mike
Total $0 $(500)
had no other capital gains or losses prior
to 2002, Mike would have no capital loss
carryforward into 2003 because he had a
net capital loss of $1,000 for 2002,
computed as if he was a resident for that Example 8-2 Characterization of Gains and Losses
year, which is within the $3,000 limitation. 2004 - Nonresident
The character of gains or losses on the
During 2003, Mike has a $5,000 capital Assume that on January 1, 2004, Mike sale or exchange of property used in a
gain from the sale of property located in becomes a nonresident again. He restates trade or business or certain involuntary
another state and a $4,000 capital loss his carryforwards taking into account conversions (Internal Revenue Code
from property located in California. As a items of gain and loss sourced to section 1231 gains and losses) are
resident of California, Mike will net his California. On a source basis, Mike had a determined for purposes of calculating
gain and loss for a net $1,000 capital gain. $1,000 capital loss carryforward from California Taxable Income by netting
If Mike had been a nonresident, he would 2002. In 2003, he had a $4,000 capital loss California sourced section 1231 gains
have had a $4,000 capital loss sourced to carryforward. He would have been and losses only.
California. He would have taken $3,000 of allowed to use $3,000 of that loss in 2003
that amount and would have carried and would have carried forward $1,000
from 2003 and $1,000 from 2002 into 2004. Continued on page 12
forward $1,000.
Page 12

Example 8-4: (see page 11) Paula, a passive activity losses allowed and the
resident of Florida, has a $2,500 section amount that is suspended are determined
Section 8 1231 gain sourced to California, a $3,000 based only upon California source
Capital gains and losses section 1231 loss sourced to California, a passive income and loss items. (Note:
$1,000 section 1231 gain sourced to For aggregation purposes, only those
Florida and a $500 section 1231 loss activities with a California source may
sourced to Florida. For determining be aggregated. Only the California
Continued from page 11
California Taxable Income, Paula will net source passive losses carry forward into
Example 8-3: (see page 11) Peter, a her $2,500 gain and her $3,000 loss for a the subsequent year.)
resident of Washington, has a $3,000 $500 net section 1231 loss. This loss will
Example 9-1: Charles, a resident of
section 1231 gain sourced to California, a be ordinary.
Arizona, owns three rental properties.
$2,000 section 1231 loss sourced to
Properties A and B are located in Arizona,
California, a $4,000 section 1231 gain
Section 9 and Property C is located in California.
sourced to Washington and a $5,000
Suspended gains and losses In 2002, the Arizona rental property
section 1231 loss sourced to
activities resulted in net income of $1,000
Washington. For determining California
for Property A and $4,000 for Property B.
Taxable Income, Peter will net his $3,000
Property C incurred a $26,000 net loss.
gain and his $2,000 loss for a $1,000 net For those who were always nonresidents
section 1231 gain sourced to California.
For the computation of California Taxable
This gain will be a capital gain. Continued on page 13
Income of nonresidents, the amount of

Example 9-1A - 2002

Total Taxable Total Suspended CA Taxable CA


Income losses to 2003 Income Suspended
Losses to 2003

AZ Property A $1,000 – – –

AZ Property B 4,000 – –
CA Property C ($26,000) – ($26,000) ($1,000)**
Suspended Loss
to 2003 $1,000

Total ($21,000)* ($25,000)* ($1,000)**

*Internal Revenue Code section 469 (i) $25,000 passive activity loss offset
* * ($26,000) + $25,000 (passive activity loss offset) = ($1,000) carryforward

Example 9-1B - 2003

Total Taxable Total Suspended CA Taxable CA


Income losses to 2004 Income Suspended
Losses to 2004

AZ Property A ($2,000) – – –

AZ Property B ($1,000) – –
CA Property C $2,000 – $2,000 –
Prior Year Suspended
Loss Allowed ($1,000)
Total ($1,000) $1,000

September/October 2002
Page 13

Example 9-2: Sierra, a resident of New For California residents who were
York, owns rental property located in formerly nonresidents
California, is a member of a Limited
Section 9 When a nonresident becomes a resident,
Liability Company doing business
Suspended gains and losses all prior year items are restated as if the
exclusively within California that elected
taxpayer had been a California resident
to be taxed as a partnership, and is a
for all prior years.
shareholder of an S Corporation doing
business solely within Texas. In 2002, Example 9-3: Assume Sierra becomes a
Continued from page 12 Sierra’s rental property had a $2,000 loss, California resident on January 1, 2003.
her share of the Limited Liability When Sierra becomes a resident, she
In determining Charles’ California Taxable Company losses was $5,000 and her restates her carryovers into 2003 as if she
Income, his gross income and deductions share of the S Corporation income had always been a resident. Had she
may only include those items derived was $1,000. been a resident in 2002, she would have
from sources within this state. (Note: been able to offset her Texas S
Sierra is allowed to take the full $2,000
Revenue and Taxation Code section corporation income and she would have
loss on the rental property under the
17041(i)(1)(B).) had only $4,000 of loss to carry forward.
special real estate allowance. (Note:
Therefore, her suspended loss carryover
All of Charles’ passive losses have been Internal Revenue and Taxation Code
from 2002 to 2003 as a resident is $4,000.
allowed for federal purposes. But since section 469(i).)
only California sourced items are
She may, however, only take her other
considered for California Taxable Income,
losses to the extent that they are offset
Charles exceeded the $25,000 passive
by gains. For California Taxable Income Continued on page 14
activity loss offset and must carry
purposes, Sierra may not offset the LLC
forward the $1,000 remaining loss for
losses against the Subchapter S
California purposes.
Corporation income because the S
Assume in 2003 (See Example 9-1B, page Corporation income is sourced to Texas,
12), Property A has a $2,000 loss, not California. Therefore, she will carry
Property B has a $1,000 loss and Property forward the entire $5,000 loss. For federal
C has $2,000 of net income. purposes, Sierra will offset the Texas S
corporation income with $1,000 of the
Even though Charles has a loss for LLC loss and carry forward the
federal purposes, he has a gain on his remaining $4,000.
California sourced property. For
California purposes, in 2003 Charles may
use his $1,000 in suspended losses from
2002 against the net income of his
California property.

Example 9-2 - 2002


Total Taxable Total Suspended CA Taxable CA
Income losses to 2003 Income Suspended
Losses to 2003
CA Rental Property ($2,000) – – –
CA LLC. ($5,000) ($4,000) ($5,000) ($5,000)
Texas S Corp $1,000 – –
Suspended Loss to
2003 $4,000 $5,000

Total ($2,000) ($4,000) ($2,000) ($5,000)


Page 14

Example 10-1A Total Taxable Income California Taxable


Section 10 2001 Income
Net operating Texas Business $7,000
losses and deductions California Business ($2,000) ($2,000)
Total $5,000 ($2,000)

Continued from page 13

The net operating loss (NOL) deduction Example 10-1B Total Taxable Income California Taxable
allowed in computing the California 2002 Income
Taxable Income of a nonresident or part- Texas Business $9,000
year resident for the portion of the year California Business ($3,000) ($3,000)
the part-year resident is a nonresident is Total $6,000 ($3,000)
no longer limited by the amount of net
operating loss from all sources. Example 10-2 Total Taxable Income
2002
For those who were always nonresidents
Nevada Business $1,000
Starting January 1, 2002, a nonresident is
California Business ($3,000)
allowed a net operating loss deduction
Total $2,000
for California Taxable Income purposes
x 60%
based upon sourced income and
Net Operating Loss, 2002 ($1,200)
deductions, regardless of whether he or
Prior Year NOL Carryover ($2,000)
she has a net operating loss in
Net Operating loss
computing Total Taxable Income.
Carryover to 2003 ($3,200)
Example 10-1: Kim is a resident of Texas
and operates two businesses – one
Example 10-3
conducts business wholly within
2002 (As if Nonresident) Total Taxable Income California Taxable
California and the other wholly without
Income
California. (Note: The two businesses are
not unitary.) In 2001 and 2002, Kim’s Nevada Business $1,000
businesses produced the following California Business ($3,000) ($3,000)
results (See example 10-1 located at the Total ($2,000) ($3,000)
top of the right column.) x 60% x 60%
Net Operating
For years prior to 2002, California law did Loss, 2002 ($1,200) ($1,800)
not allow Kim a NOL carryover for Prior Year
California Taxable Income purposes NOL Carryover ($2,000)
because Kim did not have a NOL NOL Carryover
carryover from all sources. Kim is not to 2003 ($3,200) ($1,800)
able to utilize the $2,000 loss from 2001
for California purposes in future years.
Beginning January 1, 2002, only
Example 10-3
California sourced items are considered
2003 (Nonresident) Total Taxable Income California Taxable
in determining if a taxpayer has a
Income
California NOL. For 2002, Kim has a
California NOL of $3,000. Kim may Nevada Business $5,000
carryover 60% of the $3,000 NOL, or California Business $4,000 $4,000
$1,800, to 2003 to offset her California Total $9,000 $4,000
Source Income. NOL Carryover
from 2002 ($3,200) ($1,800)
Continued on page 15
Total $5,800 $2,200

September/October 2002
Page 15

her partnership interest while she is a


nonresident, the gain or loss on the sale
would not be sourced to California,
Section 10 Section 11 unless her partnership interest had a
Net operating Basis in business situs in California. (Appeal of
losses and deductions pass-through entities Ames et al., 87-SBE-042, June 17,
1987.))
Continued from page 14 For California residents who were
A taxpayer-owner’s basis in a pass- formerly nonresidents
For California residents who were through entity (Note: Pass-through
formerly nonresidents entities include partnerships, S When a nonresident owner becomes a
corporations and LLCs that elect to be resident of California, his or her basis in
When a nonresident becomes a resident, the pass-through entity is restated under
treated as partnerships. The term
all prior year items are restated as if the California law as if the former nonresident
“owner” is used here to refer to a
taxpayer had been a California resident had been a resident for all prior periods.
partner, shareholder or member of a
for all prior years. Basis is adjusted for his or her share of
pass-through entity.) for California
Example 10-2: (see page 14) Nick moves purposes is equal to his or her flow through items, regardless of source,
to California on January 1, 2002. Prior to contributions to capital, adjusted (as generated during periods of
2002, Nick incurred $2,000 in NOL required under California law) by nonresidency.
carryovers from his Nevada business California sourced items only. Example 11-2: Brandi, from Example 11-1,
under California law. In 2002, Nick incurs becomes a resident of California on
For those who were always nonresidents
a $3,000 loss from his California business January 1, 2003. Brandi’s basis as of
and income of $1,000 from his Nevada Example 11-1: Brandi, a resident of December 31, 2002, would be restated to
business. For California purposes, Nick Nevada, invests $10,000 in Partnership Z. include all adjustments, regardless of
has a current year carryover loss of Brandi is a 50 percent partner. At the source. Her initial investment is reduced
$1,200 and may carryover $3,200 to future close of the year, the partnership had by $2,000 – 50% of the $4,000 loss
years. generated a $4,000 loss, 30 percent, or incurred by the partnership. Her
$1,200, of which is sourced to California. adjusted basis as of January 1, 2003
Example 10-3: (See page 14) Assume the
Brandi’s share of the California loss is 50 is $8,000.
same facts as Example 10-2, but Nick
percent, or $600. (Note: See Regulation
moves back to Nevada on January 1, 2003
17951-4(d) regarding sourcing of
and is full year nonresident. In 2003,
distributive shares of a multistate
Nick’s Nevada business incurs income of
partnership.)
$5,000 and his California business incurs
income of $4,000. Brandi’s adjusted basis in Partnership Z
as of December 31, 2002 is $9,400; her
To compute his 2003 California Taxable
initial investment of $10,000 less the $600
Income, Nick restates his 2002 NOLs as if
distributive share. (Note: This
he had been a nonresident for all prior
California adjusted basis is used for
years. Nick has a net operating loss
determining loss limitations while
carryover to tax year 2003 of $1,800.
Brandi is a nonresident. If Brandi sells Continued on page 16

Editor’s note:
At press time the budget (AB
2065) had not been signed.
Therefore, the examples shown
in this article do not reflect the
suspension of net operating
expenses.
Page 16

California Alternative Minimum Tax


Section 12 California Alternative Minimum Tax equals:
Alternative California Tentative Minimum Tax minus Prorated regular tax
minimum tax
California Tentative Minimum Tax
California Tentative Minimum Tax equals:
California Alternative Minimum Taxable Income multiplied by
Continued from page 15
Total Tentative Minimum Tax
AB 1115 changed the Alternative
Minimum Tax computation for
nonresidents and part-year residents to
parallel the changes in the regular tax To calculate the percentage
computation. for California: Instruction

California Alternative Minimum Tax AMT Tax Rate Divide the total tentative minimum
The California Alternative Minimum Tax tax by the total alternative
of a nonresident or part-year resident is minimum taxable income.
the amount by which the California
Total Tentative Minimum Tax
tentative minimum tax exceeds the
Total Alternative Minimum
prorated regular tax.
Taxable Income
California Tentative Minimum Tax
The California Tentative Minimum Tax is AMT Itemized Deductions Divide the California alternative
minimum tax adjusted gross income
the California alternative minimum taxable
by the total alternative minimum tax
income multiplied by a rate. The rate is
adjusted gross income.
the amount of tax on total tentative
minimum tax divided by the total Calif. Alternative Minimum Tax AGI
alternative minimum taxable income. The Total Alternative Minimum Tax AGI
computation is as follows:
The California Alternative Minimum for the year. They received $100,000 after
Taxable Income Total Alternative Minimum
Taxable Income their move to California. On October 1,
The California Alternative Minimum 2002, Rita exercised an incentive stock
Taxable Income is the alternative The Total Alternative Minimum Taxable
Income is the Alternative Minimum option valued at $90,000 for which she
minimum taxable income derived from paid $10,000 (preference amount $80,000).
California sources for any part of the Taxable Income determined as if the
nonresident or part-year resident were a The total taxable income for the year was
taxable year that the taxpayer was a $150,000. The total itemized deductions
nonresident plus California resident in the current year;
and, in all prior years for any carryovers, for the year was $20,000. Five thousand
The alternative minimum taxable income deferred income, suspended losses, or ($5,000) of the itemized deductions are
from all sources for any part of the suspended deductions. real and personal property taxes, which
taxable year that the taxpayer was a are preferences items. Their prorated
resident. Total Tentative Minimum Tax regular tax was $6,035.
The Total Tentative Minimum Tax is the
For the period of nonresidency, any tax on the Total Alternative Minimum Tax Credit Ordering – Credit for Prior Year
carryovers, deferred income, suspended Income. Alternative Minimum Tax
losses, or suspended deductions are AB 1115 clarifies that the Credit for Prior
included or allowable only to the extent Example 12-1: (See page 17) The
following example illustrates the Year Alternative Minimum Tax is applied
they were derived from California before any credit that can reduce regular
sources. computation of the alternative
minimum tax. tax below the tentative minimum tax.
(Note: Personal Income Tax – R&TC
Rick and Rita moved to California and sections 17039(a), 17039(c) and
became residents on May 1, 2002. Rick
and Rita had $170,000 in combined wages Continued on page 17

September/October 2002
Page 17

Continued from page 16 before and after the application of the


17063(c) Bank and Corporation Tax - Credit for Prior Year Alternative Minimum
R&TC sections 23036(c), 23036(d) Tax. This change resolves conflicting
Section 12: Alternative provisions in the law over whether the
minimum tax and 23453)
Credit for Prior Year Alternative Minimum
Prior to this change, taxpayers were Tax should be applied before or after
allowed to claim credits that can reduce credits that can reduce regular tax below
regular tax below tentative minimum tax the tentative minimum tax.

Example 12-1 California Alternative Minimum Taxable Income

Calculation of Rick and Rita’s 2002 California Alternative Total Alternative Minimum Tax
Minimum Tax: Itemized Deductions $15,000
Multiply $15,000 by the following ratio:
Total Alternative Minimum Taxable Income
California Alternative Minimum
Real and personal property tax preference $5,000
Tax Adjusted Gross Income $180,000
Plus: Incentive stock option preference + $80,000
Total Alternative Minimum
Plus: Total taxable income + $150,000
Tax Adjusted Gross Income $250,000
Total Alternative Minimum
Equals: .7200
Taxable Income + $235,000
.7200
Equals:
Total Tentative Minimum Tax Prorated alternative minimum tax
itemized deductions - $10,800
Total Alternative Minimum Taxable Income
$235,000
Less: Exemption amount* (-$64,152) California Alternative Minimum
$170,848 Taxable Income ($180,000 minus $10,800) $169,200
Alternative Minimum Tax rate x .07

California Alternative Minimum Tax


Total Tentative Minimum Tax $11,959
California Alternative Minimum
Taxable Income $169,200
California Alternative Minimum Tax Adjusted Gross Income
Multiply $169,200 by the following ratio:
California (regular tax) adjusted gross Total Tentative
income $100,000 Minimum Tax $11,959
Plus: Incentive stock option Total Alternative Minimum
preference amount +$ 80,000 Taxable Income $235,000
California Alternative Minimum Tax
Equals: .0509
Adjusted Gross Income $180,000
.0509
California Tentative Minimum
Total Alternative Minimum Tax Adjusted Gross Income Taxable Income
$8,612
Total Alternative Minimum Taxable
Less: Prorated regular tax - $6,035
Income $235,000
Total itemized deductions $20,000 California Alternative
Less: Real and personal Minimum Tax $2,577
property tax preference (-$5,000)
* For purposes of Example 12-1, the 2001 exemption amount
Total Alternative Minimum Tax
was used.
Itemized Deductions +$15,000

Total Alternative Minimum Tax


Adjusted Gross Income $250,000
Page 18

October 15 -- Last day to e-file state returns


Remember, you can still e-file your period, complete our fillable application many benefits of e-file and the other
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September/October 2002
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our Electronic Services Webpage at (916) 845-7070.
the Tax News Archives
www.ftb.ca.gov/elecserv/index.html. You
can also contact the program coordinator,
Tina Stiles, at (916) 845-6060 or email her
at tina.stiles@ftb.ca.gov.
Page 20

State of Missouri offers tax amnesty program


Beginning August 1, 2002, and ending eligible for the program, taxes must have and penalties and will be subject to all
October 31, 2002, individual and business been due on or before December 31, 2001, criminal and civil actions provided
taxpayers who owe the state of Missouri and cannot be pending in a civil, criminal, by law. If you or a client may have an
back taxes will have a one-time or bankruptcy court. Lien fees and bad unpaid tax liability with the State of
opportunity to pay their back taxes and check charges are not eligible for Missouri, you may apply to participate in
have interest and penalties waived. tax amnesty. the program.

During this three-month tax amnesty Taxpayers who participate in tax amnesty To download a Tax Amnesty Application,
program, all interest and penalties on must agree to comply with state tax laws or to get additional information, please
taxes owed for eligible periods will be for the next three years from the date of visit the from the Missouri Department of
waived, provided full payment of tax due, agreement. Revenue’s Web site at:
lien fees, and bad check charges is made www.dor.state.mo.us/tax, or call
Taxpayers who owe the state of Missouri (573) 751-7200.
and postmarked by October 31, 2002.
money and do not participate in the Tax
Several types of taxes are eligible for Amnesty Program will be required to pay Note: A similar measure, Senate Bill
inclusion in the tax amnesty. To be the full amount of taxes owed, interest, 1439, was considered by the California
Legislature.

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