I have selected a few CA self-employed clients with a bit of skin in the game, for whom I propose to file amended California returns requesting refund of the CA income tax resulting from the CA adjustment taken to the federal above-the-line deduction for a portion of self-employment tax. My argument is set out in the following (all suggestions for improvement will be welcome):
"Form 540X (2011)
Line 2e Details
On the original return, a California adjustment was applied by the tax preparation software to reduce the federal adjustment for self-employment tax. In a “Tax News” bulletin dated March 2, 2012, FTB references Legal Division Guidance 2012-02-01 and represents:
“The federal 2010 Tax Relief Act increased the amount of self-employment tax that may be deducted in computing federal adjusted gross income. California has not conformed to this change. For state income tax purposes, taxpayers may only deduct 50 percent (50%) of the self-employment tax paid in computing state adjusted gross income.”
Taxpayer and preparer believe this California adjustment to be based on an incorrect reading of the federal tax law and to be unsustainable on its face. In fact, the 2010 Tax Relief Act did NOT change the amount of self-employment tax that may be deducted in computing federal adjusted gross income by a single penny! It remains what it has been for a number of years - the employer's share of the self-employment tax, equal to 7.65% per cent of income subject to SE tax, up to the Social Security limit, and 1.45% for income beyond the limit - to which California has conformed until now. All that has changed is the method of calculation. This change in calculation method was necessitated by a decrease in the Employee's share of self-employment tax. Had the change not been made, the federal adjustment would actually have decreased, which was not the intent of the law passed by Congress. Calculation of the adjustment from the self-employment tax paid is strictly a computational convenience; it could equally well have been calculated directly from the taxpayer's self-employment income, in which case it would be self-evident that no change has taken place.
Since the amount of the federal adjustment remains the same, there is nothing new to which California can conform or not conform. Rather, the FTB has abrogated California's conformance to the adjustment and has, in effect, imposed an additional “stealth tax” on self-employment income. It has done this on its own initiative and authority. With due respect, we do not believe that the Board has such authority.
We respectfully request not only that the FTB approve removal of the California adjustment in our amended return, but that it also recognize publicly the invalidity of its position and instruct software providers to remove this adjustment from further versions of their software."
The FTB has introduced this adjustment by stealth in the middle of the tax season -- they have bullied the software providers into including it in later versions of their software. The board is clearly counting on the fact that it is such a small item that most people won't even notice, and those that do won't consider it worth their while to make a fuss. This kind of behavior ill-becomes the taxing authority of one of the world's largest economies.
The legal principal here is "Obsta principiis." -- "Resist beginnings." There is obviously no money in this for anyone -- it is a question of preserving the honor of the profession. I invite and challenge all California preparers to join me in this project.
"Form 540X (2011)
Line 2e Details
On the original return, a California adjustment was applied by the tax preparation software to reduce the federal adjustment for self-employment tax. In a “Tax News” bulletin dated March 2, 2012, FTB references Legal Division Guidance 2012-02-01 and represents:
“The federal 2010 Tax Relief Act increased the amount of self-employment tax that may be deducted in computing federal adjusted gross income. California has not conformed to this change. For state income tax purposes, taxpayers may only deduct 50 percent (50%) of the self-employment tax paid in computing state adjusted gross income.”
Taxpayer and preparer believe this California adjustment to be based on an incorrect reading of the federal tax law and to be unsustainable on its face. In fact, the 2010 Tax Relief Act did NOT change the amount of self-employment tax that may be deducted in computing federal adjusted gross income by a single penny! It remains what it has been for a number of years - the employer's share of the self-employment tax, equal to 7.65% per cent of income subject to SE tax, up to the Social Security limit, and 1.45% for income beyond the limit - to which California has conformed until now. All that has changed is the method of calculation. This change in calculation method was necessitated by a decrease in the Employee's share of self-employment tax. Had the change not been made, the federal adjustment would actually have decreased, which was not the intent of the law passed by Congress. Calculation of the adjustment from the self-employment tax paid is strictly a computational convenience; it could equally well have been calculated directly from the taxpayer's self-employment income, in which case it would be self-evident that no change has taken place.
Since the amount of the federal adjustment remains the same, there is nothing new to which California can conform or not conform. Rather, the FTB has abrogated California's conformance to the adjustment and has, in effect, imposed an additional “stealth tax” on self-employment income. It has done this on its own initiative and authority. With due respect, we do not believe that the Board has such authority.
We respectfully request not only that the FTB approve removal of the California adjustment in our amended return, but that it also recognize publicly the invalidity of its position and instruct software providers to remove this adjustment from further versions of their software."
The FTB has introduced this adjustment by stealth in the middle of the tax season -- they have bullied the software providers into including it in later versions of their software. The board is clearly counting on the fact that it is such a small item that most people won't even notice, and those that do won't consider it worth their while to make a fuss. This kind of behavior ill-becomes the taxing authority of one of the world's largest economies.
The legal principal here is "Obsta principiis." -- "Resist beginnings." There is obviously no money in this for anyone -- it is a question of preserving the honor of the profession. I invite and challenge all California preparers to join me in this project.
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