California Tax Conformity After SB 711 and SB 1435
California substantially updated its relationship with federal income tax law through Senate Bill 711, enacted October 1, 2025, and Senate Bill 1435, enacted September 14, 2026. These laws affect how California taxpayers calculate business deductions, partnership and S corporation income, depreciation, business interest, and other items that can differ from the federal return.
The most important distinction is that California moved its general Internal Revenue Code conformity date to January 1, 2025, but did not automatically adopt the federal tax legislation enacted later that year.
Consequently, the federal tax benefits introduced by the One Big Beautiful Bill Act, Public Law 119-21, do not necessarily produce equivalent California deductions.
For business owners and high income taxpayers, these differences should be considered as part of broader proactive tax planning rather than waiting until the federal return is complete.
SB 711 Changed California's Federal Tax Conformity Date
Before SB 711, California generally referenced the Internal Revenue Code as it existed on January 1, 2015, subject to numerous modifications and later provisions separately adopted by California.
SB 711, the Conformity Act of 2025, became law on October 1, 2025.
For taxable years beginning on or after January 1, 2025, the legislation generally advances California's specified Internal Revenue Code conformity date to January 1, 2025.
The principal statutory provisions are Revenue and Taxation Code Sections 17024.5 and 23051.5, which govern the incorporation of federal income tax provisions into California personal income tax and corporation tax law.
The change allows California to incorporate additional federal provisions enacted before the new specified date, but only to the extent that California law otherwise conforms to those provisions.
California maintains numerous statutory exceptions and modifications.
Therefore, advancing the conformity date does not mean California now follows every federal tax rule enacted between 2015 and 2025.
Why California Did Not Automatically Adopt OBBBA
The One Big Beautiful Bill Act was enacted on July 4, 2025, approximately six months after California's new January 1, 2025 conformity date.
That timing is important.
California uses a specified date conformity system. Federal changes enacted after that date generally require separate California legislation before they become applicable under state law.
The federal law therefore can establish a deduction for federal income tax purposes without creating an equivalent California deduction.
This is particularly relevant for taxpayers claiming:
- 100% bonus depreciation on qualifying business property.
- Expanded federal Section 179 expensing.
- The federal Section 199A qualified business income deduction.
- New or expanded federal deductions enacted after January 1, 2025.
- Other federal tax benefits that California has not specifically adopted.
California's conformity analysis must consider both the date of the federal legislation and any California provision that expressly conforms to or departs from the federal rule.
For a broader discussion of the federal legislation, see my article on when the OBBBA tax provisions take effect.
SB 1435 Clarified California Business Interest Deductions
On September 14, 2026, California enacted SB 1435.
The legislation makes numerous technical amendments associated with the conformity changes introduced by SB 711. It also includes several substantive clarifications.
One of the most consequential provisions concerns the federal limitation on business interest deductions under Internal Revenue Code Section 163(j).
Federal Section 163(j) generally limits the amount of business interest expense that certain taxpayers may deduct.
The limitation generally involves:
- The taxpayer's business interest income.
- 30% of adjusted taxable income, as specially defined.
- Applicable floor plan financing interest.
The federal limitation is subject to important exceptions, including the small business exception and certain elections for qualifying businesses.
When the federal limitation applies, some business interest expense may be disallowed in the current year and carried forward under the applicable federal rules.
California's treatment is different.
California Does Not Apply the Federal Section 163(j) Limitation
SB 1435 amended California Revenue and Taxation Code Section 17225 to provide expressly that Section 163(j) does not apply for California personal income tax purposes.
The amendment applies to taxable years beginning on or after January 1, 2025.
California corporation tax law already contained a separate modification excluding the federal business interest limitation under Revenue and Taxation Code Section 24344.
Accordingly, California taxpayers generally must determine allowable business interest deductions without applying the federal Section 163(j) limitation.
This does not eliminate every restriction on deducting interest.
The expenditure must still satisfy the otherwise applicable requirements for deductibility, including any relevant capitalization, related party, passive activity, investment interest, or other state tax limitations.
For businesses subject to Section 163(j) federally, the difference can produce a material California tax adjustment.
Example: Business Interest Limited Federally but Not in California
Assume the following:
- A qualifying business incurs $100,000 of otherwise deductible business interest expense.
- The business is subject to the federal Section 163(j) limitation.
- The applicable federal calculation permits only $60,000 to be deducted in the current year.
- The remaining $40,000 is disallowed for federal purposes under Section 163(j).
For federal income tax purposes, the business generally deducts $60,000 and tracks the remaining $40,000 under the applicable federal carryforward rules.
For California purposes, Section 163(j) does not impose the same limitation.
If the full $100,000 otherwise satisfies California's deduction requirements, the California calculation may permit an additional $40,000 deduction for the year.
Potential current year California difference: $40,000.
This example isolates the Section 163(j) difference. The amount ultimately deductible by an individual owner may depend on partnership allocations, S corporation reporting, outside basis, at risk limitations, passive activity rules, and other applicable requirements.
A taxpayer should also maintain separate federal and California records of interest expense and carryforwards to prevent incorrect deductions when federal amounts become deductible in later years.
Partnerships and S Corporations Need Separate Calculations
The Section 163(j) difference can be important for owners of partnerships, LLCs taxed as partnerships, and S corporations.
For federal purposes, Section 163(j) contains special rules for partnerships and S corporations, including the treatment of disallowed business interest and the application of the limitation at the appropriate entity or owner level.
California's nonconformity means the federal result may not flow directly to the state return.
For example, a California Schedule K-1 may need to reflect the state treatment of business interest that differs from the federal amount.
Owners should also consider whether the entity has business activities in more than one state.
The California deduction and the amount sourced or apportioned to California are separate questions. A deduction allowed in computing total income is not necessarily fully attributable to California for a nonresident owner.
For more on these distinctions, see my discussion of California multistate taxation for business owners.
SB 1435 Also Clarified the Excess Business Loss Rules
Another important SB 1435 provision concerns excess business losses of taxpayers other than corporations.
Internal Revenue Code Section 461(l) limits the deduction of certain excess business losses by noncorporate taxpayers.
The federal rules distinguish income and deductions attributable to a trade or business from income earned as an employee.
SB 1435 clarified California's treatment of the changes made by Section 2304 of the CARES Act.
Under the clarified rule, amounts attributable to performing services as an employee are not included in determining the business income and deductions used in the excess business loss calculation.
This distinction can affect individuals who receive substantial W-2 wages while also reporting losses from partnerships, S corporations, rental activities, or sole proprietorships.
A taxpayer cannot necessarily use employment income to increase the amount of current year business losses that escape the excess business loss limitation.
California also has its own rules governing the carryforward treatment of disallowed excess business losses.
The federal and California calculations should therefore be performed separately rather than assuming that the federal limitation automatically determines the California result.
Federal Bonus Depreciation Still Does Not Apply in California
One of the largest continuing differences involves federal bonus depreciation under Section 168(k).
Public Law 119-21 restored 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025, subject to the applicable statutory requirements and limitations.
For federal purposes, qualifying businesses may deduct the full eligible cost of certain machinery, equipment, business vehicles, and other property during the year the property is placed in service.
California does not conform to the federal bonus depreciation provision.
A business claiming 100% federal bonus depreciation may therefore receive a significantly smaller California depreciation deduction for the same property.
The difference can be substantial for businesses making large capital investments.
For a detailed explanation of the federal rule, see my article on the restoration of 100% bonus depreciation.
California Section 179 Limits Remain Much Lower
Section 179 provides another important federal and California difference.
The federal deduction limits were substantially expanded under Public Law 119-21.
California did not adopt those increased federal limits.
Under California's applicable Section 179 rules, the general maximum expensing deduction remains $25,000.
The California deduction begins to phase out when the taxpayer's cost of qualifying Section 179 property placed in service exceeds $200,000.
The deduction is also subject to the applicable taxable income and property qualification requirements.
For a business purchasing substantial equipment, the California Section 179 limitation may eliminate the opportunity to expense most or all of the acquisition immediately for state tax purposes.
The remaining eligible basis generally must be recovered under the applicable California depreciation provisions.
The resulting federal and California basis differences can also affect the calculation of gain or loss when the property is eventually sold.
California Still Does Not Allow the Federal Section 199A Deduction
Internal Revenue Code Section 199A provides a federal deduction for certain qualified business income from pass through businesses, subject to the applicable requirements and limitations.
This can benefit eligible sole proprietors, partners, S corporation shareholders, and certain trust or estate taxpayers.
California does not conform to the federal Section 199A qualified business income deduction.
Accordingly, a business owner may receive a federal deduction based on qualifying pass through income without receiving an equivalent deduction on the California return.
The distinction should be considered when estimating the combined federal and California tax liability of a business owner.
It also means that the federal income tax benefit of operating through a pass through entity should not automatically be assumed to provide an identical California benefit.
Federal and California Tax Treatment: Key Differences
| Tax provision | Federal treatment | California treatment |
|---|---|---|
| General IRC conformity date | Current federal law applies according to each federal provision's effective date. | Generally January 1, 2025, for tax years beginning in 2025 or later, subject to California modifications. |
| Section 163(j) business interest | Deduction may be limited based on adjusted taxable income and other statutory factors. | Does not apply the federal Section 163(j) limitation under the applicable California statutes. |
| Section 168(k) bonus depreciation | 100% deduction available for qualifying property under the restored federal rules. | Does not conform to federal bonus depreciation. |
| Section 179 expensing | Higher federal deduction and phaseout limits apply. | Generally $25,000 maximum with a $200,000 phaseout threshold, subject to other limitations. |
| Section 199A qualified business income deduction | Available to eligible taxpayers, subject to federal requirements and limits. | Does not conform to the federal deduction. |
| Section 461(l) excess business losses | Limits certain excess business losses of noncorporate taxpayers. | Applies California modifications, including the SB 1435 clarification excluding employee service income and deductions from the business loss computation. |
This comparison addresses the principal rules affecting 2025 and 2026 planning. A particular transaction can involve additional federal and California limitations, elections, effective dates, and entity level rules.
Some California Conformity Changes Are More Favorable
California's updated conformity legislation does not simply reject federal provisions.
SB 711 also brought portions of California law into closer alignment with federal rules enacted before January 1, 2025.
For example, California modified its treatment of alimony for certain divorce or separation agreements.
For qualifying agreements executed after December 31, 2025, California generally follows the federal treatment under which alimony payments are not deductible by the payor and are not included in gross income by the recipient.
Similar treatment may apply to certain earlier agreements that are modified after December 31, 2025, when the modification expressly adopts the applicable new rules.
Agreements governed by older provisions can continue to receive different treatment.
This illustrates why the correct analysis requires identifying the specific California statutory modification and its effective date, not merely reviewing the general conformity date.
Why These Differences Matter for 2025 California Returns
Although SB 1435 was enacted in September 2026, its principal conformity amendments apply to taxable years beginning on or after January 1, 2025.
That timing is particularly relevant for taxpayers preparing or reviewing their 2025 California returns during October 2026.
For most calendar year individual taxpayers who obtained a valid filing extension, October 15, 2026, is the general extended deadline for filing the 2025 federal and California individual income tax returns.
Different deadlines may apply to particular entities or taxpayers eligible for disaster relief or other filing postponements.
A 2025 California return involving business interest expense or an excess business loss should reflect the enacted California rules rather than an earlier interpretation of the conformity legislation.
For returns already filed, a material difference should be evaluated to determine whether the existing California return remains correct and whether an amended return is appropriate.
The conclusion depends on the facts, amounts involved, current law, and applicable limitation periods.
Separate Federal and California Tax Basis Records Remain Necessary
California nonconformity creates differences that can continue for many years.
The most common example involves depreciable property.
If a business deducts the entire cost of qualifying property federally but recovers the cost over several years for California purposes, the property's adjusted federal tax basis and adjusted California tax basis will differ.
A later sale or disposition can therefore produce different federal and California taxable gains.
Similar tracking issues can arise with:
- Federal business interest expense carryforwards.
- Excess business losses.
- Net operating loss carryovers.
- Partnership outside basis.
- S corporation stock and debt basis.
- Depreciation recapture.
- Other deductions recognized in different tax years.
The business or its owners should maintain sufficient records to reconcile the federal and California treatment throughout the period in which the difference remains relevant.
This is particularly important when an ownership interest or business asset is sold, because historical basis adjustments may become material to the final tax calculation.
California PTE Elective Tax Planning Remains Separate
California's pass through entity elective tax provides another planning opportunity that should be coordinated with federal and California conformity differences.
The elective tax can allow qualifying entities to pay specified California income tax at the entity level and provide an associated California tax credit to consenting qualified taxpayers.
The potential federal benefit depends on the applicable treatment of qualifying entity level state income taxes, including the principles addressed in IRS Notice 2020-75.
California extended the PTE elective tax for taxable years beginning in 2026 through 2030 and modified the treatment of certain late or insufficient June payments.
The election, payment requirements, credit calculation, and availability of federal deductions must be analyzed separately from the underlying California adjustments for depreciation or business interest.
For more information, see my article on California PTE tax payment rules beginning in 2026.
Business Owners Should Review Their 2026 Tax Projections
The difference between federal and California taxable income can materially affect estimated tax payments and year end planning.
An owner who expects a substantial federal deduction from equipment purchases, business interest, or qualified business income should determine whether the same deduction is available for California purposes.
The review should address:
- Federal and California depreciation deductions for property placed in service during 2026.
- Separate Section 179 limitations and elections.
- Business interest expense and the federal Section 163(j) calculation.
- Any California adjustment resulting from SB 1435.
- Excess business loss limitations and carryovers.
- Partnership and S corporation California Schedule K-1 reporting.
- California PTE elective tax payments and credits.
- Other state income tax obligations and available credits.
- Estimated tax payments and potential underpayment penalties.
The objective is to calculate the combined federal and California tax consequences of a transaction before relying on a projected deduction.
For a business considering substantial expenditures, the optimal tax result may differ from the result suggested by the federal deduction alone.
Final Takeaway
California's federal tax conformity rules have changed materially since the original OBBBA legislation was enacted.
SB 711 advanced the general conformity date to January 1, 2025, while preserving numerous California modifications and exceptions.
SB 1435 subsequently clarified important provisions, particularly California's nonconformity to the federal Section 163(j) business interest limitation and the treatment of excess business losses.
At the same time, California continues to reject major federal tax benefits, including 100% bonus depreciation, the expanded federal Section 179 limits, and the Section 199A qualified business income deduction.
The practical consequence is that federal taxable income and California taxable income can differ substantially for the same taxpayer and the same transaction.
Business owners should evaluate these differences when preparing 2025 returns, projecting 2026 taxes, considering major equipment purchases, or planning a future business transaction.
