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Heading Off a Tax Headache

January 30, 2002

California taxpayers with retirement accounts may be in for a nasty surprise unless the Legislature steps lively to conform state tax law with recent changes in federal law. If the state fails to act, it may penalize those who take advantage of the new liberal limits set by the federal government for contributions to individual retirement accounts, 401(k) accounts and similar plans.

There is some foot-dragging in the Legislature because of the cost of making the change while the state faces a $12.4-billion deficit. But the cost is only an estimated $44 million--an amount that could easily be offset by closing one or more of the many loopholes in California's Swiss-cheese tax law.

Federal law was changed last year to boost the limits on tax-deferred contributions to 401(k) retirement savings plans, individual retirement accounts, education IRAs and other programs. Despite the problems with 401(k)s that were brought to light in the Enron bankruptcy, they are popular with workers and here to stay. Though reforms are needed, government should do what it can to encourage and increase their use.

The federal change also allowed people 50 years old or older to make "catch-up" contributions to their retirement plans. But state law is stuck on the old federal limits. Without conformity, those who take advantage of the higher federal limits could face a bigger state income tax bill or penalties for exceeding the state limits.

There are bills in the Legislature that would adopt some but not all of the federal limits. Government should be making it as easy as possible to save, especially since fewer and fewer employers offer old-style pension benefits.

Even beyond retirement accounts, the state should make its tax laws as similar as possible to the federal system to simplify the job facing tax filers. State forms now are far more complicated than necessary.

By closing odd loopholes such as the business deduction the state offers for club memberships, Sacramento could pick up enough revenue to cover the loss from conforming retirement plan rules.

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