Introduction

Numerous updates have occurred in the regulatory landscape pertaining to California taxpayers and litigants in the tax arena. Care must be taken to ensure compliance with these new requirements. Also note that the cases below indicate increasing focus by Treasury on high-stakes, highly technical disputes, with both substantive and technical rigor paramount. These will be discussed in more depth below.

Legislative Update – SB 711; California New Tax Law: Rates, Credits, and Filing Rules - LegalClarity

California updates its Internal Revenue Code (IRC) conformity date

California updated its IRC conformity date. For taxable years beginning on or after 1 January 2025, California’s personal income tax law conforms to the IRC as enacted on 1 January 2025, pursuant to Cal. Rev. & Tax. Code § 17024.5(Q). This represents a meaningful change from the prior conformity date of 1 January 2015, which had governed taxable years 2015 through 2024, and it will affect a broad range of deductions, credits, and exclusions. Note, however, that California continues to decouple from various changes in the federal Tax Cuts and Jobs Act (TCJA) and has not conformed to the changes made by the “One Big Beautiful Bill Act” (OBBBA), enacted on 4 July 2025.

Key federal tax changes adopted in California

Some federal changes that California does conform to include:

• limitation of IRC Section 1031 expenses to real property only;
• deductions for IRA contributions for taxpayers age 70½ and older and increased deductions for catch-up contribution amounts;
• treatment of alimony; and
• limitations on gain exclusion for sale of stock to an employee stock ownership plan for tax years beginning after 1 January 2028.

Federal provisions from which California continues to decouple

Some federal changes that California continues to decouple from include:

• business interest expense limitation under IRC Section 163 (j);
• changes to the corporate alternative minimum tax;
• qualified business interest deduction under IRC Section 199A;
• IRC Section 174 relating to amortisation of research and experimental expenditures, instead following the provision as it was stated in 2015;
• federal limit on miscellaneous itemised deductions under IRC Section 67; and
• USD750,000 cap on mortgage interest expenses.

Further California conformity updates expected

California legislature has cited the over 1,000 changes in federal tax law since the state last updated its conformity rules and further conforming rules will be addressed at a later session.

OTA’s Authority in Appeals ‒ Putting Regulations to the Test: California Taxpayers Cleared to Challenge Regulations in OTA Appeals, Pillsbury SeeSalt Blog (JDSupra); Office of the California Attorney General, Opinion No 23-701,31 July 2025

In this opinion, the California Attorney General concluded that the Office of Tax Appeals (OTA) has the authority, when deciding a taxpayer appeal, to evaluate whether applying a tax regulation to a particular taxpayer would conflict with the governing statute, and, if they are conflicting, to decline to apply that regulation in that specific case. However, the OTA’s authority is limited:

• it must afford appropriate deference to the issuing authority;
• it cannot invalidate or repeal a regulation generally or remove it from the California Code of Regulations; and
• its determinations apply only within the context of the specific taxpayer appeal.

The Opinion explains that its authority derives from its predecessor, the State Board of Equalization, which allowed taxpayers to raise statutory, but not constitutional, objections to tax regulations. In the Opinion the AG determined that neither the Administrative Procedure Act (APA) nor the California Constitution prohibits the OTA from following this course. Notably, the Opinion mentions in a footnote that the OTA could expand its jurisdictional rules to also permit a Constitutional challenge to a tax regulation. The Opinion alerts taxpayers that the OTA is clearly a forum for challenging regulations which go beyond the scope of a statute and that raising such an argument at the time of an OTA appeal may be necessary to preserve them for review in a judicial setting.

Note that this Opinion appears to be consistent with the recent US Supreme Court case, Loper Bright Enterprises v Raimondo, (US 2024), limiting the authority of administrative agencies (such as those which issue regulations). In Loper, the Supreme Court held that the APA requires courts to exercise independent judgement as to whether an agency has acted within its statutory authority and courts may not defer to an agency’s interpretation of a statute merely because it is ambiguous. (Loper Bright at pp 7-35). Article III of the Constitution assigns to the judiciary the obligation and power to adjudicate “cases and controversies” as held by the seminal case of Marbury v Madison. As Chief Justice Marshall said there, although due respect must be given to administrative agencies, it is “emphatically the province and duty of the judicial department to say what the law is.” This is consistent with the recent Opinion discussed above, affording redress when a regulation is arguably inconsistent with a statute. The Opinion notes that the OTA may afford a more practical avenue to address such an inconsistency rather than having to resort to judicial procedures on each occasion. It is consistent with Loper Bright in reinforcing that administrative agencies may not issue regulations that are inconsistent with a statute, as the role of each branch of government must be respected.

PACE Assessments and the Exhaustion of Tax Remedies

The most significant California Supreme Court decision of 2025 on tax procedure is Morgan v Ygrene Energy Fund, Inc., 18 Cal.5th 1061 (2025). In Morgan, the Court held that homeowners challenging Property Assessed Clean Energy (PACE) loans ‒ which are collected as property tax assessments ‒ must follow the statutory “pay first” framework before bringing civil claims, including claims under the Unfair Competition Law (UCL) against private companies. (See Rev. & Tax. Code Sections 5097, 5140; see generally Steinhart v Co. of Los Angeles, 47 Cal. 4th 1298 (2010)). The Court applied a functional test: because the homeowners' claims effectively sought to invalidate the underlying PACE assessments, they were required to pay the assessments and then seek refunds under Cal. Rev. & Tax. Code §§ 5096 and 5097 Morgan v Ygrene Energy Fund, Inc., 18 Cal.5th 1061 (2025). The plaintiffs argued that they had not appreciated the risks of foreclosure and alleged that the PACE administrators failed to comply with licensing requirements. In particular, they contended that payments were made directly to contractors rather than by joint cheque to the homeowners and contractors, as they alleged was required by the Business and Professions Code Section 7159.2. The Court clarified that this rule applies whether the tax challenge is direct or indirect, and it extends even when the defendant is a private party rather than a government taxing authority. However, the Court also made an important distinction: claims seeking relief unrelated to the tax obligation itself ‒ such as challenges to the administration of the PACE loan – are not subject to the tax exhaustion requirement. The case was remanded for the trial court to consider whether plaintiffs should be permitted to amend their complaints to plead only claims that do not implicate the tax assessment obligation.

Residency Cases

In 2025, several cases addressed taxpayer residency. In the two cases highlighted below, the OTA’s decisions highlight the analysis used to determine residency and underscore that a taxpayer’s home (for purposes of determining residency) is not necessarily where the heart is, but rather, determined based on the totality of objective facts, with significant emphasis on physical presence.

Objective facts and physical presence support California residency

In Matter of Peters, 2025-OTA-489 (Cal. OTA, issued 27 June 2025), the taxpayer, a Canadian-born entertainer, owned homes in both Nevada and California and maintained Nevada business ties, but his family life and substantial time were centred in California. After he filed California non-resident returns for 2012–2014, the Franchise Tax Board (FTB) determined he was a California resident and issued assessments. In reaching this conclusion, the FTB reconstructed the taxpayer’s physical presence using his personal credit cards, finding that he spent significantly more time in California than in Nevada.

The OTA evaluates residency by first determining domicile and then considers whether any absence is temporary or transitory, based on objective factors.

Here, the taxpayer argued that his Nevada business ties, homeownership, and Nevada driver’s licence demonstrated that he was not a California resident. The OTA rejected these arguments, finding that the existence of a familial abode in California and the taxpayer’s significant physical presence in the state established that he was domiciled in California.

The OTA further found his time outside California was temporary by conducting a multi-factor analysis, examining the taxpayer’s: (i) registrations and filings; (ii) personal and professional associations; and (iii) physical presence and property. 

Although the taxpayer was a foreign citizen with an out-of-state driver’s licence, owned property and vehicles outside California, and maintained Nevada business entities, his familial ties, California properties, and substantial physical presence in California outweighed those factors and supported a finding of California residency.

Insufficient physical presence to establish reservation residency

Likewise, in R. Garcia & M. Garcia, OTA Case No 20076335 (Cal. Off. Tax App. 2026), the OTA considered whether the taxpayer, a member of the San Manuel Band of Mission Indians, resided on the San Manuel Indian Reservation (Reservation) during the years at issue.

As in Peters, the OTA evaluated physical presence and objective connections to determine residency.

The OTA found that the taxpayer did not provide sufficient evidence of any significant physical presence on the Reservation during the years at issue. Although the taxpayer asserted that the Reservation was his domicile and principal residence, the record lacked concrete support such as dates, travel records, or corroborating testimony. Instead, the evidence indicated he spent the vast majority of his time in New York as a full-time student, with only brief and unclear visits elsewhere.

Additional factors also failed to establish residency on the Reservation:

• most property interests were located off the Reservation;
• business activities were centred in New York and Los Angeles;
• and tax filings and vehicle registrations reflected mixed ties.

While his personal and tribal affiliations were significant, they did not clearly favour any single location. Overall, the record did not demonstrate that the taxpayer had his closest connections on the Reservation, which is necessary to qualify for the claimed tax exemption.

As such, the OTA found that the taxpayer failed to meet his burden to show that he resided on the Reservation, emphasising his time, business, and property interests were primarily centred off-reservation.

Compensation-Related Decisions 

In late 2024 and 2025, several decisions addressed the taxation of different forms of compensation. These cases showcase the tax implications that various forms of compensation can have – whether within or outside of the ordinary course of business. 

Matter of Hall

In Matter of Hall, 2025-OTA-113 (Cal. OTA, issued 13 December 2024), the taxpayer lived and worked in California through 2013, where he earned stock-based compensation (NSOs and RSUs) from his employer, Monster Beverage Company, before relocating to Hawaii in 2014. After exercising the options and receiving stock awards in 2014, the taxpayer and his spouse reported no California-source income, arguing that the income realised from the NSOs and RSUs was not subject to California’s tax because they were non-residents at the time of exercise and vesting.

The FTB disagreed, asserting the income was attributable to services performed in California, and the OTA affirmed. The OTA held that NSOs and RSUs are treated as compensation for personal services, with income recognised upon exercise (NSO) or vesting (RSUs), and that California may tax non-residents on the portion of such income tied to services performed in the state, even if recognised after moving away.

Because the underlying services were performed in California, the income was California-source. The OTA also endorsed the use of a reasonable apportionment method (eg, a working-day ratio) to source such compensation to California.

In re Levandowski

In In re Levandowski, 668 B.R. 308 (2025), the bankruptcy court addressed the taxation of a USD179 million payment made by Uber directly to Google (“Google Judgment”) in connection with the resolution of claims for breach of fiduciary duty, misappropriation of trade secrets, and related misconduct brought against former Google engineer Anthony Levandowski. Google claimed that while employed by Google, Levandowski misused Google’s confidential information to compete with Google in the autonomous vehicle industry, including the formation of Ottomotto LLC, which was later acquired by Uber. Levandowski resigned from Google in January 2016, shortly before Uber’s acquisition of Ottomotto. 

Google initiated arbitration against Levandowski regarding his alleged breaches of fiduciary duty and contract. The arbitration resulted in the Google Judgment. Subsequently, Levandowski filed for Chapter 11 bankruptcy. He then initiated litigation against Uber, asserting that Uber was obligated to satisfy the Google Judgment pursuant to an indemnification agreement. This resulted in Uber providing a payment to Levandowski of USD2 million and, as part of a broader settlement among Levandowski, Uber, and Google, Uber also agreed to make a substantially larger payment directly to Google to partially satisfy the Google Judgment.

The court found that the payment constituted gross income to Levandowski, and was not excludable. It reasoned that the payment was made pursuant to the Settlement Agreement (despite the existence of an indemnification agreement) and was therefore not analogous to insurance or otherwise excludable from income. Accordingly, because the payment satisfied Levandowski’s personal liability under the Google Judgment, it constituted income to him notwithstanding that the funds were paid directly to Google.

Utility Property Unitary Taxation – A Multi-County Litigation Wave

In 2025, there was a wave of co-ordinated litigation across numerous counties by utility companies challenging the validity of California Revenue and Tax Code, Section 100(b), which articulates tax rate assessments for utility companies and the like across the state. See Pac. Bell Tel. Co. v County of Ventura (2025) 114 Cal.App.5th 755 (Second District); Pac. Bell Tel. Co. v County of Riverside (2025) 114 Cal.App.5th 717 (Fourth District); Pac. Bell Tel. Co. v County of Napa (2025) 112 Cal.App.5th 952 (First District); Pac. Bell Tel. Co. v County of Placer (2025) 111 Cal.App.5th 634 (Third District); Pac. Bell. Tel. Co. v County of Merced (2025) 109 Cal.App.5th 844 (Fifth District). Specifically, these companies challenged Section 100 as imposing an unconstitutional “gross in lieu” tax which should be comparable to other local taxes as imposed on real property. See Ventura, 114 Cal.App.5th at 767-68 (citing ITT World Comm., Inc. v City and Cnty. of San Francisco (1985) 37 Cal.3d 859, 811); id. at 768-72 (discussing the statutory interpretation of Cal. Const. Article 13, § 19); id. at 772-74 (discussing the statutory interpretation of Cal. Const. Article 13, § 1). The courts disagreed and uniformly rejected the utilities’ constitutional claims. Id. at 767-74 (citing Merced, 109 Cal.App.5th at 856; Napa, 112 Cal.App.5th at 964). 

The courts held that the statute ‒ which requires that utility property be subject to taxation “to the same extent and in the same manner as other property” – does not mandate identical tax rates between utility and common property. Id.; see also id. at 772 (“We agree […] that ‘the purpose of Article XIII, Section 19 had nothing to do with mandating equal tax rates, but instead was to restore public utility values to the local tax rolls and alleviate the local tax burden.’” (quoting Cnty. of Santa Clara v Superior Ct. (2023) 87 Cal.App.5th 347, 368) (cleaned up)).

The appellate courts recognised the significant tax burden placed on the utility companies. Id. at 774 (“We acknowledge the overarching concern Appellants and their amici express regarding alleged disparately higher property tax rates on utility property[.]”); Merced, 109 Cal.App.5th at 867 (“We note appellants’ policy arguments against what they allege is […] disproportionate taxing of utilities.”); cf. Napa, 112 Cal.App.5th at 991 (Tucher, P.J., dissenting) (finding “the constitutional test unequivocal [ …]. It does not allow, or enable, taxation at double the rate of common property.”). But still, the stood firm that this remains “a policy question for the legislature, not a constitutional question for courts.” Riverside, 114 Cal.App.5th at 754 (Raphael, J., concurring).

Given the number of such cases and their dismissal at an early stage of litigation, they are strong candidates for California Supreme Court review.

Replacement Property

Another recent case demonstrates California’s tax impacts on its steeply rooted agricultural economy. In Skouti v Franchise Tax Bd. (2025), 108 Cal.App.5th 841, the appellate court dissected the limits of Section 1033, which “permits nonrecognition of gain from involuntarily conversions of property in certain circumstances.” Id. at 845 (emphasis added). As the court explains, one of those limits is whether the replacement property is “similar or related in service or use to” the original property. Id. (citing 26 U.S.C. § 1033). Where the replacement property is an agricultural fixture that is an improvement to the land, the replacement property is not sufficiently similar to reap the tax benefit upon which the original property sowed. Id. at 848.

In Skouti, the plaintiff’s original property consisted of grape vines killed by chemical pesticides. Id. at 844. The plaintiff sued its pesticide provider and prevailed. Id. Using over USD3 million of its awarded damages, plaintiff reinvested in mature citrus orchards, not premature grape vines. Id. Both the trial and appellate court determined that these were not a “substantial continuation” because the losses accounted for the time, effort, and investment required to plant seedlings as opposed to mature grapevines. Id. at 846-47. It was not an issue of converting apples ‒ or grapes ‒ to oranges; rather, it was whether the benefit received from the original property was of equal, lesser, or greater value than the replacement property.

To reap the benefit of Section 1033, special care should be given to the nature of the previous and new investment to avoid any unintended consequences.