Did a bank have to include its federal IRC section 1397E Qualified Zone Academy Bond credit in California franchise-tax income?

Plain-English summary

California Chief Counsel Ruling 20-0322 concluded that a bank did not include its federal Qualified Zone Academy Bond credit in California franchise-tax income.

Federal law granted an eligible holder a credit under IRC section 1397E and required the credit amount to be included in federal gross income.

California had not incorporated section 1397E into its Bank and Corporation Tax Law. The federal credit did not offset California franchise tax, and California law contained no provision adding the federal credit amount to state income.

The transaction

The redacted bank bought Qualified Zone Academy Bonds at a discount.

The bonds provided federal tax credits and benefits under IRC section 1397E, and the request stated that the bank qualified as an eligible taxpayer.

Section 1397E(g) required the bank to include the allowed credit in federal gross income.

Why California did not include the credit

FTB identified three linked points:

• California's Bank and Corporation Tax Law did not incorporate IRC section 1397E.
• The federal credit did not reduce or offset the bank's annual California franchise tax.
• California law did not separately require the federal credit amount to be included in California income.

Because the federal provision was not incorporated and no state inclusion rule applied, FTB did not carry the federal gross-income amount into California franchise-tax income.

Holding

The bank was not required to recognize the federal section 1397E credit as income for California franchise-tax purposes.

Important limits

The ruling addressed only income determined under section 1397E(g).

FTB expressly did not address the original-issue-discount rules or any other tax consequence of purchasing or holding the Academy Bonds.

The conclusion was limited to the named bank, the submitted facts, and the law then in effect.

What this means for you

Banks and financial institutions

A federal credit's inclusion in federal gross income did not automatically create California income under this ruling. The state conformity and state-specific inclusion rules had to be examined separately.

Bond accounting teams

Track the credit, any discount on acquisition, and other bond-related items separately. This ruling resolved only the credit-inclusion question.

Tax professionals

Do not extend the holding to original-issue discount, basis, timing, or other consequences that FTB expressly left open.

Common questions

Q: Did the federal Academy Bond credit reduce California franchise tax?

A: No. The ruling said the federal credit did not reduce or offset the annual California tax.

Q: Why was the federal credit included in federal income?

A: IRC section 1397E(g) required inclusion of the allowed credit amount.

Q: Why was the same amount excluded from California income?

A: California had not incorporated section 1397E and had no separate provision including that credit amount.

Q: Did FTB rule on the bonds' original-issue discount?

A: No. Original-issue-discount treatment and other tax consequences were expressly outside the ruling.

Key source language

• Federal rule: “Internal Revenue Code section 1397E(g) requires the taxpayer to include in gross income the amount of the credit allowed under Internal Revenue Code section 1397E.”
• California conformity: “The California Bank and Corporation Tax Law does not incorporate Internal Revenue Code section 1397E into the Revenue and Taxation Code.”
• Holding: “**** is not required to recognize as income for California franchise tax purposes the amount of federal tax credit it is allowed under Internal Revenue Code section 1397E.”
• Scope limit: “This chief counsel ruling specifically does not address application of the original issue discount rules or any other tax consequences of this transaction.”

Citations and references

• I.R.C. § 1397E, including § 1397E(g)
• Cal. Rev. & Tax. Code § 21012(a)(1)

Source

• Landing page: Chief Counsel Ruling index
• Official ruling: Chief Counsel Ruling 20-0322
• Identifier check (2026-10-07): this February 23, 2001 PDF prints “Chief Counsel Ruling 20-0322.” A distinct May 3, 2001 ruling prints the same number.

Original ruling text

STATE OF CALIFORNIA
KATHLEEN CONNELL
FRANCHISE TAX BOARD
Chair
Legal Branch
CLAUDE PARRISH
PO Box 2229
Member
Sacramento, CA 95812-2229
(916) 845-3307 Fax (916) 845-3191
B. TIMOTHY GAGE
Member

February 23, 2001
Chief Counsel Ruling
20-0322

Re: ****

Dear ***:

This chief counsel ruling is issued in response to your ***, request on behalf of your client, **** (the "Bank"), and pertains only to that entity.

In your request, as supplemented by a clarifying letter dated **, you note that the Bank purchased, at a discount, Qualified Zone Academy Bonds ("Academy Bonds") with an aggregate principal amount of ***. You stated that the Academy Bonds provided certain federal tax credits and benefits as set forth in Internal Revenue Code section 1397E, and that the Bank qualifies as an eligible taxpayer for such benefits. You also noted that Internal Revenue Code section 1397E(g) requires the taxpayer to include in gross income the amount of the credit allowed under Internal Revenue Code section 1397E.

ISSUE

Will the Bank be required to recognize as income for California franchise tax purposes the amount of federal credit allowed for federal income tax purposes under Internal Revenue Code section 1397E ?

DISCUSSION

Internal Revenue Code section 1397E provides an eligible taxpayer who holds an Academy Bond with a federal income tax credit in the amount determined in subsection (b) of that section. The California Bank and Corporation Tax Law does not incorporate Internal Revenue Code section 1397E into the Revenue and Taxation Code. The annual California franchise tax on banks, financial corporations, or corporations is not reduced or offset by the federal tax credit provided by the provisions set forth in Internal Revenue Code section 1397E. The California Bank and Corporation Law does not contain a provision that includes in a California taxpayer's income the amount of credit allowed by Internal Revenue Code section 1397E.

Page 2

February 23, 2001
Page 2

HOLDING

**** is not required to recognize as income for California franchise tax purposes the amount of federal tax credit it is allowed under Internal Revenue Code section 1397E.

Please be advised that the tax consequences expressed in this letter are applicable to the named taxpayer only and are based upon and limited to the facts submitted. Moreover, this chief counsel ruling specifically does not address application of the original issue discount rules or any other tax consequences of this transaction. You specifically confirmed with me that your request was not addressing any income other than the income that would be determined by the provisions of Internal Revenue Code section 1397E(g).

In the event of a change in relevant statutory, judicial, or administrative case law, a change in federal interpretation of federal law in cases where our opinion is based upon such interpretation, or a change in the material facts or circumstances relating to your request upon which this opinion is based, this opinion may no longer be applicable. It is your responsibility to be aware of these changes should they occur.

This letter is a legal ruling by the Franchise Tax Board’s Chief Counsel within the meaning of Revenue and Taxation Code section 21012, subdivision (a)(1). Please attach a copy of this letter and your request to the back of the appropriate return(s) (if any) when filed or any notices or inquiries which might be issued.

Very truly yours,

David Gemmingen
Tax Counsel III