Proposition 26, which passed on November 2 in California, may inadvertently subject Treasury cash grants on renewable energy projects to taxes in California unless the state legislature votes by November 2, 2011 to waive the taxes.

It is unclear whether grants paid before November 2, 2011 would become taxable.

The state Franchise Tax Board concluded last year that the grants are taxable in California even though they are not taxable at the federal level.

California starts with a federal definition of taxable income for calculating California taxes. However, it has not conformed its tax code fully to recent changes in the US tax laws. Every so often it pushes the conformity date forward. The legislature voted in April this year to conform to federal treatment of Treasury cash grants.

Proposition 26 requires a two-thirds vote for tax increases, including fees and other charges. Unfortunately, the bill with the conformity language on Treasury cash grants also included some tax increases, and it did not have a “severability” clause allowing the conformity provisions to stand if the rest of the bill is negated.

It is unclear what this means for grants that have already been paid. The proposition says the following: “Any tax adopted after January 1, 2010, but prior to the effective date of this act, that was not adopted in compliance with the requirements of this section is void 12 months after the effective date of this act unless the tax is reenacted by the Legislature and signed into law by the Governor in compliance with the requirements of this section.” The act is effective on November 2, 2011.

One issue the state attorney general and legislative counsel’s office in the state legislature must consider is what it means to say a tax is “void” 12 months from now unless properly reenacted.

A California Supreme Court decision in 2006 suggests that the wording used in the proposition—that a law will be “void” on a future date unless properly reenacted—should be treated as a sunset clause where the statute is valid until the sunset date as opposed to being void from inception.

Keith Martin