Background
Governor Gavin Newsom submitted his 2021-22 State Budget proposal to the Legislature on January 8. Overall, it anticipates $227.2 billion in funding for California’s upcoming fiscal year, with specific allocations for immediate COVID-19 response and relief while making investments with tax credits, grants, and loan funding intended to spur an economic recovery.
Overview
The section of the Budget Proposal entitled Equitable and Broad-based Recovery proposes a recovery package of $14 billion to support businesses, individuals and job creation during the pandemic and to help California recover. Specific items of the Proposal include:
Mitigation of SALT deduction for S Corporation shareholders. The budget contains a provision that would allow S-corporations to elect for S-corporation taxable income be taxed at the S-corporation level while providing S-corporation shareholders a tax credit equal to 13.3% of their s-corporation income. As such, we would expect that S-corporation level California income taxes would be fully deductible by S-corporations for federal income tax purposes and federal deductions for California income taxes incurred by S-corporations would added back to federal taxable income on S-corporation shareholders’ California personal income tax returns, with a tax credit provided to the S-corporation shareholders for 13.3 percent of California S-corporation taxable income. Please note that on January 5, Democratic members of the California Senate and Assembly introduced SB 104 that would similarly establish an elective pass-through entity (PTE) level tax for both S-corporations and certain partnerships and allow owners of these electing PTEs an exclusion for pass-through income. We expect modifications as SB 104 goes through the legislative process. We will continue to monitor SB 104 and similar legislation and plan to provide updates as significant changes are made.
Increased funding for the Small Business Grant program that was announced in November 2020. Initially funded for $500 million, the program would receive an additional $550 million in the 2021/2022 fiscal year. The Program gives grants up to $25,000 to small businesses ($2.5 million or less in 2019 gross receipts), with an emphasis on helping businesses in underserved areas and that are minority-owned or female-owned.
Increased funding for the California Competes Tax Credit which is normally allocated $180 million in each fiscal year. The proposal requests an additional $180 million in funding, with $90 million contemplated for the 2020/2021 tax year and $90 million for the 2021/2022 tax year. The California Competes Tax Credit program awards tax credits to businesses creating jobs and making investments in California following three application periods each fiscal year.
Creation of a new California Competes Grant program with $250 million in one-time funding from the General Fund. As a grant, a business would not need to have California income tax liability to take advantage of this program. Eligibility would be for high impact projects that meet one or more of the following criteria –
Extension of the Small Business Hiring Credit. This hiring credit was enacted in 2020 with $100 million to help businesses with 100 or fewer employees who had experienced a drop in revenues during the second quarter of 2020 and were able to hire employees during the third quarter of 2020. The credit is $1,000 for each full-time employee added. The proposal allocates $100 million to create a similar hiring credit in 2021.
$25 million in grants to smaller cultural institutions (museums and art galleries) impacted by the pandemic.
Creation of a California Dream Fund with $35 million to give micro-grants of up to $10,000 in seed money and small business creation funds to underserved groups (people of color, women, and immigrants) who are seeking access to capital.
Additional funding of $50M for the CA Rebuilding Fund. The fund provides loans to small businesses with 50 or fewer full-time employees and less than $2.5M in gross revenues in 2019, as well as other eligibility criteria.
Stimulus payments of $600 to individuals receiving the California Earned Income Tax Credit (EITC). The payments would be to 2019 taxpayers who received the EITC in 2020 and to 2020 taxpayers who will receive the EITC in 2021. The intent is to assist lower income households that have been more disproportionately affected by the loss of jobs in service industries and restaurants.
One-time allocation of $100 million in additional funding for the California Alternative Energy and Advanced Transportation Financing Authority (CAEATFA) sales tax exclusion program. The CAEATFA offers a full sales tax exemption on manufacturing equipment to innovative manufacturers in the alternative energy and advanced transportation sectors. The exemption must be applied for prior to purchase of the equipment.
Potential Application for Businesses and Individuals
The Equitable and Broad-based Recovery section of the Budget proposal is intended to assist individuals, as well as large and small businesses. While the Small Business Tax Credit may have been narrow in its focus in 2020, hiring that takes place as part of an economic recovery in 2021 could make that credit much more applicable to our clients with 100 and fewer employees. The elective S-corporation tax and corresponding individual tax credit for tax on S-corporation income would help owners of closely-held businesses to reduce their federal individual income tax liabilities. The additional funding for the California Competes Tax Credit and California Competes Grant will make more money available to larger businesses that are creating high-paying jobs in the state.
HCVT’s State and Local Tax Practice will be monitoring the budget process to assist our clients when new credit statutes are passed or new grant funding is allocated. If you have questions about these tax incentives or grant programs (some of which are currently active incentive programs), please contact one of the following HCVT state and local tax team members for assistance to evaluate your eligibility.
Douglas Andersen Partner 562.216.5512 douglas.andersen@hcvt.com
Brett Johnson Principal 310.566.1971 brett.johnson@hcvt.com
Nancy Chher Principal 562.216.1814 nancy.chher@hcvt.com
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