May Revision – California Budget: Net Operating Loss 3-year Suspension and Business Tax Incentives Limits Passed by California Legislature

June 24, 2020
Douglas Andersen, Tax Partner, Edvin Givargis, Tax Senior Manager

Background

Business closures and job losses have had a significant impact on the California (“State”) budget. The State is facing a combination of rising costs in health and human services programs and costs to address COVID-19 pandemic; the combination of these factors has led the state to a projected budget deficit of approximately $54 billion.

Pursuant to Governor Newsom revisions to his originally proposed 2020-2021 state budget and proposed tax increase, the California legislature has voted to approve a $9.2 billion tax increase over a three-year period through suspension of the net operating loss deduction and a limit of $5 million per year on business tax credits for three years retroactive to the beginning in 2020. The legislation, Assembly Bill 85, has been enrolled and awaiting Newsom’s approval as of June 15, 2020, and is expected to be signed by Governor Newsom later this week

Suspension of Net Operating Losses

For tax years 2020 through 2022, the budget trailer bill suspends the use of net operating losses for medium and large businesses.

Specifically, under the personal income tax law, the net operating loss suspension applies to taxpayers with net business income or modified adjusted gross income of one million or more dollars for the taxable year. Under the corporate tax law, the net operating loss suspension applies to taxpayers with income subject to tax (post-apportionment income) of one million dollars or more for the taxable year.

The bill allows an extension of the carryover period for any net operating losses that were suspended under the operative provision. The extension periods granted for any suspended net operating loss is as follows:

(1)  By one year, for losses incurred in taxable years beginning on or after January 1, 2021, and before January 1, 2022.

(2)  By two years, for losses incurred in taxable years beginning on or after January 1, 2020, and before January 1, 2021.

(3)  By three years, for losses incurred in taxable years beginning before January 1, 2020.

California may be expected to follow FTB Legal Ruling 2011-04, which concluded extensions for an NOL carryover are determined on a year-by-year basis and are only available if some portion of the unexpired NOL would have otherwise been usable during the suspension period.

Limitation on Tax Credits

The budget revision also limits the use of business incentive tax credits for tax years 2020 through 2022 - the credits may not offset more than $5 million of tax liability in the affected years. The limitation is applied on an aggregate basis to corporate taxpayers that file on a combined basis (i.e., credits allowable by all members of a combined report may not reduce the aggregate, or combined, amount of tax). A few of the impacted credits are as follows: research and development credit, new employment credit, California Competes credit, motion picture credit, credit for rehabilitating certified historic structures, and low-income housing credit. Note that this is not a comprehensive list. For additional information, please refer to Assembly Bill 85. Under the proposal, any credit that is disallowed under the new provisions will be treated as a carryover; the carryover period will be increased by the number of taxable years the credit, or any portion thereof, has been disallowed.

Application our Clients

Given that the preparation of many of our clients 2019 California returns and 2020 estimated payment calculations predated the enactment of AB 85, our clients may now have new considerations in the ongoing planning for the challenges of 2020. 

For further information on AB 85, please contact one of the following HCVT state and local tax team members with any related questions:

Douglas Andersen (douglas.andersen@hcvt.com
Nancy Chher (nancy.chher@hcvt.com)
Edvin Givargis (edvin.givargis@hcvt.com)
Elisa Reyes (elisa.reyes@hcvt.com)
Goran Jovicic (goran.jovicic@hcvt.com)
Micah Sims (micah.sims@hcvt.com)

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