California: Governor Signs Massive Budget Package and Tax Bill – Suspends NOLS and Other Business Tax Credits

July 2020

Summary

On June 29, 2020, Governor Newsom signed the highly-anticipated budget package for California’s fiscal year that begins on July 1. The package contains two main budget bills and 17 other companion bills. Due to the COVID-19 pandemic, the extensive budget package took much longer than usual, as California, like most states, is required to have a balanced budget. Experts estimate that California is up against a $54 billion deficit, and these newly enacted laws are seen as an attempt to close this gap by generating an estimated $9.2 billion in additional revenue.
 
As part of the budget package, Assembly Bill 85 (AB 85) was enacted into law.  The bill contains several tax changes to help with the budget deficit.  Notably, AB 85 contains two major tax changes: (1) it suspends the usage of net operating losses (NOLs); and (2) it limits certain business tax credits for tax years 2020, 2021, and 2022. 
 

Details

Suspension of Net Operating Loss Deductions

For tax years beginning on or after January 1, 2020, and before January 1, 2023, AB 85 suspends the usage of NOLs for California corporate taxpayers with at least $1 million of income subject to tax, and individual taxpayers with at least $1 million in net business income or modified adjusted gross income (MAGI).  California’s 20-year NOL carryforward period will be extended by up to three years for losses that are not utilized due to said suspension in the following manner:
 
  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.
 
Certain personal and corporate taxpayers may be exempt from the NOL suspension provisions.  Personal taxpayers with net business income or MAGI of less than $1 million are exempt from the suspension of NOLs. Similarly, corporate taxpayers with less than $1 million of income subject to tax (i.e., post-apportioned net income plus any non-business income allocated to the state) are exempt from the NOL suspensions. Notwithstanding the NOL suspension periods, taxpayers should continue to calculate and carryover NOLs in the tax year that the loss is generated. 
 
Taxpayers should continue to track their NOLs annually. Due to the NOL suspension provisions in AB 85, there could be situations where an NOL generated in earlier tax years may expire in the same tax year as an NOL generated in a subsequent tax year. This consequence may occur due to the different carryover periods resulting from California law changes in earlier tax years (which also experienced similar NOL suspensions in the 2008 through 2011 tax years).  The table below provides an example of the maximum carryover period allowable for any NOL arising from the 2007 tax year:

chart.jpg
 

Limit on Business Tax Credits

For tax years 2020, 2021, and 2022, AB 85 also limits utilization of certain business tax credits.  Specifically, businesses can only claim a maximum of $5 million in tax credits (including credit carryovers from previous tax periods) during taxable years beginning on or after January 1, 2020, and before January 1, 2023.  Corporate taxpayers that are part of a combined report must apply this $5 million limit on an aggregate basis, and therefore can only reduce the total tax paid by the group by $5 million (as opposed to each member utilizing $5 million in tax credits each year).  Any credits that are not allowed due to this limitation will have their utilization period extended by the number of years said credit was disallowed.
 
Credits subject to this limitation for individual taxpayers include any allowed under California’s personal income tax laws.  Additionally, credits subject to this limitation for business taxpayers include any permissible under California’s corporate tax laws.  The following credits, among others, are limited for both individual and corporate taxpayers: New Employee Credit, Prison Inmate Labor credit, Qualified Motion Pictures Credit, California Competes Credit, Oil Recovery Credit, Research Credit, Jobs Tax Credit, Rehabilitating Certified Historic Structures Credit, Transporting Donated Agriculture Product Credit, and Natural Preservation Credit.
 
Individual tax credits exempt from this limitation include: Low Income Housing Credit, Household and Dependent Care Credit, Adoption Costs Credit, Renter’s Tax Credit, Head of Household Credit, Personal Exemption Credit, Qualified Joint Custody Credit, Qualified Taxpayer with A Dependent Parent Credit, The Earned Income Credit, Young Child Credit, Qualified Senior Head of Household Credit, and Unemployment Insurance Refund Credit.
 
However, unlike these individual credits listed under the personal income tax laws, the only exempt credit under the corporate tax laws is the Low-Income Housing Credit.
 

Other Notable Tax Measures

Limited liability companies, limited liability partnerships, and limited partnerships doing business in California are exempt from the $800 minimum franchise tax for their first year of organization or qualification to do business, for tax years beginning on or after January 1, 2021, and before January 1, 2024.  (The exemption is contingent on at least $1 million being appropriated in the California budget each year for the Franchise Tax Board’s costs to administer the exemption.)
 

Effect on Estimated Payments

The timing of AB 85 comes just as taxpayers are preparing their 2019 California tax returns, as well as, their 2020 Q2 Estimated Tax payment, which is presently due July 15, 2020 (extended due to the Covid-19 pandemic). For both individual and corporate taxpayers, quarterly installments of California estimated tax are generally equal to 30% for the first quarter, 40% for the second quarter, 0% for the third quarter, and 30% for the fourth quarter. Taxpayers expecting an NOL deduction for the 2020 tax year may now face the challenge of having to make “catch-up” estimated payments with the upcoming second quarterly installment payment. The “catch up” payment could be up to 70% of the estimated tax due. Absent this payment, both individual and corporate taxpayers may be subject to underpayment of estimated tax penalties and interest.
 
 

 

CONTACT