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Wednesday, July 1, 2020

California Governor Signs Budget Bill — Suspends NOLs and Puts Limitations on Business Incentive Credits


As noted in our previous blog, prior to COVID-19, California was projecting a budget surplus of $5.6 billion for the 2020-2021 fiscal year with March actual revenues coming in $1.35 billion above projections. However, the COVID-19 pandemic changed all that as businesses were forced to close temporarily and lay off or furlough employees, and the entire U.S. economy soon came to an abrupt halt. The resulting recession has significantly changed the economic landscape, and California is now projecting a budget deficit of about $54 billion!

Due to the projected budget deficit, Governor Gavin Newsom signed a bill on June 29, 2020, to increase revenue by $9.2 billion and close the budget gap with measures including but not limited to:

  • Temporarily suspend the utilization of net operating losses (NOLs) for tax years beginning on or after January 1, 2020, and before January 1, 2023.
  • Temporarily limit the utilization of credits to $5 million per tax year.

Newsom and lawmakers are planning to update the budget in August after tax returns are filed by July 15. It is unclear at this time if further tax impacts will be made.


Suspension of Net Operating Loss Deductions

The recently enacted AB-85 provides a temporary suspension of NOLs for tax years beginning on or after January 1, 2020, and before January 1, 2023, and applies to individuals with an adjusted gross income of $1 million or greater and corporations with income subject to tax of $1 million or greater for the taxable year.

Like previous years when CA suspended NOLs, the bill extends the NOL carryover period for losses incurred in taxable years beginning before January 1, 2022.

  • 3-year extension for NOLs beginning before 1/1/2020
  • 2-year extension for NOLs beginning on or after 1/1/2020, and before 1/1/2021
  • 1-year extension for NOLs beginning on or after 1/1/2021, and before 1/1/2022

Unlike prior NOL suspension years, the bill does not limit the extended carryforward period to only those losses that could have been utilized in the corresponding suspended year. The silver lining here is taxpayers will at least still be able to utilize CA NOLs on their 2019 returns, thereby allowing for some 2020 state and local tax (SALT) planning!

NOTE: CA conforms to the TCJA’s elimination of NOL carrybacks for tax years beginning after 1/1/2018 but does NOT conform to the TCJA’s unlimited carryforward, the TCJA’s 80% NOL or the other related CARES Act NOL modifications.


Limitation of Tax Credits

In addition to the suspension of NOLs, the budget bill limits credit utilization to $5 million per year. For corporations filing a combined report, the $5 million limitation is applied to the aggregate group income. This applies to credits otherwise allowable under any provision of Chapter 3.5 (starting with Section 23604), which includes the California R&D credit and the California Competes Credit. It does not apply to any credits for which an irrevocable election was made to use against sales and use tax nor to the credit for low-income housing. The carryover will be extended, like the NOLs, for any credit restricted by a carryover period. The $5 million limitation also applies to several credits available to individuals.

As with the NOL suspension, the silver lining is that the amendment does not impact taxpayers’ ability to fully utilize all available CA credit without restriction on their 2019 California tax returns and highlights the importance of SALT planning for the tax year 2020 and beyond.


Other Tax Impacts

The bill also allows for several other measures, including the following:

  • New limited liability companies and limited partnerships are exempt from the first year $800 annual minimum franchise tax.
  • Film and TV tax credit carryforwards are extended from six to nine years.
  • Manufacturers of strategic aircraft can utilize an existing tax credit to reduce the tax below the tentative minimum tax.
  • The funding for the low-income housing tax credit is increased by $500 million.
  • The sales and use tax exemption on diapers and menstrual products is extended through the 2022-23 fiscal year.

Insights

Now is the time for all California taxpayers, especially those expecting to utilize CA NOLs and/or credits to reduce future CA tax liabilities, to consider significant SALT planning. A few areas of considerable opportunity include:

  • Filing group analysis
    • World-wide vs. water’s-edge election
    • Unitary positions
  • Apportionment
    • Sales factor sourcing analysis
      • Cost of performance analysis (sales of other than TPP)
      • Throwback analysis (sales of TPP)
    • Non-business vs. business income analysis

In addition, for ASC 740 purposes, be aware that if your quarter end or year end occurred prior to June 29, then this will impact the following quarter-end or year-end provision.

If you have any additional concerns or issues, reach out to Alex Thacher, Partner-In-Charge of our State and Local Tax Practice.

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