May 26, 2020
CA Revised Budget Proposal Includes Suspension of NOLs and Limits on Business Tax Incentive Credits
Posted by Alex Thacher
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. COVID-19 changed all that as businesses were forced to temporarily close and lay off or furlough employees, and the entire US economy came to an abrupt halt. The resulting recession has significantly altered the economic landscape, and California is now projecting a budget deficit of about $54 billion!
The state’s unemployment rate is now expected to exceed 18% for 2020 and may go higher if shelter-in-place orders are continued to the end of the year.
Due to the projected budget deficit, Governor Gavin Newsom has issued a May Revision Budget Summary outlining numerous proposed amendments to close the budget gap, including:
- 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.
By implementing these two short-term amendments alone, the state projects that it can generate new revenue of $4.4 billion in 2020-21, $3.3 billion in 2021-22, and $1.5 billion in 2022-23, allowing the state to properly fund schools, community colleges, and other core services.
Suspension of NOL Deductions
The recently proposed amendment, Section 17276.23 of the Revenue and Taxation Code, provides a temporary suspension of NOLs for tax years beginning on or after January 1, 2020 and before January 1, 2023 and is applicable to taxpayers with a net income of $1 million dollars or greater for the taxable year.
Similar to prior years when California suspended NOLs, the proposed amendment extends the NOL carryover period for losses incurred in taxable years beginning before January 1, 2022.
- 3-year extension for NOLs beginning before January 1, 2020
- 2-year extension for NOLs beginning on or after January 1, 2020, and before January 1, 2021
- 1-year extension for NOLs beginning on or after January 1, 2021, and before January 1, 2022
Unlike prior NOL suspension years, the proposed amendment (as currently drafted), does not limit the extended carryforward period to only those losses that could have been utilized in the corresponding suspended year. However, given California’s history with NOL suspensions, it would not be surprising if the bill’s language is later updated to include such a restriction. The silver lining here is that taxpayers will at least still be able to utilize California NOLs on their 2019 returns, thereby allowing for some 2020 state and local tax (SALT) planning.
NOTE: California conforms to the TCJA’s elimination of NOL carrybacks for tax years beginning after January 1, 2018, but does NOT conform to TCJA’s unlimited carryforward, 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 also proposes to “[…] temporarily limit to $5 million the amount of credits a taxpayer can use in any given tax year.” The draft language has not yet been made available and the state has yet to comment on the specific credits that the limit would apply to. The general consensus is that the limitation will likely apply to the CA R&D credit and potentially the CA Competes Tax Credit as well as the CA New Employment Credit.
As with the NOL suspension, the silver lining is that, as currently drafted, the proposed amendment does not impact the ability of taxpayers to fully utilize all available CA credit without restriction on their 2019 California tax returns and also highlights the importance of SALT planning for tax year 2020 and beyond.
The budget bill is now heading to the California legislature for negotiations with a constitutional deadline of June 15, 2020. As a result, it won’t be long before we see a finalized budget bill. The bill is expected to pass the two-thirds majority requirement in both the Assembly and Senate.
Given the magnitude of California’s significant budgetary shortfalls and deficit (which is materially growing every day), coupled with the inevitable passage of this bill, now is the time for all California taxpayers, especially those expecting to utilize California NOLs and/or credits to reduce future California tax liabilities, to consider SALT planning. A few areas of significant opportunity include:
- Filing group analysis
- World-wide vs. water’s-edge election
- Unitary positions
- Sales factor sourcing analysis
- Cost of performance analysis (sales of other than tangible personal property)
- Throwback analysis (sales of tangible personal property)
- Non-business vs. business income analysis
- Sales factor sourcing analysis
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Alex is the National Practice Leader of Armanino’s State & Local Tax (“SALT”) Practice and has over 18 years of deep technical experience in multi-state income/franchise tax, sales/use tax, local taxes, and credits and incentives. Alex has served clients across sectors including technology, retail, media and entertainment, utilities, pharmaceuticals, manufacturing, telecommunications, government contractors, e-commerce, software, construction, engineering and financial services.
Alex’s technical expertise includes unitary and consolidated filings; mergers and acquisitions consulting and due diligence; the development, evaluation and implementation of restructuring plans; apportionment reviews and planning; ASC 740 and ASC 740-10 reviews; audit representation; transaction analysis; residency audits; nonresident withholding; Wayfair nexus studies; and voluntary disclosure negotiations.
Alex earned his BA from Boston College and his JD from the University of Connecticut School of Law, where he served as the Administrative Editor of the Connecticut Journal of International Law. Alex is admitted to the New York State Bar, the District of Columbia Bar, the Connecticut Bar, and the United States Tax Court. Alex is a California Tax Education Council (CTEC) Registered Tax Preparer and a Registered Lobbyist with the City of Los Angeles.
Co Authors :
Mark is a Tax Director at Armanino and is the practice leader of the Southern California State and Local Tax division, specializing in finding innovative solutions for clients. With over 30 years of experience, he specializes in planning, reorganizations, mergers, acquisitions, compliance and tax provisions. Specific areas of expertise include tax controversy, global tax structures, ASC 740, tax due diligence on acquisitions, defense contractors and media entertainment companies, and tax issues related to Intellectual Property rights.
Mark has a bachelor’s degree in business administration with an emphasis in marketing from the University of Illinois Urbana-Champaign. He is a Certified Public Accountant in California and Texas.