California Legislature Passes Budget Bill With Net Operating Loss Suspension and Credit Limitation

Both houses of the California state legislature have passed a bill expected to generate over $9 billion in income taxes. Assembly Bill (AB) 85 passed in the Senate along party lines 27-11 (with two senators not voting) and passed in the Assembly on a vote of 56-20. AB 85 was granted immediate transmittal to the Governor’s office and many believe Governor Newsom will sign AB 85 into law to help mitigate an estimated $54 billion budget shortfall in 2020.

Net Operating Losses Suspended for 2020‒2022

AB 85 will suspend use of net operating losses (NOLs) for corporations and individuals with at least $1 million of net business income or modified adjusted gross income subject to the tax imposed under the California Revenue & Taxation Code. Suspended NOLs will receive an extended carryover period for the amount that was disallowed. The AB 85 NOL suspension will be operable as to taxable years beginning on or after January 1, 2020, and before January 1, 2023.

Credits Limited to $5 Million for 2020‒2022

AB 85 also imposes a credit utilization limit of $5 million. This credit limit shall apply to the “total of all business credits otherwise allowable” including carryovers. Corporations filing combined returns are limited to $5 million total for all taxpayers included in the combined report. The credit limitation does not apply to credits for earned income, young child, household/dependent care, adoption costs, renter’s tax credit, personal exemption, head of household, dependent parent, low-income housing, and unemployment insurance.

Bill language indicates the “carryover period for any credit that is not allowed due to application of this bill will be increased by the number of taxable years the credit or any portion thereof was not allowed.” The AB 85 credit limitation will be operable as to taxable years beginning on or after January 1, 2020, and before January 1, 2023.

Other AB 85 Provisions

AB 85 also contains a number of other provisions relevant to some business entities or high net worth individuals, summarized as follows:

• After January 1, 2021, requires sales tax on retail sales of vehicles to be made to the California DMV within 30 days of the sale.
• Extends sales and use tax exemptions on sale, storage, use or consumption of diapers for infants, toddlers, and children until July 1, 2023.
• Items for which an irrevocable election is made in lieu of tax credits are limited to $5 million (2020‒2022).
• Motion picture tax credit carryover period extended from six to nine taxable years.
• If specified appropriation is made, exempts LPs, LLPs, and LLCs from first taxable year annual tax (2020‒2023).
• For 2020‒2025, strategic aircraft credit will be permitted to reduce the regular tax below the tentative minimum tax.

The Takeaway

In response to the COVID-19 pandemic’s economic toll, California’s 2020‒2022 budget will fully suspend NOLs and limit the amount of tax credits that may be claimed by large to medium sized businesses.

Taxpayers should consider options that may be available for the 2019 tax year that may impact the 2020‒2022 years. For example, taxpayers may consider accelerating income in 2019 to use tax attributes that otherwise would be limited. California is unique among states allowing California-only elections and accounting methods. Where methods depart from the federal income tax method, taxpayers may need consent of the Franchise Tax Board.

Other states may take similar action, such as decoupling from some or all of the tax benefits under the federal Coronavirus Aid, Relief, and Economic Security Act (CARES) Act. While California may present unique planning options, the changing state and local tax landscape highlights the need to review a taxpayer’s overall footprint.