Blog Post 05.18.20
On June 15, 2020, the California Legislature passed Governor Newsom’s proposed tax legislation to raise additional income tax revenue to assist in balancing the California budget. (AB 85). The Senate and Assembly each achieved the two-thirds majority vote required for California tax increases (27-11 in the Senate and 56-20 in the Assembly), with Governor Newsom expected to sign the legislation later this week. The tax legislation contains two principal components:
Suspension of Net Operating Losses for 2020 – 2022
The 2020 – 2022 NOL suspension applies to both individuals and corporations in years when the taxpayer has more than $1 million of taxable income before application of NOLs. CRTC §§ 24416.23 and 17276.23. Other than exempting taxpayers with less than $1 million of income, the suspension is much like California’s prior NOL suspensions in effect during 2002 – 2003 and 2008 – 2011. As was done previously, NOL carryover periods will be extended when the 2020 – 2022 suspension prevents use of all or part of a prior year’s NOL, including a three-year extension for unexpired NOLs that were incurred before 2020, a two-year extension for NOLs incurred in 2020, and a one-year extension for NOLs incurred in 2021.
California is expected to follow FTB Legal Ruling 2011-04 (September 23, 2011), 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. For example, if the 2020 – 2022 suspension period included the last year the taxpayer’s unused 2007 NOL was otherwise available, and the taxpayer had no 2020 – 2022 taxable income to absorb the 2007 NOL, then the 2007 NOL would expire and would be ineligible for any extended carryover period. Legal Ruling 2011-04 further provides that multiple carryover extensions can be applied. For example, a 2007 NOL that would have been usable in 2011 had there been no 2011 NOL suspension, previously received an additional four-year carryover pursuant to CRTC sections 17276.21 and 24416.21, which extended the normal 10-year carryover period (for pre-2008 NOLs) to a 14-year carryover period expiring in 2021. If some portion of that 2007 NOL remained unused and was prevented again from being used by the new 2020 – 2022 NOL suspension, the 2007 NOL would secure an additional three-year extension, further lengthening the 2007 NOL carryover period from 2021 to 2024.
Limitation of Tax Credits to $5 Million Per Taxpayer for 2020 – 2022
The new legislation also specifies that California taxpayers can only apply $5 million of business tax credits in a given tax year to reduce their California income tax liability in 2020, 2021 and 2022. CRTC §§ 17039.3 and 23036.3. This standard limitation of $5 million in annual credits for every California taxpayer during 2020 – 2022 is different than California’s credit limitations in 2008 – 2011, where credits were limited to 50% of the taxpayer’s annual taxable income. CRTC § 23036.2.
The $5 million annual limit applies to individuals and corporations. Taxpayers required to be included in a combined group are subject to a single combined $5 million limit. Like the NOL provisions, any credits barred by the annual $5 million limit in 2020, 2021 or 2022 are provided an extended carryover period for each year the limit applies.
The $5 million limit on tax credits extends to most California business credits specified in Chapter 3.5 of the California Revenue and Taxation Code (CRTC §§ 23604 through 23695).2 This includes the R&D credit (CRTC § 23609), enterprise zone credits and hiring credits including the California Competes Credit (CRTC §§ 23612 through 23646 and 23689), college access credits and motion picture credits (CRTC §§ 23685 through 23695), and credits for produce donations by agricultural producers to food banks (CRTC §§ 23688 and 23688.5). The $5 million limit does not apply to low-income housing credits (CRTC §§ 23610.5 and 23036.3(d)) or personal credits for individuals, such as the head of household credit, earned income credits, adoption credits, dependent care credits or a renter’s credit (CRTC §§ 17052 through 17061).
California’s new law limiting NOL deductions and the availability of California tax credits in 2020 – 2022 provides new considerations for taxpayers who recently filed or are in the process of filing their California 2019 returns and 2020 estimated payments, which may pre-date these changes, and in the ongoing planning for the challenges of 2020. We welcome your inquiries on how best to address these new changes in California’s personal and corporate income tax law.
1. AB 85 also includes specific provisions affecting more limited groups of taxpayers such as: (1) accelerating the remittance of sales tax collections on motor vehicle sales by car dealers (California Revenue and Taxation Code (CRTC) § 6295); (2) extending the sales tax exemption on children’s diapers and menstrual hygiene products through June 30, 2023 (CRTC §§ 6363.9 and 6363.10); (3) a $5 million annual limit on sales tax credits for motion picture production in 2020, 2021 and 2022 when an election has been made to take sales tax credits rather than income tax credits under CRTC §§ 17053.95 and 23695 (CRTC § 6902.5); (5) allowing the strategic aircraft credit to reduce income tax below the tentative minimum tax (CRTC §§ 23036 (d)(1) and 23636); and (6) exemptions for the first year of the $800 minimum tax on newly formed California partnerships and limited liability companies (CRTC §§ 17935, 17941 and 17948).
2. This $5 million a year limit on offsetting credits for 2020, 2021 and 2022 also applies to California’s gross receipts tax on insurance company premiums, limiting insurance companies to $5 million per year in offsetting credits from pilot programs for uninsured motorists and college access credits. CRTC §§ 12207, 12208 and 12209.