Faced with California’s $45 billion budget deficit, Sacramento lawmakers continue to grapple with how to cure the shortfall. It comes as no surprise that in late June, the state’s Lt. Gov. Eleni Kounalakis, in her role as acting governor, and Gov. Gavin Newsom signed Senate Bills 167 and 175. The bills’ passage resulted in suspending the net operating loss deduction for businesses with greater than $1 million in income and limiting business tax credit utilization, along with other changes.
SB 167 suspends the net operating loss (NOL) deduction for tax years beginning on or after Jan. 1, 2024, and before Jan. 1, 2027. In California, net operating losses can be carried forward for 20 years. To the extent that any NOL is denied as a result of the suspension, carryforward periods are extended three years for losses incurred in tax years prior to Jan. 1, 2024, two years for losses incurred in tax years beginning on or after Jan. 1, 2024, and prior to Jan. 1, 2025, and one year for losses incurred in tax years beginning on or after Jan. 1, 2025, and prior to Jan 1, 2026. The loss suspension does not apply if either the net business income or modified AGI subject to California tax is less than $1 million.
Further limitations included in the bill restrict the utilization of certain business credits, which may not be used to offset more than $5 million in taxable income per year for taxable years beginning on or after Jan. 1, 2024, and before Jan. 1, 2027. The bill allows for exemptions related to personal income tax credits such as for earned income, low-income housing and foster youths, and the credit for the elective pass-through entity tax. The carryforward period for any credits disallowed because of the limitation is extended by the number of tax years that any portion of the credit was disallowed.
SB 175, a companion bill to SB 167, provides additional benefits for California research and development (R&D) credits, amongst other credits. Beginning Jan. 1, 2024, through Jan. 1, 2027, a taxpayer will be permitted to make an irrevocable election to receive a refund equal to 20 percent of the qualified credits that would have been available to the taxpayer in the absence of the $5 million limitation imposed by SB 167. The “refundable period” is the first five consecutive tax years beginning the third tax year after the tax year for which the taxpayer makes the election. The 20 percent annual credit is only refunded to taxpayers to the extent that the unused annual credit and other credits and/or NOLs exceed the amount of tax due for that tax year.
SB 175 renders inapplicable the suspension of NOLs and the business tax credit limitation if the California Director of Finance determines that revenues over a multi-year forecast is sufficient without the revenue impact of the NOL suspension and credit limitation.
Senate Bills 167 and 175 will significantly change the impact of credits and NOLs that Taxpayers had been planning to use in 2024 or later, and 2024 estimates must be reevaluated to consider the impact of these changes for the 2024 – 2026 tax years.
Authors: Penny Sweeting, CPA | [email protected] and Rebecca Stidham, CPA, Partner | [email protected]
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