The California legislature on June 15, 2020, approved a $143 billion budget, including a “trailer bill” that suspends the use of California net operating loss (NOL) deductions and certain tax credits for the 2020, 2021, and 2022 tax years.
The trailer bill (Assembly Bill 85) was approved by both houses of the California legislature with a two-thirds majority vote in each chamber, as required under the California Constitution for bills that increase taxes for any taxpayer.
Assuming the governor signs the bill (as expected), the result will be an estimated $9.2 billion tax increase for California taxpayers that will affect cash flow and the California effective tax rate. History seems to repeat itself with this California budget. The California legislature suspended NOLs and limited credits in prior years when the state faced budget deficits. Although estimates vary, it has been widely reported that California—a state that relies heavily on individual income taxes for general fund revenues—is facing a $54.3 billion deficit.
The NOL suspension provisions would apply to individuals, flow-through entities, and C corporations. For tax years beginning on or after January 1, 2020 and before January 1, 2023, NOLs would be suspended for both corporate and individual (personal) income taxes.
The carryover periods for the suspended NOL deductions would be extended. as follows:
The carryover period for each year’s NOL is extended only when an NOL deduction was denied, in whole or in part, because of the application of the suspension provisions. When a taxpayer has multiple NOL carryforwards, the oldest year must be used first. (FTB Legal Ruling 2011-04; Treas. Regs. §1.172-4(a)(3))
Businesses will continue to compute and carryover NOLs during the suspension period.
Each tax year that has an NOL must be considered separately. This is because an NOL carryforward is the balance from an NOL generated in a single tax year—not an aggregate of all losses generated in prior years. Applying this rule to California’s suspension provisions can result in an NOL from an earlier tax year with a later expiration date than an NOL generated in a later year, and a taxpayer can lose the NOL generated in the later year.
Under current law, NOL carrybacks are no longer allowed for California purposes for tax years beginning or after January 1, 2019.
For tax years beginning on or after January 1, 2020 and before January 1, 2023, a business (including all taxpayers that are members of a combined report) may claim a total of only $5 million in credits under both the corporation and individual income tax laws (including the carryover of any business credit). Most business credits, including the California research and development (R&D credit), are subject to this limitation. However, certain individual income tax credits and the low-income housing credit that applies to both corporate and individual income taxpayers are exempted.
The carryover periods (if applicable) are extended by the number of years that a credit is disallowed by reason of this limitation. The new legislation also allows taxpayers to use the “advanced strategic aircraft credit” to offset the California alternative minimum tax for the 2020 through 2025 tax years.
There are conforming changes to the gross premiums tax levied on insurance companies that apply to the 2020, 2021, and 2022 years.
For retail sales of vehicles occurring on or after January 1, 2021, all licensed car dealers (except new vehicle dealers) must collect and remit sales tax on vehicle sales to the Department of Motor Vehicles, acting on behalf of the Department of Tax and Fee Administration, within 30 days from the date of sale.
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