California Raises Taxes to Address Budget Shortfalls

On June 29th, 2020, California Governor Gavin Newsome signed the 2020 Budget Act, a $202.1 billion spending plan primarily focused on funding emergency response and public health and safety. Included in the bill are a number of key tax law changes aimed at closing the $54.3 billion budget shortfall caused by the COVID-19 pandemic.

These changes significantly minimize or delay key tax deductions and credits and will have a major impact on the tax burden for individuals and businesses in California. In the following we provide details of some of the most essential tax code changes.

Suspension of Net Operating Loss (NOL) deductions

NOL deductions have been suspended for individuals and corporations with more than $1 million in taxable income before the application of NOLs. For any NOL deduction that is denied because of the suspension, California will extend the carryover period. The extension periods are:

• three years for losses incurred in tax years beginning before January 1, 2020;
• two years for losses incurred in tax years beginning on or after January 1, 2020, and before January 1, 2021; and
• one year for losses incurred in tax years beginning on or after January 1, 2021, and before January 1, 2022.

The move to suspend NOL has precedent, as similar legislation was put into effect to address budget shortfalls during 2002–03 and from 2008 to 2011.

Limits added for business tax credits

California taxpayers can only apply $5 million in business tax credits to reduce their California income tax liability for the tax years 2020, 2021 and 2022. Taxpayers included in a combined report are subject to a combined $5 million limit.

The $5 million limit on tax credits extends to most California business credits, including, but not limited to:

• R&D credits
• Enterprise zone credits
• Hiring credits
• College access credits
• Motion picture credits

The limit does not apply to low-income housing credits, or personal credits for individuals.

The amount of any credit not allowed because of the limit will remain a credit carryover, extended by the number of tax years the credit or any part of it was not allowed.

Minimum tax exemptions

Limited partnerships, LLPs, and LLCs are exempt from the minimum tax in their first taxable year for tax years beginning January 1, 2021, and before January 1, 2024.

Carryover of motion picture tax credits

The carryover period for film and television tax credits allocated under Program 2.0 has been increased from six years to nine years.

Advanced strategic aircraft credit

The advanced strategic aircraft credit may reduce a taxpayer’s regular tax below the tentative minimum tax for tax years beginning on or after January 1, 2020, and before January 1, 2026.

Tax planning considerations

As the changes to California net operating loss and credit limitations impact the 2020-2022 years, state & local tax planning is recommended. This includes the following:

• Reviewing accounting methods and elections to see whether a deferral of revenue, an acceleration of deductions, and/or a change in unitary group reporting would be beneficial.
  • Since 2019 income tax returns have not been filed for a number of businesses, this can be an important exercise for cash tax savings.
• Modeling state tax liabilities (including reviewing apportionment, allocations, unitary group positions, and tax attributes) for 2019-2022 to project out where tax efficiencies can be obtained.

Conclusions

California’s new tax laws will have a significant impact on many businesses and individuals filing 2019 returns and/or preparing 2020 estimated payments. We recommend consulting with a tax professional to fully understand the impact going forward.