Tax Planning for California’s Temporary NOL Deduction Suspension and Business Tax Credit Limitation

Amidst the commercial shutdowns brought on by COVID-19, state revenue collections have plummeted nationwide resulting in significant budget shortfalls. In response, many states are taking action. In an effort to overcome an estimated budget deficit of over $50 billion, California Governor Gavin Newsom signed Assembly Bill 85 (“A.B. 85”) on June 29, 2020. The bill contains several tax measures to provide much-needed tax revenue.

A.B. 85 presents two notable, albeit temporary, changes to California’s income taxes:

  • Suspension of its net operating loss deduction; and
  • Cap for business incentive tax credits.

Net Operating Loss Deduction Suspension

A.B. 85 provides a three-year suspension of the California net operating loss (“NOL”) deduction for taxpayers with $1 million or more in taxable income. For individual taxpayers, the $1 million exclusion applies to net business income or modified adjusted gross income; whereas, the $1 million exclusion applies to corporate taxpayers’ California taxable income. Any NOL deductions disallowed during this suspension have an extended carryforward period, which is particularly important considering California has not, to date, conformed with the federal CARES Act NOL provisions (e.g., unlimited NOL carryforward with an annual 80% utilization limitation, see generally Cal. Rev. & Tax Code sec. 24416.) The NOL suspension is effective for the 2020-2022 tax years.

Business Incentive Tax Credit $5 Million Cap

A.B. 85 also issues a three-year cap on business incentive tax credits, requiring that credits, whether current year or carryforward, not reduce the applicable tax by more than $5 million. This cap directly reduces utilization of more notable credits, such as the R&D tax credit, jobs tax credits and film tax credits. Notably, the $5 million cap applies to a single combined group, not $5 million for each combined group member. Any credit carryforward created by this cap is afforded a carryforward extension for the years the credit was not allowed. As with the NOL suspension, the business credit cap is effective for the 2020-2022 tax years.

What Does This Mean?

As taxpayers begin preparing 2020 tax filings, businesses should be advised as to the tax planning ramifications of these changes to assess their prospective California filing position. Corporations should also consider potential ASC 740 implications including, but not limited to, valuation allowance assessments.

We’re Here to Help

If you would like to discuss how your business may be impacted by these changes or for more information about Bennett Thrasher’s State & Local Tax practice, contact Brian Sengson by calling 770.396.2200.