July 1, 2020
California adopts 2020–2022 NOL suspension and business tax credit limitation
On June 29, 2020, California's Governor Newsom signed AB 85 suspending California net operating loss (NOL) utilization and imposing a cap on the amount of business incentive tax credits companies can utilize, effective for tax years 2020, 2021 and 2022.
The ability of California taxpayers with net business income of $1 million or more to utilize their California NOLs will be suspended for tax years beginning on or after January 1, 2020 and before January 1, 2023. The suspension affects business entities as well as individuals with business income such as through ownership in pass-through entities. Similar to NOL suspensions California has previously enacted, AB 85 includes an extended carryover period for the suspended NOLs with an additional year carryforward for each year of suspension.
The suspension applies only to the use of California NOLs for tax years 2020, 2021 and 2022. Accordingly, for tax year 2019, corporate taxpayers will still be able to fully utilize NOL carryforwards on their California returns.
Although California law eliminated the ability to carryback NOLs to tax years beginning after December 31, 2018 consistent with the similar elimination of NOL carrybacks in the federal Tax Cuts and Jobs Act (P.L. 115-97) (TCJA), California has not adopted and does not conform to any of the provisions in the federal Coronavirus Aid, Relief and Economic Security Act (P.L. 116-136) (CARES Act), which relaxed some of the TCJA's NOL provisions (i.e., California does not conform to the unlimited carryforward, the 80% deduction limitation)1 or to any of the other NOL changes made by the CARES Act).
In previous suspension periods, the California Franchise Tax Board (FTB) has interpreted this provision to disallow an additional extension period if the affected taxpayer would have otherwise been in a loss position and would not have been able to utilize the NOL in such tax year. It is unclear if the FTB will continue this interpretation of this provision of AB 85.
Limit on business incentive tax credits
AB 85 also limits the use of business tax credits for tax years 2020, 2021 and 2022, requiring that credits may not reduce the applicable tax by more than $5 million. Significantly, the $5 million limitation is applied on a combined group basis such that the aggregate tax of all members of the combined reporting group cannot be reduced by more than $5 million due to tax credits. AB 85 also provides that if a taxpayer is unable to utilize a credit due to the limitation, then the carryforward period for the credit will be extended with an additional carryforward year for each year the credit is impacted by the limitation.
The credit limitation provisions impact both corporate and personal income taxpayers. The corporate tax credits affected included but are not limited to the following: the research and development credit, the jobs tax credit, the California competes credit, and the motion picture production credits.2 On the corporate tax credit portion of the provision, there is an exclusion from the limitation for the low-income housing tax credit. The personal income tax portion provides for the exclusion of 10 specified credits from the limitation including the earned income tax credit and renter's tax credit, among others.
Other notable provisions of AB 85
AB 85 limits the utilization of the motion picture production credits as applied to California sales and use tax to $5 million annually for tax years 2020, 2021 and 2022. However, utilizing the $5 million of motion picture production credit for sales and use tax would not preclude a taxpayer from also utilizing $5 million of tax credits against its income/franchise tax liability. AB 85 extends the carryover period for motion picture credits from five taxable years to eight taxable years.
AB 85 limits the total amount of insurance tax credits otherwise allowable to $5 million for the years 2020, 2021 and 2022 but the limitation does not apply to the low-income housing tax credit.
Finally, AB 85 allows an exemption from the annual minimum franchise tax for a limited partnership, a limited liability partnership and a limited liability company for its first taxable year beginning on or after January 1, 2020, and before January 1, 2024.
With preparations for the 2019 tax filings currently underway, businesses will want to understand the impact of these changes and analyze both their 2019 and 2020 California filing positions.
1 Cal. Laws 2019, ch. 39, §24 (amending Cal. Rev. & Tax Code §24416), enacted July 1, 2019.
2 "Motion Picture Production Credits" includes all three versions of the motion picture production, or "film", credits under Cal. Rev. & Tax. Code §§ 23685, 23695, and 23698.