On January 25, 2022, California Governor Newsom and legislative leaders announced they reached an agreement that would support businesses impacted by the ongoing COVID-19 pandemic. The agreed-to framework calls for the shortening, by one tax year, of a prior suspension of net operating losses (NOLs) for tax years tax years 2020 through 2022 and prior limits on the use of business tax credits, including the research and development (R&D) credit, for the same period. Other agreed-to actions include relief for restaurants and shuttered venues that received federal relief grants and additional funds for the Small Business Covid-19 Relief Grant Program.

The Governor's announcement describes these agreements as "[e]arly budget actions," although a timeline for these actions was not specified.

Meanwhile, some California legislators recently introduced a measure to significantly increase state taxes to fund a proposed single-payer healthcare system for the state, while the California Secretary of State announced the withdrawal of an initiative that would have increased income tax on certain corporations to fund programs to reduce greenhouse gas emissions.

Governor's budget proposal

On January 10, 2022, Governor Newsom released his 2022-23 budget proposal. A key tax law change would restore, one year earlier than under current law, NOLs and business tax credits that were suspended or limited beginning in 2020 to combat the pandemic's anticipated effects on the state budget. For tax years 2020, 2021 and 2022, 2020 CA AB 85 (Cal. Laws 2020, ch. 8) suspended the use of NOLs for California taxpayers with net business income of $1 million or more and limited the use of business tax credits to $5 million in any one year. (See Tax Alert 2020-1691.) The Governor's 2022-23 budget proposal recommends restoring the NOLs and business tax credits in the 2022 tax year.

Other tax law changes in the Governor's 2022-23 budget proposal would:

• Modify the state's elective pass-through entity (PTE) tax by (1) removing a provision that prohibits the credit for PTE tax paid from reducing tax owed below a taxpayer's tentative minimum tax and (2) allowing a business owned by individuals using a disregarded entity to participate in the elective PTE tax and credit¹
• Establish a new credit, in addition to the existing R&D credit, that would provide $250 million per year from 2022 through 2024 for qualified California-headquartered companies investing in activities and technologies that mitigate climate change
• Establish a new tax credit totaling $100 million per year for three years for those opting to develop green energy technologies
• Assist small businesses by waiving fees for new businesses and providing additional funding for existing grant programs
• Conform California's income tax treatment of federal Restaurant Revitalization Funds and federal Shuttered Venue Operators Grant program to the federal income tax treatment of these grants²

Changes to the Governor's budget proposals based on the latest economic forecasts will be released in May 2022. The California Constitution requires the Legislature pass the budget bill by midnight on June 15, 2022.

Proposed single-payer health care system

California lawmakers are moving forward with 2022 CA AB 1400 (AB 1400), which, if enacted, would establish a universal single-payer health care system that could cost California taxpayers an estimated $365.5 billion per year. AB 1400 has a January 31, 2022 deadline for a California Assembly vote to advance to the California Senate. The bill only requires a simple majority to pass.

A funding mechanism for AB 1400 was introduced with 2022 CA ACA 11 (ACA 11). Under ACA 11, the single-payer health care system would be funded with (1) a new 2.3% excise tax on the gross receipts of a qualified business above $2 million; (2) a 1.25% payroll tax imposed on employers that pay wages or compensation to 50 or more California resident employees; (3) a 1% payroll tax on every employer on wages or other compensation paid to California resident employees in excess of $49,900 per resident employee; and (4) an additional individual income tax ranging from 0.5% to 2.5%, on residents with taxable income of $149,509 or more.

Since it imposes new taxes, ACA 11 would need to be approved by a two-thirds vote of both houses of the California Legislature, under California's constitution. If approved by the Legislature, ACA 11 would be placed on the ballot for the November general election and would need to be approved by a majority of California's voters. While ACA 11 has been introduced, it may not be the only funding mechanism proposed to support the single-payer health care system described in AB 1400.

Greenhouse gases

On January 25, 2022, California Secretary of State Shirley Weber announced the withdrawal of Initiative 1932, regarding greenhouse gas emissions. The initiative was seeking to fund programs aimed at reducing greenhouse gas emissions by imposing an additional 2.45% income tax on a corporation's net income over $20 million.

Implications

Restoring NOLs and full business credit utilization for tax year 2022 may significantly impact companies that rely on these tax attributes to offset California taxable income. Restoration could also implicate estimated tax payments, as well as other California tax planning and compliance considerations for the 2022 tax year. The proposal to restore NOLs and business credit utilization for 2022, however, is still in the proposal stage. As indicated in Governor Newsom's January 25, 2022 announcement, some provisions of his budget proposal could be considered, and acted on, earlier than the typical May revision timeframe, which could provide taxpayers and their tax advisors with much greater certainty sooner rather than later.

The proposed legislative fixes to questions that have arisen on the application of the PTE tax would also bring some welcomed relief to taxpayers and their tax advisors.

With the January 31, 2022 deadline for the California Assembly to vote on AB 1400, there is a very short timeline before the next big step in the legislative progress of the single-payer health-care-system bill is known. The timeline for ACA 11, the funding mechanism for the single-payer health care system, is longer but regardless, taxpayers may not have answers until the results of the November 2022 ballot referendum on the issue are known. In the meantime, alternative proposals may be introduced to enact and fund a universal single-payer health care system in California.

EY will continue to monitor California's budget proposals and will issue alerts providing updates on these proposals as they move through the legislative process.

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ENDNOTES

¹ The budget proposal recommends enacting this change to assist businesses with their 2021 tax liabilities before the March 15, 2022 tax filing and payment deadline for certain business entity filers.

² The budget proposal recommends enacting this change to assist businesses with their 2021 tax liabilities before the March 15, 2022 tax filing and payment deadline for certain business entity filers.