California's Governor signed into law at the end of June 2024 the state budget bill (AB 107) along with tax bills SB 167 (enacted June 27, 2024) and SB 175 (enacted June 29, 2024). SB 167 suspends most taxpayers' net operating losses (NOLs) and limits the use of tax credits to $5 million for tax years 2024 through 2026, and modifies corporate income tax apportionment provisions, among other changes. SB 175 provides for a potential early end to the suspension of NOLs and, notably, provides for the refundability of limited credits after the limitation ends.

Below is a summary of the income/franchise tax and administrative changes in SB 167 and SB 175.

Income tax

NOL suspension and limit on business tax credits

The ability of California taxpayers with net business income, or modified adjusted gross income, of $1 million or more to utilize their California NOLs will be suspended for tax years beginning on or after January 1, 2024 and before January 1, 2027. The suspension affects business entities as well as individuals with business income such as through ownership in pass-through entities or rental activity.

Similar to NOL suspensions California has previously enacted, SB 167 includes an extended carryover period for the suspended NOLs with an additional year carryforward for each year of suspension. In previous suspension periods, under Legal Ruling 2011-04, the 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 during the suspension year.

The suspension applies only to the use of California NOLs for tax years 2024, 2025 and 2026. Accordingly, for tax year 2023, corporate taxpayers will still be able to fully utilize NOL carryforwards on their California returns.

For tax years 2024, 2025 and 2026, the total of all business credits cannot reduce the net tax by more than $5 million. Significantly, the $5 million limitation applies on a combined group basis such that the business tax credits cannot reduce the aggregate tax of all members of the combined reporting group by more than $5 million. SB 167 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 include, 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. 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 12 specified credits from the limitation including, notably, the California pass-through entity (PTE) elective tax credit as well as the earned income tax credit and renter's tax credit, among others.

SB 175 provides some potential relief for taxpayers affected by the NOL suspension and credit limitation. First, SB 175 allows the Director of Finance and the Legislature to evaluate whether there is a continued need for the NOL suspension or credit limitation provisions of SB 167 after each of the first two suspension years. If the Director of Finance determines "that the General Fund money over the multiyear forecast is sufficient without the revenue impact" of the NOL suspension and credit limitation, then the suspension may be lifted. During the prior NOL suspension and credit limitation, the Legislature agreed to end the suspension and limitation that was originally imposed for tax years 2020, 2021 and 2022 early by one year by removing the suspension and limitation for the 2022 tax year.

SB 175 also includes a refundability of limited credit provision that accomplishes the Legislature’s intent statement to provide such relief to affected taxpayers. Affected taxpayers can make an irrevocable election on an original timely-filed return for tax years beginning on or after January 1, 2024 and before January 1, 2027, to receive an annual refundable credit amount of qualified credits. The refundable credit amount will be available for the five consecutive tax years beginning the third tax year after the election is made. For each of these five years, the refundable credit amount is equal to 20% of the qualified credits that would have otherwise been available but for the $5 million limitation in SB 167.

Apportionment

In response to ongoing litigation, SB 167 modifies both retroactively and prospectively certain corporate income tax apportionment provisions. New statutory provision Cal. Rev & Tax Code Section 24831.6 provides that when a corporation receives income that is not included in net income excluded from taxable business income, it must exclude this income from its apportionment factor. For purposes of this provision, "not included in 'net income'" is defined as "income from transaction and activities that is not included in net income subject to apportionment for any reason, including...exclusion, deduction, exemption, elimination, or nonrecognition."

In creating Cal. Rev & Tax Code Section 24831.6, the Legislature's stated that its intent is that (1) FTB Legal Ruling 2006-1 on the treatment of apportionment factors attributable to income exempt from California's corporate income tax "apply with respect to apportionment factors attributable to the income of taxpayers subject to tax under the Corporation Tax Law" and (2) new Cal. Rev & Tax Code Section 24831.6 "apply to any apportionment formula currently and formerly allowed..."

This section of SB 167 applies to tax years beginning before, on or after the effective date of SB 167, and takes effect immediately.

Oil and gas tax subsidies

Effective January 1, 2024, SB 167 eliminates the following oil and gas direct tax subsidies:

• Accelerated expensing for intangible drilling and development costs for oil and gas wells
• Percentage depletion rules for oil, gas, coal and oil shale fossil fuels
• Qualified enhanced oil recovery costs credit

Conservation easements

Starting in 2024, SB 167 conforms to the federal changes in the Consolidated Appropriations Act that limit the deduction for charitable conservation easements by the Federal Consolidated Appropriations Act (CAA) of 2023. The CAA modified the charitable conservation easement by limiting the deduction for pass-through entity owners to two and a half times the value of the taxpayer's investment and disallowed the deduction for participants who previously engaged in fraud.

New advanced strategic aircraft credit

SB 167 extends the new advanced strategic aircraft credit through January 1, 2031 (from January 1, 2026).

Administrative

SB 167 exempts California Department of Tax and Fee Administration legal rulings of counsel from the Administrative Procedure Act. Such exemption already applies to legal rulings of counsel issued by the FTB and the State Board of Equalization. This change takes effect immediately.

SB 167 also repeals the expiration date for electronic notifications to taxpayers from the FTB. Without the repeal, these provisions would have sunset on January 1, 2025.

In addition, SB 167 empowers the Director of Finance, instead of the currently empowered FTB, to determine whether a taxpayer is affected by a state of emergency when determining whether the postponement of certain tax-related deadlines applies to a taxpayer. For purposes of the declared disaster provisions, the law adds definitions of "impacted taxpayer" and "supporting documentation." This change applies to any federally-declared disasters or Governor-proclaimed state of emergencies announced on or after June 27, 2024 (i.e., the effective date of SB 167).

Implications

With the enactment of SB 167, companies again must grapple with loss of the utilization of NOLs and business credits for tax year 2024, when the calendar year is already half over. Taxpayers that made business decisions in the first half of the year that resulted in significant taxable gains may be particularly hard hit by the suspension and limitation provisions. Taxpayers that had been anticipating the ability to use NOLs and unlimited credits may now need to recalculate what California estimated payments will be needed for their 2024 tax year. California does provide a waiver process for requesting relief from estimated tax payment penalties due to a change in law during the tax year, but California will still require timely payment of tax due to avoid a late payment penalty.

The provision in SB 175 to allow a timely election for a refundable credit equal to the credit limited by SB 167 will be a new process for affected taxpayers to navigate. Because the election needs to be made on a timely-filed return for each of the years in which credits are limited, companies will need to evaluate whether to make the irrevocable election and also understand how to comply with the yet to be developed process for making the election each year.

Many companies will also need to evaluate their original return and amended return positions regarding apportionment representation for deductible income. While SB 167 is intended to apply retroactively and prospectively, the California Franchise Tax Board still will need to provide guidance to both taxpayers and its own auditors that are currently examining this issue. Taxpayers may also plan to challenge the new statute as well as the retroactive application of the new statute, which could cause uncertainty regarding this issue for quite some time to come.