California enacts tax legislation to reduce projected budget deficit

| 7/23/2020
California enacts tax legislation to reduce projected budget deficit

On June 29, California Gov. Gavin Newsom approved Assembly Bill 85 (AB 85), which includes temporary income tax measures applicable to tax years beginning on or after Jan. 1, 2020, and before Jan. 1, 2023, to help reduce the projected budgetary deficit resulting from the COVID-19 pandemic. The measures include:

  • Suspending the net operating loss (NOL) deduction
  • Limiting the use of most income tax credits

AB 85 also temporarily exempts limited partnerships (LPs), limited liability partnerships (LLPs), and limited liability companies (LLCs) that are organized or doing business in California during 2021, 2022, and 2023 from having to pay the $800 minimum tax on an initial return.1

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NOL deduction suspension

AB 85 suspends the use of an NOL deduction for individuals and corporations with $1 million or more of income subject to tax on returns filed for tax years beginning in 2020, 2021, and 2022. The suspension also applies to tax-exempt organizations with unrelated business taxable income that generally are allowed an NOL deduction to offset this income. The NOL carryover period2 is extended up to three years during the suspension period if an individual or corporation is not able to take an NOL deduction. California is not expected to extend the carryover period for any NOLs generated during the suspension period (in tax years beginning in 2020, 2021, and 2022) based on California Legal Ruling 2011-04, which stipulated that the carryover period for an NOL is extended only when an NOL deduction is denied.

Tax credit use limitation

Individuals and corporations may use most tax credits to offset no more than $5 million of income tax liability per year in California during tax years beginning in 2020, 2021, and 2022. Some of the tax credits that are limited include the research and development credit, the California competes credit, and the new employment credit. The tax credit limitation does not apply to low-income housing credits or personal credits for individuals. For corporations that are part of a unitary combined group, the tax credit limitation of $5 million is applied in the aggregate and not on a separate company basis. Any tax credits that are not allowed to be used during the suspension period will have the carryover period extended accordingly.

$800 minimum tax for initial returns filed by LPs, LLPs, and LLCs

AB 85 temporarily allows LPs, LLPs, and LLCs that are newly formed or legally qualified to do business within California on or after Jan. 1, 2021, and before Jan. 1, 2024, an exemption from being required to pay the $800 minimum tax on an initial return. 

Estimated tax implications of NOL and tax credit limits

California does not impose a penalty for underpayments of estimated tax resulting from tax law changes occurring and becoming effective during the year of the underpayment.3

1 Previous law had provided only a first-year exemption from having to pay the $800 minimum tax to corporations that were incorporated or had qualified business in the state (Cal. Rev. & Tax. Code Section 23153).
2 For NOLs generated in tax years beginning on or after Jan. 1, 2008, 100% of the NOL may be carried forward, and the carryover period is 20 years. California does not conform to IRC Section 172 as amended by the Tax Cuts and Jobs Act of 2017 and the Coronavirus Aid, Relief, and Economic Security Act of 2020.
3 California Revenue and Tax Code Section 19142(b).

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