California lawmakers have approved budget legislation that would temporarily suspend net operating loss deductions for some businesses and caps the amount of income that can be offset by business tax credits.
A.B. 85 was amended by the State Senate and approved in that chamber June 15 on a 27–11 vote; the State Assembly concurred with the Senate's amendments with a vote of 56 to 20. The bill now goes to Gov. Gavin Newsom (D) for his signature.
Also on June 15, lawmakers approved a fiscal 2021 budget in order to meet a constitutionally imposed deadline, but are still negotiating with Newsom over the actual provisions of the state’s budget, including the extent of cuts in the event the federal government doesn’t provide the state with relief funds. Those issues will be addressed in subsequent legislation.
The provisions of A.B. 85 include several tax proposals Newsom proposed in his May budget revision. One would suspend the use of NOLs during 2020, 2021, and 2022 for taxpayers with net business income or modified adjusted gross income of $1 million or more. Another would limit business incentive tax credits from offsetting more than $5 million of a taxpayer's annual liability for 2020, 2021, and 2022. However, the bill also extends the time frame for taxpayers to use losses and credits that they’re temporarily prevented from using due to the provisions of A.B. 85.
California is facing a $54 billion deficit as a result of the COVID-19 pandemic and resulting lockdown. The suspension of NOLs and the capping of credits is projected to generate $1.8 billion and $2 billion in additional fiscal 2021 revenue, respectively, and an additional $611 million as a result of the interaction of those two provisions, according to a legislative staff analysis of the bill. All told, the legislation’s tax provisions are expected to collectively net an additional $4.4 billion in state revenue for the upcoming fiscal year, and roughly $3.3 billion in 2021–22, and $1.5 billion in 2022–23.
Republicans have criticized the legislation, characterizing it as an ill-timed tax increase in comments on the Senate floor June 15. Sen. John Moorlach (R) warned that suspending NOLs for businesses with $1 million or more in income is “going to capture a good amount of our businesses here in California, and that is not a good gesture as we’re trying to dig out from [the] coronavirus.” He warned that curbing deductions and tax credits for businesses struggling to recover and looking to rehire following the pandemic could further harm the state’s economy.
“If we make the climate too hostile for good business people,” they will leave, Moorlach said, arguing that the state already has some of the highest tax rates in the country. “We’re seeing migration to states like Texas and Nevada,” he added.
However, Democrats argue that California’s business environment has been strong for years despite the state's tax environment, and said the revenue being sought through the suspension of NOLs and by restricting the use of business tax credits is necessary to limit the spending cuts necessitated by the pandemic. Sen. Holly Mitchell (D) noted that the measures would be temporary and the NOLs and tax credits taxpayers couldn’t use during the three years in question would be usable afterward.
“They are actually delays of when someone can utilize these tax benefits, not tax increases,” Mitchell said, adding, “To be impacted by the net operating loss provisions of this bill, you would need to have income of $1 million or more . . . to offset losses against." She also noted that to be affected by the tax credit cap provision, "generally a corporation would need to have income of over $56 million to be affected, and a personal income taxpayer would need to have income over $40 million,” citing Department of Finance estimates.
The legislation also would provide a tax break to small businesses by temporarily expanding the state's first-year exemption from the $800 annual minimum franchise tax to include limited liability companies, limited partnerships, and limited liability partnerships. The provision would be effective from January 1, 2021, until January 1, 2024, and is estimated to cost the state some $50 million annually.
Under the bill, used car dealers would be required to remit to the Department of Motor Vehicles the sales tax due on vehicles they sell, to ensure greater compliance. The provision is anticipated to generate an additional $12 million annually.
The bill would allow aerospace businesses to use the state's advanced strategic aircraft credit to reduce their alternative minimum tax for tax years beginning on or after January 1, 2020, and ending before January 1, 2026, and would extend “the existing carryover period of the prior version of the film and television tax credit” from six to nine tax years, according to the bill’s legislative staff analysis.
Other provisions of the bill would extend until July 2023 a sales tax exemption for diapers and feminine hygiene products.