California Gov. Gavin Newsom (D) has approved the state's $202 billion fiscal 2021 budget, including a bill temporarily restricting the use of net operating losses and business tax credits in light of the state’s projected drop in revenue stemming from the COVID-19 pandemic.
The budget package, signed June 29, seeks to close a projected $54 billion deficit through a variety of maneuvers, including cuts, reserve spending, and temporary limits on business tax breaks. California is also hoping to receive a portion of the proposed $1 trillion federal bailout for all states.
The business tax measures are in budget trailer bill A.B. 85. For 2020, 2021, and 2022, the legislation suspends the use of NOLs by taxpayers with net business income or modified adjusted gross income of $1 million or more in a given year. For the same three years, it also limits taxpayers' ability to use business tax credits to offset more than $5 million of their annual tax liabilities. Those provisions are retroactive to the start of 2020.
The legislation also extends the time period for taxpayers to carry forward and use the NOLs and the amount of credits that they're prevented from using during any or all of those three years as a result of the temporary restrictions.
A.B. 85 temporarily expands the one-time exemption from the state’s $800 annual minimum franchise tax to include new partnerships, limited liability companies, and limited partnerships. That tax break normally applies only to entities taxed as corporations. The temporary expansion will run from 2021 through the end of 2023 and will cost the state roughly $50 million in 2021.
The bill also allows aerospace companies to use the advanced strategic aircraft credit to reduce their alternative minimum tax liability for tax years 2020 through 2025; extends from six years to nine years the carryover period for some film and television production tax credits; requires used car dealers to remit sales tax on cars that they sell to the state Department of Motor Vehicles; and extends the sales tax exemption for diapers and feminine hygiene products to July 2023.
According to the bill analysis by legislative staff, its provisions are expected to collectively net an additional $4.4 billion in state revenue for the upcoming fiscal year, with most of that coming from the suspension of NOLs and the capping of business tax credits. The changes are projected to net roughly $3.3 billion in fiscal 2022, and $1.5 billion in fiscal 2023.
A.B. 85 was backed by the State Legislature's Democratic majority, who argued that the tax increases would help avoid cuts to important programs, while mainly affecting larger businesses and exempting smaller ones. Republican lawmakers, however, criticized it as a tax increase during a time of economic vulnerability.
The California Taxpayers Association also criticized the bill. Robert Gutierrez, president of the association, told Tax Notes June 30 that while “there are no good options when it comes to bridging a multibillion-dollar deficit,” A.B. 85 “hinders economic recovery by increasing taxes retroactively on California employers.”
“Now that our home-state employers have taken this $9.2 billion hit, all other tax increases must be taken off the table,” Gutierrez said.
Correction, July 1, 2020: An earlier version of this article stated that California is hoping to receive a $1 trillion federal bailout. The proposed bailout amount is for all the states, and California is seeking only a portion of it.