On June 27, California enacted Senate Bill (S.B.) 167 and on June 29 California enacted S.B. 175. Following are highlights of the legislation:
NOL and credit suspension
The recent California legislation suspends the use of the NOL deduction for corporate and individual taxpayers with California net income or modified adjusted gross income of $1 million or more for tax years beginning on or after Jan. 1, 2024, and before Jan. 1, 2027. It also extends the NOL deduction carryover period for up to three years for any NOL for which a deduction was denied during the suspension period.
California has a history of suspending or limiting NOLs. Most recently, the NOL deduction was suspended for the 2020 through 2022 tax years. This suspension later was repealed for the 2022 tax year.
The legislation also imposes an annual $5 million limitation on the use of income tax credits, including the California pass-through entity elective tax credit, for tax years beginning on or after Jan. 1, 2024, and before Jan. 1, 2027. Any income tax credit not allowed due to the annual limitation is allowed an additional carryover period equal to the number of taxable years that the income tax credit was disallowed. Similar to the NOL suspension, a $5 million credit limitation originally was in place for the 2020 to 2022 tax years and later was repealed for the 2022 tax year.
It is unclear whether an accelerated repeal of the NOL deduction suspension or the annual credit limitation will occur similar to last time. However, the legislation does allow the governor to end the NOL deduction suspension and annual tax credit limitation earlier if state revenue satisfies certain parameters.
Crowe observation
Certain taxpayers expecting to claim an NOL deduction in 2024 might not be able to do so. Regarding 2024 estimated payments, California law provides an estimated tax understatement penalty exception when the underpayment is created or increased by legislation that was enacted and operative during the year of the underpayment.
Refundable credits
For tax years beginning in 2024, 2025, and 2026, the legislation offers taxpayers an irrevocable annual election on a timely filed original return to receive a refund of 20% of most tax credits that would have been taken on their California income tax return filed for that year if the $5 million annual limitation on the use of tax credits was not enacted. Credits not eligible for this refundable election include the California pass-through entity elective tax, earned income, household and dependent care, renters, and low-income housing credits. These refunds will occur beginning in the third taxable year after the taxable year in which the election was made.
Sales factor gross receipts
The legislation prohibits taxpayers from including in their sales factor apportionment formula any income not included in California net income. This change effectively overrules the Office of Tax Appeals’ recent decision in Microsoft Corporation & Subsidiaries. The legislative analysis released by the California Assembly and Senate indicates that this change is intended to be declaratory of existing law, signaling that the recent legislation will be applied retroactively as well as prospectively.
Other tax changes
- Beginning Jan. 1, 2025, the legislation will exclude lenders and affiliates of retailers from the definition of retailer for purposes of the sales and use tax bad-debt deduction. Current treatment allows lenders, retailers, and retailer affiliates to claim a bad-debt deduction for sales and use tax purposes.
- The legislation extends from tax year 2025 to tax year 2030 the period that cannabis businesses subject to the personal income tax may claim business deductions. In contrast to the federal tax provisions, California currently allows such deductions under the state corporate income tax provisions.
- The legislation requires the California Director of Finance to determine when IRC Section 7508A, regarding the postponement of certain federal tax-related deadlines, applies to a taxpayer affected by a state of emergency declared by the governor. Additionally, during any period beginning on the date the state postponement period expires and ending on the date the federal postponement period expires, IRC Section 7508A will apply to an affected taxpayer that requests relief from the Franchise Tax Board and provides specified supporting documentation.
Looking ahead
Changes to California tax law could have a significant impact on California taxpayers for the 2024 tax year and beyond. Taxpayers with significant income tax credits, NOLs, items of income not in the California tax base, and retailers claiming a bad-debt deduction should consult with their tax adviser regarding these legislative changes.
