Facing a projected $54 billion budget deficit, California Governor Gavin Newsom was forced to go back to the budget drawing board. In an effort to close the deficit gap, Governor Newson revised his initial fiscal year 2020-2021 budget proposal to include familiar, yet for many taxpayers unwelcome, tax provisions.

Notably, the revised budget’s tax proposals suspend the use of net operating loss carryforwards (“NOLs”) entirely for taxpayers with net business income of $1 million or more, and limits the use of certain business tax credits to $5 million total for 2020, 2021, and 2022.  A.B. 85 also contains a number of other provisions governing a wide range of areas, including sales tax on used vehicles and a strategic aircraft credit.  

On Monday, the California Senate approved A.B. 85 (also approved by the California Assembly) and sent it to Governor Newsom for signature.  The bill incorporates the tax provisions contained in the Governor’s budget; as such, it is highly likely to be signed into law.  

This isn’t the first time California taxpayers have faced tax provisions like these. In response to budget shortfalls induced by the 2008 recession, then Governor Schwarzenegger signed legislation that restricted the use of NOLs and tax credits for 2008 and 2009. The restrictions were subsequently extended to cover 2010 and 2011. 

While California may be among the first states to limit NOLs and tax credits in response to the abrupt economic downturn attributable to COVID-19, it is far from the only state feeling the tension between increased social spending, decreased tax revenue, and balanced budget requirements. Taxpayers should prepare for other states to follow suit and enact similar provisions, as well as take other revenue-seeking measures, such as increasing tax rates and ramping up audit activity. 

A&M Taxand Says

Although A.B. 85 is expected to generate over $9 billion in income taxes, the news isn’t all bad for taxpayers.  For example, the period within which to use limited losses and credits is extended by the bill.  Additionally, A.B. 85 extends the sales and use tax exemption on the sale, storage, use, or consumption of diapers until July 1, 2023 and also extends the motion picture tax credit carryover period from six years to nine years.  Historically, many taxpayers ignored the California credits because of their ability to utilize NOLs to offset income.  Now, taxpayers may want to revisit the use of credits (notably R&D credits) due to the inability to utilize NOLs for three years (assuming the bill is signed into law).  Additionally, taxpayers may want to consider options to accelerate income into 2019, to the extent it is able to offset such income with NOLs. A&M is happy to assist taxpayers in evaluating the possibility of qualifying for or utilizing credits or the ability to make California elections or change their California method of accounting.