California Tax and Policy Monthly: What Businesses Should Know

Update for the third quarter of 2025

A series of legislative, regulatory, and judicial actions in late 2025 will shape California tax and business considerations heading into 2026. Below is a concise roundup of the most consequential tax and policy developments, including changes to pass-through taxation and apportionment rules, new employment mandates, and regulation of emerging technology.

Tax Policy and Administration

Extension of the Elective Pass-Through Entity Tax

As part of California’s 2025 budget package, Governor Gavin Newsom signed SB 132, extending the state’s elective pass-through entity (PTE) tax for five additional years. The regime, originally scheduled to sunset after the 2025 tax year, will now apply to taxable years ending before January 1, 2031.

The extension allows partnerships and S corporations to continue paying entity-level tax and claiming a corresponding owner-level credit, preserving a state-level workaround to the federal SALT deduction cap. SB 132 also modifies the prepayment mechanics. While the June 15 payment date remains relevant, entities that miss the deadline may still make the election, subject to a credit reduction equal to 12.5% of the unpaid or underpaid amount. Fiscal-year filers receive limited transitional relief.

For pass-through businesses, the extension provides planning certainty through the end of the decade, but increases the importance of payment timing and cash-flow management.

Financial Institutions Required to Use Single-Sales-Factor Apportionment

SB 132 also eliminates a long-standing apportionment option for banks and financial institutions. Beginning with taxable years starting on or after January 1, 2025, businesses deriving more than 50% of gross receipts from banking or financial activities may no longer use an equally weighted three-factor formula.

Instead, these taxpayers must apportion income using a single-sales-factor methodology, aligning them with most other California taxpayers. For institutions with significant California customer activity but limited in-state payroll or property, the change may materially increase California tax exposure.

Franchise Tax Board Rulings and New Reporting Requirements

In July, the Franchise Tax Board (FTB) issued Legal Ruling 2025-1 addressing the treatment of Deferred Intercompany Stock Accounts (DISA) in certain nonrecognition transactions. The ruling clarifies how basis adjustments apply in multistate corporate structures, adding complexity for groups engaging in internal reorganizations.

Separately, the FTB introduced new disclosure requirements aimed at evaluating the effectiveness of specific tax expenditures. Taxpayers claiming certain deductions, credits, or exclusions on 2024 returns may be required to file new informational forms documenting usage and outcomes. These reporting changes reflect increased legislative scrutiny of tax incentives and may raise audit or compliance risks.

Revised Market-Based Sourcing Rules for Intangibles

The California Franchise Tax Board finalized amendments to its market-based sourcing regulations governing receipts from intangible property, with the updated rules taking effect for taxable years beginning on or after January 1, 2026.

The revisions place greater emphasis on identifying where the customer receives the benefit of an intangible, rather than relying on legal domicile or contract terms. While described as clarifications, the changes may shift income into California for businesses deriving revenue from licensing, digital services, or technology-enabled offerings.

Multistate taxpayers with significant intangible revenue should reassess sourcing methodologies and documentation well before the 2026 filing season.

Property Tax and Disaster-Related Relief

Hotel Valuation and Enterprise Intangibles

In a significant property tax decision, the California Supreme Court ruled that county assessors may include both transient occupancy tax receipts and certain upfront payments when valuing hotels under the income-capitalization method.

The Court concluded that Los Angeles’s transient occupancy tax and a substantial “key money” payment constituted income from the use of the real property itself. However, the Court also held that enterprise-level intangibles—such as brand goodwill, food-and-beverage operations, and an assembled workforce—must be identified and excluded from assessed value.

The decision reinforces the importance of separating real property income from operating business value in hotel assessments statewide.

Expanded Income Tax Exclusion for Wildfire Settlements

SB 159, enacted in September, broadened and clarified California’s exclusion from gross income for qualified wildfire settlement payments. The exclusion applies retroactively to tax years beginning on or after January 1, 2021, and extends through January 1, 2030.

Recent amendments refine eligibility definitions to reduce uncertainty around which payments qualify, including amounts tied to property damage, relocation costs, and other wildfire-related losses. Businesses and individuals affected by California wildfires should review settlement agreements and prior filings to assess refund or amendment opportunities.

Permanent Extension of Non-Resident Alien Filing Provisions

Separate legislation permanently extends administrative provisions affecting non-resident aliens with California-source income. Eligible taxpayers may continue to elect inclusion in group non-resident returns instead of filing individually, and estimated tax payment requirements have been eliminated for those making the election. The changes simplify compliance for employers and international assignees alike.

Federal Trade Signals Affecting California Industries

Former President Donald Trump renewed threats in late September to impose a 100% tariff on films produced outside the United States, arguing that foreign incentives have displaced domestic production, particularly in California.

The announcement lacked detail, and no executive order or regulatory guidance has been issued. While speculative, the proposal bears watching for studios, distributors, and investors with cross-border production or financing arrangements.

Employment and Workforce Policy

As the 2025 legislative session closed, dozens of workplace-focused bills awaited gubernatorial action ahead of the October signing deadline. Many measures would expand employee protections, increase employer reporting obligations, or enhance enforcement authority.

Separately, several employment laws enacted earlier in the year will take effect in 2026, covering wage and hour standards, paid leave mandates, and personnel record requirements. Collectively, these changes continue California’s trajectory toward broader employee protections and higher compliance costs.

Local Authority, Small Business, and Innovation

Small Business Procurement and Licensing

Legislative activity during the summer months highlighted proposals to expand small business participation in public contracting. SB 781, though not enacted, would have authorized local Small Business Utilization Programs with participation targets and reporting requirements, signaling ongoing interest in procurement reform.

Other measures addressing licensing, cannabis regulation, lodging taxes, and local revenue authority advanced through committee, underscoring continued legislative focus on small business regulation.

Artificial Intelligence Transparency Requirements

In September, California enacted SB 53, establishing one of the nation’s first transparency regimes for advanced artificial intelligence systems. The law applies to companies meeting defined revenue and model-complexity thresholds and requires public disclosures of risk assessments, safety practices, and significant incidents.

The statute also includes whistleblower protections and reporting obligations, positioning California as an early mover in AI governance and adding compliance considerations for large technology developers.