Repeal of NOL and Tax Credits Suspension Absent from Proposed Tax Agenda
Key business tax provisions remain in effect while short-term fiscal outlook strengthens.
In June 2020, amid a projected budget crisis, California imposed a three-year suspension of the net operating loss (NOL) deductions and business incentive tax credits crisis. The projected budget deficits did not emerge, and state tax revenues have instead continually exceeded projections. Given the improved fiscal situation, businesses are beginning a push to reverse the NOL and tax credit suspensions, but lawmakers have so far not addressed the topic.
AB 85 and Projected Budget Crisis
Facing a projected deficit of more than $54 billion, California lawmakers passed AB 85, a budget trailer bill that suspended NOL deductions for three years for corporate and individual taxpayers with incomes of more than $1 million. The bill also imposed a $5 million limit on business incentive tax credits for three years for a combined group.
According to a June 2020 analysis of AB 85, the provisions of the bill would provide a net benefit to the state’s general fund of approximately $4.4 billion for the 2020-21 fiscal year, including $1.8 billion from the NOL suspension, $2 billion from the tax credit limits, and $611 million from the interaction between the two provisions.
Governor Gavin Newsom argued at the time that suspension of the business provisions “recognize[s] the disproportionate tax relief that has been provided to larger corporations, compared to small businesses, which has resulted in relatively lower tax payments.” He said the proposed thresholds and limits for the suspension of NOL are “in recognition of the COVID-19 Recession and its impacts on small businesses.”
California has used NOL suspensions and tax credit limitations during past budget crises. The state suspended NOL deductions and carryovers for tax years 2002 and 2003 and extended the carryover periods by one year for losses incurred in 2002 and by two years for losses incurred before 2002. California also suspended the NOLs and carryovers for 2008-2009 and extended the carryover period through 2011 for losses occurred in 2008.
California selectively conforms to the federal tax code regarding the treatment of NOL deductions and carrybacks. Notably, it did not conform to the NOL changes in the CARES Act, which amended Section 172(a) of the Internal Revenue Code to allow businesses to carry back NOLs incurred in 2018, 2019 and 2020 for up to five years and allowing taxpayers to offset fully 2020 or prior-year taxable income.
Outlook
Recently, a group of 25 California legislators wrote to the chairs of the of the Assembly Budget Committee and Assembly Budget Subcommittee on State Administration asking them to support a reversal of the suspension, according to The Center Square. However, the outlook for long-term deficits in California could bring continued pressure to raise taxes and make the repeal of the NOL and tax credit suspensions unlikely. Legislators could come under pressure, however, if economic growth falters. The NOL deduction is viewed as critical for promoting business investment, as it allows businesses to “smooth” income by using immediate short-term losses to offset later taxable income.