Two companion tax bills that recently passed in California suspend the ability of most taxpayers to claim a net operating loss (NOL) deduction in 2024 through 2026 and place a $5 million limitation on the aggregate amount of most income tax credits that can be claimed in 2024 through 2026.
Law background
Senate bill 167 was signed by California’s governor on June 27, 2024, and contained a number of important changes to California tax law, including new limitations on the ability to use NOLs and business credits in tax years beginning on or after Jan. 1, 2024, and before Jan. 1, 2027 — tax periods beginning in the 2024 through 2026 calendar years. Additionally, a companion tax bill, SB 175, was signed into law on June 29, 2024, augmenting certain provisions of SB 167.
California’s new attribute limitations and selected other provisions of SB 167 and SB 175 are summarized below.
NOL deduction suspension
As noted, SB 167 disallows an NOL deduction for most California taxpayers in tax years beginning on or after Jan. 1, 2024, and before Jan. 1, 2027. For taxpayers whose NOL deduction is denied by this law change, the carryover period will be extended as follows:
One year for losses incurred in tax years beginning on or after Jan. 1, 2025, and before Jan. 1, 2026
Two years for losses incurred in taxable years beginning on or after Jan. 1, 2024, and before Jan. 1, 2025
Three years for losses incurred in taxable years beginning before Jan. 1, 2024
It has historically been the position of the California Franchise Tax Board (FTB) that the carryover extension is only available to the extent that it is the NOL suspension itself that prevents the utilization of NOLs. Accordingly, if a company is in losses during the suspension years and would not have utilized NOLs in the absence of the suspension, the carryover period extension may be unavailable.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
Small business exception included in NOL suspension
A small business exception to the NOL suspension applies to taxpayers with income subject to tax under the Corporation Tax Law of less than $1 million for the taxable year.
Consistent with California’s post-apportioned approach to NOLs, this exception appears to apply separately on a taxpayer-by-taxpayer basis in instances where there are multiple corporate taxpayers in a combined reporting group.
For taxpayers subject to California’s Personal Income Tax law, there is a similar small business exception providing that the NOL suspension shall not apply to taxpayers having either:
Net business income of less than $1 million for the taxable year
Modified adjusted gross income of less than $1 million for the taxable year.
$5 million credit limitation
SB 167 also limits the use of business tax credits to offset tax only to up to $5 million for each
taxable year beginning on or after Jan. 1, 2024, and before Jan. 1, 2027. Concerning this annual business credit limitation, SB 167 specifies that for taxpayers required to be included in a combined report, this limitation is applied to the entire group, which shall not reduce the aggregate tax of all members by more than $5 million during each of the limitation years.
For taxpayers whose credit utilization is disallowed under SB 167, the legislation provides that the carryover period for any disallowed credit shall be increased by the number of taxable years the credit or any portion thereof was not allowed.
Exceptions to credit limitation
For corporate taxpayers, this limitation applies to all credits allowable under Chapter 3.5 of the Corporation Tax Law other than the credit allowed by California Revenue and Taxation Code (CRTC) Section 23610.5 relating to credit for low-income housing, which is exempted from the limitation.
For taxpayers subject to the Personal Income Tax Law, SB 167 exempts certain types of credits from the definition of a business credit. Particularly noteworthy is the exclusion from this definition of the credit allowed by CRTC Sec. 17052.10 relating to California’s elective pass-through entity tax under the Small Business Relief Act. A complete list of exempted credits can be found in CRTC Sec. 17039.4.
Refundable suspended business credit election
SB 175 adds an annual election in 2024 through 2026 whereby an electing taxpayer can receive a refundable tax credit equal to the value of credits in excess of $5 million that are disallowed in a given year under the provisions of SB 167.
For an electing taxpayer, this annual refundable credit would become available for use during the five consecutive taxable years beginning the third taxable year after the tax year in which the election is made.
During this five-year refundable period, the amount of refundable credits that may be claimed each year will be equal to 20% of the qualified credits that would have otherwise been utilized by the taxpayer in the absence of the $5 million limitation in the year of the election.
Potential trigger allowance for 2025–2026
The companion tax bill, SB 175, adds a conditional trigger provision to the NOL deduction suspension withdrawing the suspension if the State Director of Finance determines that General Fund money over the multiyear forecast is sufficient to meet revenue needs in one or both of 2025 or 2026.
Although this trigger provision leaves 2024 unaffected, if the General Fund money over the multiyear forecast is sufficient to meet revenue needs in one or both of 2025 or 2026, the suspension may potentially go away in one or both of those years.
SB 175 adds the same conditional trigger language to the $5 million credit limitation, providing that it won’t apply in 2025 or 2026 if the multiyear forecast is sufficient to meet revenue needs in one or both of 2025 or 2026. This leaves 2024 unaffected but opens the door to the $5 million business credit limitation potentially ending early in 2025 or 2026.
Attempted legislative reversal of the recent Microsoft decision
In an attempt to mitigate the fiscal impact of the California Office of Tax Appeals’ (OTA) unanimous decision in the Appeal of Microsoft Corporation relating to the includability of gross receipts from deductible dividends in the computation of the sales factor, SB 167 declares that FTB Legal Ruling 2006-01 shall apply with respect to apportionment factors of taxpayers subject California’s Corporation Tax Law.
SB 167 further declares that any transaction or activity, to the extent that it generates income or loss not included in net income subject to apportionment, must be excluded from the apportionment formula.
Under SB 167, this legislative declaration is identified as not constituting a change in law, but rather as declaratory of existing law and applicable to all taxable years beginning before, on, or after the effective date of the legislation.
The collateral implications of this legislative declaration regarding the composition of the sales factor are, at best, unclear. This legislative language could potentially have significant consequences that reach well beyond the issue addressed by the OTA in the Appeal of Microsoft.
Other important changes in SB 167
Intangible drilling and development cost deduction changes
Based on modified conformity with federal income tax laws, California had historically allowed:
A deduction for intangible drilling and development costs related to oil wells, gas wells, and geothermal wells
An income tax deduction for depletion of natural resource deposits based on a percentage of gross income from the property
SB 167 disallows the deduction for intangible drilling and development costs in the case of oil and gas wells paid or incurred on or after Jan. 1, 2024.
Additionally, for tax years beginning on or after Jan. 1, 2024, SB 167 disallows the calculation of depletion of natural resource deposits as a percentage of gross income from the property for specified natural resources, including coal, oil, oil shale, and gas.
Elimination of automatic conformity to IRS disaster related postponements
Under SB 167, the postponement of certain tax related deadlines will now be determined by the State Director of Finance, whose office is also tasked with determining whether a taxpayer is affected by a state of emergency.
Prior to SB 167, California generally conformed to Internal Revenue Code Section 7508A relating to postponement of certain tax-related deadlines, and the FTB was tasked with determining whether a taxpayer was affected by a state of emergency declared by the governor.
Considerations
Practitioners and taxpayers are encouraged to consider the potential impacts of the tax law changes made by SB 167 and SB 175.
For California taxpayers that have had historically utilized significant NOLs or business tax credits to mitigate their California tax liability, it may be an appropriate time to consider opportunities to accelerate deductions in the NOL suspension and credit limitation years to mitigate against the potential application of attribute limitations, or to consider ways to accelerate income into the 2023 tax year, when the attribute limitations of SB 167 are not yet in play.
Additionally, for those multistate businesses impacted by the NOL suspension and credit limitation, it may be an opportune time to review historical positions regarding the sourcing of receipts and apportionment of income to California.
