On June 3, 2020, lawmakers in California announced that they have reached a budget agreement that includes a number of California income tax changes previously proposed by California Governor Gavin Newsom, including a temporary suspension on the use of net operating losses (NOLs) and limitations on business incentive tax credits. While the budget has not been finalized, agreement among the governor, members of the State Senate, and members of the State Assembly on these and other provisions suggests that these provisions are likely to be included in the final budget, which must be finalized by June 15, 2020. Companies with California source income should be aware of the impact to them of these potential changes.
The budget agreement was released as a Floor Report on June 4, 2020 by Assembly Member Phil Ting, Chair of the Assembly Budget Committee. The agreement provides for a temporary suspension on the use of NOL deductions for taxpayers with business income in excess of $1 million in 2020, 2021, and 2022. Accordingly, taxpayers who have historically operated at a loss, but who have substantial business income in any of these years, will not be able to use their historical NOLs to offset income in excess of $1 million for California tax purposes.
Technology companies may often have a significant increase in business income from year to year, including as a result of a one-time sale of assets or cancellation of debt income arising from restructuring debt. In addition, biotech or pharmaceutical companies often enter into large, milestone-based contracts with a substantial upfront payment. These taxpayers may now be faced with California tax on income recognized in 2020, 2021, and 2022 that is apportioned to California, even though NOLs are largely available to offset the income for federal tax purposes. Since these rules would be in effect for the entire 2020 taxable year, taxpayers may have already entered into transactions that would implicate these rules.
The budget agreement also limits the use of business incentive tax credits, including R&D credits, to offset no more than $5 million of tax liability in 2020, 2021, and 2022. The Low-Income Housing tax credit is exempt.