California Enacts Income Tax Changes to Address the State’s Budget Deficit
July 30, 2024
At a glance
- The main takeaway: California’s final agreement on a budget bill makes notable tax law changes to personal and corporate income tax, including a statutory reversal of the recent Microsoft decision (Microsoft Fix).
- Assess the impact: Businesses must consider the impact of these tax law changes and whether their apportionment calculations from prior years are consistent with the Microsoft Fix.
- Take the next step: Aprio’s State and Local Tax (SALT) team can help you determine the appropriate adjustments to your estimated tax payments and other compliance obligations.
Schedule a free consultation today to learn more!
The full story
The Governor of California, Gavin Newsome, recently signed two pieces of tax legislation into law. Senate Bill 167 (H.B. 167), signed June 27, 2024, makes several changes to California’s personal and corporate income tax, and Senate Bill 175 (S.B. 175), a companion bill signed on June 29, 2024, provides some relief to certain taxpayers impacted by S.B. 167. This article summarizes some of the most notable tax changes from these new bills and how they will impact individuals and businesses.
Limitation on the use of tax credits
S.B. 167 makes the following changes to the use of tax credits:
- For tax years beginning on or after January 1, 2024, and before January 1, 2027, the utilization of certain personal and business credits, such as the state’s research and development tax credit and the California competes tax credit, are capped at $5,000,000. For taxpayers included in a combined report, the cap is applied on an aggregate basis.
- Certain tax credits are not subject to this cap, including the state’s pass-through entity tax credit and the low-income housing tax credit.
- Carryover periods will be increased by the number of years that a credit amount was not allowed due to the cap.
S.B. 175 provides some potential relief from the credit cap as follows:
- For tax years beginning on or after January 1, 2024, and before January 1, 2027, taxpayers will be permitted to make an annual irrevocable election to receive an “annual refundable credit amount” for certain tax credits. The “annual refundable credit amount” equals 20% of the amount of such credit that would have been available if not for the credit cap enacted as summarized above. Such amount will be applied during the “refundable period,” which is the first five consecutive tax years beginning on the third taxable year after the taxable year for which the election was made. Previously these tax credits were nonrefundable.
- For tax years 2025 and 2026, the credit limitation may not apply if the Director of Finance determines that multi-year revenue forecast is sufficient notwithstanding the impact of the credit cap and the net operating loss (NOL) deduction suspension (summarized below).
Suspension of net operating loss deduction
S.B. 167 makes the following changes regarding the state’s NOL deduction:
- For tax years beginning on or after January 1, 2024, and before January 1, 2027, the NOL deduction is temporarily suspended, except for taxpayers with less than $1 million of income subject to California tax.
- The NOL carryover period is increased by: (a) one year for losses incurred during the 2025 tax year; (b) two years for losses incurred during the 2024 tax year; and (c) three years for losses incurred prior to the 2024 tax year.
S.B. 175 provides some potential relief from the NOL deduction suspension as follows:
- For tax years 2025 and 2026, the credit limitation may not apply if the Director of Finance determines that multi-year revenue forecast is sufficient notwithstanding the impact of the credit cap (summarized above) and the NOL deduction suspension.
Apportionment factor exclusion Microsoft Fix
A few months ago, we wrote an article regarding Microsoft’s successful claim that the denominator of its California sales factor should include all its repatriated dividends even though 75% of those dividends were deducted and not included in apportionable business income.
Facing the potential of refund claims from other taxpayers and a significant budget impact, S.B. 167 reverses the Microsoft decision. Specifically, the legislation excludes from the apportionment formula any transaction or activity to the extent it generates income or loss not includible in “net income” for any reason, including due to an exclusion, deduction, exemption, elimination, or nonrecognition.
In addition, the legislation states that this amendment represents a declaration (as opposed to a change) of existing law, specifically the California Franchise Tax Board’s Legal Ruling 2006-01 (the reasoning of which was rejected by the Office of Tax Appeals in the Microsoft decision). As a result, this legislative amendment applies to tax years beginning before, on, or after the legislation’s effective date.
The bottom line
Businesses should consider the impact of these tax law changes, including whether its apportionment calculations for prior years are consistent with the Microsoft Fix. Aprio’s SALT team can assist you with understanding the impact of these changes to ensure that you are making appropriate adjustments to estimated tax payments and other compliance obligations. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
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About the Author
Jeff Glickman
Jeff Glickman is the partner-in-charge of Aprio, LLP’s State and Local Tax (SALT) practice. He has over 18 years of SALT consulting experience, advising domestic and international companies in all industries on minimizing their multistate liabilities and risks. He puts cash back into his clients’ businesses by identifying their eligibility for and assisting them in claiming various tax credits, including jobs/investment, retraining, and film/entertainment tax credits. Jeff also maintains a multistate administrative tax dispute and negotiations practice, including obtaining private letter rulings, preparing and negotiating voluntary disclosure agreements, pursuing refund claims, and assisting clients during audits.
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