Will the California Budget Include Temporary Tax Increases?

While the Governor and Legislature adopted similar proposals just four years ago at the outset of the pandemic, there are proposed significant, temporary tax increases on California’s business community in the budget proposals currently under consideration.

The net operating loss deduction has historically been suspended for two successive years during poor economic times, roughly every decade or so, including in 2020, 2010, and the early 2000s. The limit on businesses using their earned tax credits is a new proposal, having only been adopted previously in 2020.

Although these two revenue-raising proposals would increase state revenues considerably, they are temporary for up to three years because they are set for a definitive period of time and they could be fully restored to existing law if sufficient revenues are received by the state in next year’s May Budget Revise.

While temporary, they NOL carryover period would be extended for three years, in theory allowing the suspended deductions to be utilized in later years. The same would apply to the credit limit, allowing businesses to utilize those credits in three future years. In the Governor’s May Budget Revision, the following explanation is provided:

Net Operating Losses (NOL) Suspension and Limitation of Credits to $5 million— Suspending the carryover NOL tax deduction for businesses with California income over $1 million and limiting business credit usage to $5 million for tax years 2025, 2026, and 2027, with a trigger to restore if sufficient revenues are determined to be available in the 2025-26 May Revision. The credit limitation does not apply to the Low-Income Housing and Pass-through Entity Elective tax credits. Both the NOLs and credits carryover periods would be extended by three years. This solution replaces the Governor’s Budget proposal to limit NOLs to 80 percent of taxable income.

In addition, the May Revise contains a proposal to reverse long-standing California law that was applied in an Office of Tax Appeals (OTA) case that was unanimously rendered just over three months ago. By “clarifying” the law, the proposal would actually change existing law and would result in a significant tax increase for California businesses by denying certain multinational corporations from obtaining a refund due under existing state law.

The proposed trailer bill language specifies that the changes in law are applicable to tax years “before and after the effective date of the law changes.” Separately listed in the May Revise is the following:

The May Revision includes the following new proposals: • Apportionment Factor—Clarification of existing law that when a corporation receives income that is excluded from taxable business income, it must exclude this income from its apportionment factor. This proposal is projected to increase General Fund revenues by $216 million in the budget window.

As opposed to the May Revise’s proposed prospective application of the NOL suspension and tax credit limitation, the joint legislative budget package would make the NOL deduction suspension and tax credit limitation proposals retroactive to January 1, 2024. The other tax proposals from the Governor’s January 10 budget and May Revise are also adopted. From the Joint Legislative Budget Plan:

Governor’s Proposals. Approves the Governor’s proposal to suspend Net Operating Loss deductions and cap various business tax credits for three years. But, the Legislature’s Plan starts the three year period earlier than the Governor so that the suspension and cap will be in place for tax years 2024, 2025, and 2026. The Legislature’s Plan also includes several other tax and fee proposals advanced by the Governor, including changes to the MCO tax, changes to oil and gas-related taxation, changes to corporate tax apportionment law, and others.

While these proposals have been heard in the Senate and Assembly Budget subcommittees, they have not been considered by the respective Assembly and Senate Revenue and Taxation Committees.