Reed Smith Client Alerts

On June 29, 2020, California Governor Gavin Newsom signed the state’s fiscal year 2020-2021 budget which includes some noteworthy tax provisions, notably a suspension of deductions for net operating losses and a restriction on the utilization of business tax credits. Both provisions are intended to address a $54 billion projected budget shortfall due to the COVID-19 pandemic. For tax years beginning on or after January 1, 2020 and ending on or before December 31, 2022, businesses with modified adjusted gross income of $1 million or more may not offset taxable income through the use of net operating losses and businesses may not offset more than $5 million of tax liability through the use of tax credits. Also, proposed legislation is making its way through the California legislature that would expand California’s False Claims Act statute to include tax claims, thereby allowing whistleblowers to sue taxpayers for perceived tax transgressions.

Auteurs: Shail P. Shah Rebecca G. Durham

2020-2021 Budget

Assembly Bill 85, (“A.B. 85”) included in the signed 2020-2021 budget, provides for the following California tax changes:

  • Net Operating Losses (NOLs) – NOLs are suspended for taxpayers with business income or adjusted gross income of $1 million or more for tax years beginning on or after January 1, 2020 and ending on or before December 31, 2022. Like prior NOL suspensions in California, the legislation allows for an extended carryover period to take into account the tax years in which taxpayers were unable to utilize the losses.
  • Business Tax Credits – Business incentive credits, with the exception of low-income housing credits, may not offset more than $5 million of tax for tax years beginning on after January 1, 2020 and ending on or before December 31, 2022. Similar to the NOL suspension, the legislation allows for an extended carryover period to take into account the tax years in which taxpayers were unable to utilize the credits.

Reed Smith Insights1

Like prior NOL suspensions in California (2002-2003 and 2008-2011), A.B. 85 extends the standard NOL carryforward period due to suspended NOLs. For the prior suspensions, the FTB took the position that the carryforward period was only extended to the extent that a taxpayer’s NOL deduction would have produced a tax benefit during a year covered by the suspension.2 Assuming the FTB takes a similar position for the 2020-2022 suspension, we believe that the FTB’s stance is contrary to the statute. A.B. 85 simply provides that if the deduction is denied as a result of the statute, then the loss carryover period is extended based on the years in which the deduction is denied. A.B. 85 does not include a provision limiting the extension to taxpayers that would have benefitted from the NOL in a tax year covered by the extension. Consequently, affected taxpayers should take the position that all California NOLs are extended one year for each year of the upcoming suspension period.