California Corporate Tax Changes Look to Raise Revenue and Aid Small Businesses

The California legislature made several corporate tax changes during the 2019-2020 legislative session as part of its response to the economic downturn caused by the COVID-19 pandemic. These changes not only affect California businesses now but also provide an indicator of the direction that tax policy could take as the pandemic response continues during the 2021-2022 legislative session.

The early focus of the tax changes was largely on raising revenue through a suspension of NOL deductions and limits on tax credits. Additional changes include provisions to help businesses through an extension of the first year exemption of the franchise tax, CARES Act loan forgiveness, and small business hiring tax credits, and recent actions by the governor provide further tax relief for small businesses.

NOL Suspension

The most significant business tax provisions from the legislative session were included in AB 85, one of several budget trailer bills that implemented California’s 2020 Budget Act. AB 85 suspends NOL deductions for corporate and individual taxpayers with net business income or “modified adjusted gross income” of more than $1 million for 2020, 2021, and 2022. For deductions denied under the provision, the bill extends the 20-year NOL carryover period by one year for losses incurred in 2021 tax years; by two years for losses incurred in 2020 tax years, and by three years for losses incurred in taxable years beginning before January 1, 2020.

The Tax Cuts and Jobs Act (TCJA) repealed the two-year NOL carryback, reduced the NOL deduction from 100 percent to 80 percent of taxable income for NOLs after 2017, and allowed for an indefinite carryover for NOLs after December 31, 2017. California selectively conformed to these changes in 2019, as it eliminated carrybacks for NOLs after December 31, 2018, but it did not conform to the 80 percent deduction limitation or the unlimited carryforward, instead keeping the pre-TCJA 20-year carryforward period.

Tax Credit Limitations

AB 85 also limits business incentive tax credits for a combined group to $5 million in tax liability for 2020, 2021, and 2022. The $5 million limit applies to most California business credits otherwise allowable under Chapter 3.5 of the California Revenue and Taxation Code, which includes the research and development tax credit under Section 23609. The limit does not apply to certain credits for low-income housing, solar energy, hiring, and personal income tax. For credits otherwise allowable under Section 12207 that are disallowed due to the $5 million limit, the carryover period is increased by the number of years the credit or any portion of the credit was disallowed. Taxpayers can carry over otherwise allowable credits under Section 12208 that are disallowed due to the $5 million limit for as many years as necessary until they use the full amount.

Extension of Franchise Tax “First Year” Exemption

AB 85 also extends the first year exemption from California’s $800 minimum franchise tax to cover limited partnerships, limited liability partnerships, and limited liability companies that register or organize to do business in the state. This extension is for taxable years beginning on or after January 1, 2021 and before January 1, 2024. The first year exemption was previously available to qualified corporations only.

PPP Loan Forgiveness

AB 1577 conforms California law to the CARES Act by allowing businesses to exclude from gross income amounts forgiven under the Paycheck Protection Program (PPP) and subsequent amendments to the Paycheck Protection Program and Health Care Enhancement Act of 2020. The bill also denies credits and deductions for expenses paid from the forgiven loans that are otherwise allowed under the personal income tax or corporate income tax sections of the California Revenue and Taxation Code.

Small Business Hiring Tax Credit

SB 1447 created a $100 million hiring tax credit program for qualified small businesses. The hiring credit is equal to $1,000 for each net increase in qualified employees by November 30, 2020, with a limit of $100,000 for each qualified small business employer. To be eligible, businesses must have had fewer than 100 employees before the pandemic and must be able to demonstrate that they had a 50 percent decrease in gross receipts in the second quarter of 2020 compared to the second quarter in 2019. To receive the credit, companies must apply for a “credit reservation” on a first-come, first-served basis from December 1, 2020 through January 15, 2021.

Small Business Sales Tax Relief

On November 30, 2020, California Governor Gavin Newsom directed the California Department of Tax and Fee Administration to reopen its program to provide temporary tax relief for businesses impacted by COVID-19 restrictions. Taxpayers filing less than $1 million in sales tax will receive an automatic three-month extension on payments and returns originally due between December 1, 2020 and April 30, 2021. Businesses with up to $5 million in taxable sales will also be eligible for a 12-month, interest-free payment plan for up to $50,000 in sales and use tax liability for fourth quarter 2020 and first quarter of 2021; this also includes businesses with an existing payment plan. Businesses with sales greater than $5 million that also have a significant drop in sales due to operational restrictions related to the pandemic will also be eligible for interest-free tax payment plans.

Implications

The California legislature’s ongoing and evolving response to the COVID-19 pandemic could result in further tax changes for 2021 and beyond. Weaver will continue to monitor tax legislation that could impact California taxpayers when the new legislative session reconvenes for regular session on January 4, 2021. For more information, contact us. We’re here to help.

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