California Suspends NOLs and Limits Business Incentive Tax Credits

California taxpayers face significant upcoming changes to the state’s tax landscape, particularly affecting net operating losses (NOLs) and business incentive tax credits, with the enactment in late June 2024 of S.B. 167 and S.B. 175.

California will suspend the use of NOLs for personal and business taxes for tax years beginning on or after January 1, 2024, and before January 1, 2027. To mitigate the impact on taxpayers, NOLs generated prior to or during the suspension will receive additional carryover provisions:

Additionally, the legislation exempts taxpayers with less than $1 million in California taxable income (post-apportionment) from the NOL suspension. Furthermore, unlike in prior years when California NOLs have been suspended, S.B. 175 allows for the early termination of the NOL suspension if the California Director of Finance determines state revenues are sufficient based on a multi-year forecast.

Business incentive tax credits, including R&D tax credits, will be capped at $5 million for tax years beginning on or after January 1, 2024, and before January 1, 2027. Under the legislation, any disallowed credits will receive additional carryover periods equivalent to the number of years the credits were not allowed.

Similar to the NOL suspension, S.B. 175 provides for the termination of the credit limitation if the state’s Director of Finance forecasts sufficient revenue.

For tax years 2024 through 2026, personal and corporate taxpayers can make an irrevocable election to receive an annual refundable credit amount based on 20% of qualified tax credits, if those credits were limited due to the $5 million cap.

“Qualified credits” are defined under California Revenue and Taxation Code § 17039, subject to limitations outlined in § 17039.4, and include key credits such as California’s research credit and the California Competes credit.

The election can first be made on the 2024 tax return, but the first year that a refund can be claimed is not until the 2027 tax return (after the credit limitation period ends). Given the nuance in timing of when an election needs to be made and when a refundable credit can be received, planning will be essential.

S.B. 167 further clarifies that California Legal Ruling 2006-01, which deals with the apportionment factor treatment of exempt income, remains valid despite recent decisions by the Office of Tax Appeals, most recently the Appeal of Microsoft Corp. and Subsidiaries, No. 21037336, decided on July 27, 2023, and on February 14, 2024. S.B. 167 maintains that non-business income should be excluded from the apportionment factor and allocated, not apportioned, to the state and that only net dividends, not gross, should be included in the denominator of the sales factor.

These changes have significant implications for tax planning purposes. It is crucial to assess how the suspension of NOLs and the cap on business incentive tax credits can affect your tax and financial strategies. Small businesses with less than $1 million in taxable income will find some relief, while those planning to utilize California R&D credits and other incentives may need to reevaluate their tax liabilities for tax years 2024 through 2026.

For more detailed guidance on how S.B. 167 and S.B. 175 may impact your specific situation, contact Sensiba’s State and Local Tax (SALT) team. Our experts are here to help you navigate these changes and optimize your tax position.