A pair of bills have recently been signed into law by California Acting Gov. Eleni Kounalakis and Gov. Gavin Newsom that fundamentally changed the state’s business tax landscape, removing the long-standing net operating loss (NOL) deductions that businesses of all sizes have depended on for generations.
With the passing of Senate Bill 167, net operating loss (NOL) deductions are suspended full-stop for businesses with greater than $1 million in income between January 1, 2024, and January 1, 2027. To that end, the allowable carry-forward period is extended by:
- Three years for losses incurred prior to January 1, 2024
- Two years for losses incurred after January 1, 2024, and prior to January 1, 2025
- One year for losses incurred after January 1, 2025, and prior to January 1, 2026
On top of that, Senate Bill 175 puts contingencies around the new rules, which have been established to help stem a significant drop in state revenue that leadership hope to reverse through the removal of NOL deductions. The “revenue trigger provision” would restore the deduction for 2025 (and potentially 2026) if by May 14 of the preceding tax year California’s general fund is deemed sufficient without the increased tax revenue driven by the NOL suspension.
TL;DR: If the state’s own finances are in better shape by next May, legislators can consider reversing the new rules around NOLs.
While that provision offers some potential good news for businesses—despite hardly being a guarantee of a return to business-as-usual regarding NOLs—there are also significant tax credit cutbacks within the legislation.
Long-standing California tax credits hit with new exemptions
Over the same 2024-2027 taxable period of the NOL exemption, certain business tax credits can’t be used to offset more than $5 million in taxable income per year without specific exemptions.
These exemptions primarily apply to personal income tax credits, including those through earned income, low-income housing and foster youths, and the credit for the elective pass-through entity tax.
Of course, there’s more.
The $5 million limit applies in aggregate to members of a group filing a combined California corporate income tax return. The carry-forward period for any credits disallowed as a result is extended by the number of tax years that any portion of the credit was disallowed.
Senate Bill 175 does allow taxpayers to make an irrevocable election to receive an annual refundable credit amount over a five-year period, beginning the third taxable year after the election is made. The refundable credit is equal to 20 percent of the qualified credits that would have been available to the taxpayer if not for the $5,000,000 cap.
Similar to the NOL suspension, the credit limitation will not apply if an annual revenue trigger is met and the state hits it’s budget goals.
Industry-specific limitations part of the mix
Beyond the broad-based restructuring of California’s business tax-code, the new rules also apply (and reinforce) new rules for businesses within specific industries.
On the bright side, cannabis businesses may continue to deduct their “ordinary and necessary business expenses” for state-level taxes through 2030, reinforcing and extending existing tax benefits for this sector.
There’s more bad news for oil and gas businesses, however, who saw significant subsidies removed as part of the bill, including:
- No more deductions for drilling and development costs starting January 2024
- Removal of the depletion deduction for refiners of crude oil with average daily refinery runs that are greater than 75,000 barrels
- A limitation on the credit for qualified oil recovery costs so it only applies for tax years beginning prior to January 2024, with full repeal of the credit effective December 1, 2024.
Finally, retailers and certain affiliates are no longer allowed to use “bad debt deduction” on sales tax for the next three years, with a revised deduction set to return in 2028.
WIth state-level tax credits drying up, federal funding more important than ever
While businesses in California will need to rethink their capital strategy under the state’s new tax framework, they’ll also need to reconsider how they engage with tax credits at the federal level to shore up potential shortfalls that result from this “new normal.”
That includes leveraging federal R&D tax credits for businesses that put innovation at the center of their product development and who already invest heavily into truly unique research and development.
Boast partners with hundreds of innovative businesses across North America to help maximize their access to non-dilutive capital that can extend their innovation runway and stretch the investments their already making into product development further.
Our AI-driven platform gives our R&D tax experts a holistic view into every opportunity to capitalize on federal funding to fuel greater innovation. To learn more about how Boast can help you seamlessly tap into his critical funding, talk to an expert today.
California Business Tax FAQ
- What are the main changes to California’s business tax landscape in 2024? Two new bills, Senate Bill 167 and Senate Bill 175, have significantly altered California’s business tax structure. The key changes include:
- Suspension of net operating loss (NOL) deductions for businesses with over $1 million in income from January 1, 2024, to January 1, 2027
- Limitations on certain business tax credits, capping them at $5 million per year in taxable income offset
- Industry-specific changes, particularly affecting oil and gas businesses
- How does the NOL deduction suspension work? The NOL deduction suspension applies to businesses with over $1 million in income. To compensate, the allowable carry-forward period is extended by:
- Three years for losses incurred before January 1, 2024
- Two years for losses incurred in 2024
- One year for losses incurred in 2025
- What are the new limitations on business tax credits in California? From 2024 to 2027, most business tax credits can’t be used to offset more than $5 million in taxable income per year. Exceptions include personal income tax credits like earned income, low-income housing, and foster youth credits. The $5 million limit applies in aggregate to members of a group filing a combined California corporate income tax return.
- Are there any provisions for potentially reversing these new tax rules? Yes, they include a “revenue trigger provision.” If by May 14 of the preceding tax year, California’s general fund is deemed sufficient without the increased tax revenue from these changes, the NOL deduction and credit limitations could be restored for the following year.
- How can businesses adapt to these new tax changes in California? With state-level tax credits becoming more limited, businesses should:
- Reconsider their capital strategy under the new tax framework
- Focus on federal-level tax credits, such as R&D tax credits for innovative businesses
- Partner with experts to maximize access to non-dilutive capital and federal funding opportunities
- Leverage AI-driven platforms to identify all opportunities for capitalizing on federal funding to fuel innovation
