On June 13,, 2024, the California legislature passed budget legislation that included multiple changes to the Revenue and Taxation Code. Specifically, the changes affect net operating loss (NOL) deductions, utilization of credits, and calculation of the apportionment factor. The legislation takes effect immediately upon being signed into law by the governor.

Tax changes

If enacted into law, the legislation will impact the following:

NOL suspension

The NOL deduction, which uses prior year net losses to offset current year income, would be suspended in tax years 2024, 2025, and 2026 for taxpayers with net business income or modified adjust gross income greater than $1 million. 

NOLs generated before Jan. 1, 2024, will have the carryover period extended by three years. NOLs generated from Jan. 1, 2024 and before Jan. 1, 2025, will have the carryover period extended by two years. NOLs generated from Jan. 1, 2025 to Jan. 1, 2026, will have the carryover period extended by one year.

Credit limitation

The legislation caps at $5 million the amount of business credits that may be utilized in a single year for tax years 2024, 2025, and 2026. Excluded from the cap is the credit for low-income housing. Similar to the NOL suspension, the credit carryover period is extended for any credits subject to the imposed utilization cap.

The legislation includes a statement of intent to enact future legislation that would allow taxpayers to elect to receive a refund of the tax credits that are disallowed under the credit limitation in the first taxable year immediately following the last taxable year of the credit limitation period. 

Apportionment formula

Included in the legislation is language codifying Legal Ruling 2006-1, which provides that transactions and activities generating income or loss that are excluded from net income are to also be excluded from the apportionment formula. This clarifying language is in response to the recent ruling in Appeal of Microsoft, 2024-OTA-130, wherein the Office of Tax Appeals rejected the application of Legal Ruling 2006-1 as inconsistent with the law in certain circumstances. The codification is retroactive and will apply to any apportionment formula allowed under California’s Uniform Division of Income for Tax Purposes Act, and is explicitly intended as a clarification of existing law rather than a change to it.

What does CohnReznick think? 

Taxpayers in California should be mindful of the impact the NOL suspension and limitation on the use of credits will have on multiyear tax planning for tax years 2024-2026. These changes to the tax law may warrant reevaluation of existing tax planning that included the usage of NOLs or credits that would be denied under this legislation. Regarding the apportionment formula related legislation, the clarification may have significant impact on taxpayers that were considering refund claims in the wake of the Microsoft decision due to the legislation’s retroactivity. Given the effects this legislation can potentially have, taxpayers are encouraged to consult with their tax advisors to determine what impact the legislation may have on them.

_{Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.}