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New budget legislation, SB 167, passed by the California Legislature on June 13th and signed into law by the governor on June 27, 2024 will have significant impacts on taxpayers by suspending net operating loss (NOL) deductions and limiting the utilization of credits from 2024 through 2026.
NOL Suspension
For taxpayers with net business income or a modified adjusted gross income of $1 million or more, NOL deductions are suspended for tax years beginning on or after January 1, 2024 and before January 1, 2027.
NOLs or NOL carryovers that are denied due to the suspension will have an extended carryover period under Internal Revenue Code (IRC) Section 172 as follows:
- By one year, for losses incurred in taxable years beginning on or after January 1, 2025, and before January 1, 2026.
- By two years, for losses incurred in taxable years beginning on or after January 1, 2024, and before January 1, 2025.
- By three years, for losses incurred in taxable years beginning before January 1, 2024.
Credit Limitation
The legislation also limits business credits, including carryovers, to $5 million for each taxable year beginning on or after January 1, 2024 and before January 1, 2027. If a credit is disallowed due to the limitation, the carryover period will be increased by the number of tax years that the credit (or portion thereof) was disallowed.
This limitation applies to most business credits, including the California Research Credit.
Potential for Relief
A subsequent bill, SB 175, passed by the Legislature on June 26th and approved by the governor on June 29, 2024 provides that the NOL suspension and credit limitation could be lifted for the 2025 and 2026 tax years if the Director of Finance determines that the General Fund money over the multiyear forecast is sufficient without the revenue impact of the suspension and limitations.
Refundable Credit Election
SB 175 also provides an irrevocable election to receive an annual refundable credit amount, beginning the 3rd taxable year after the election is made. The credit amount is equal to 20% of the qualified credits that would have otherwise been available to the taxpayer, but for SB 167’s credit limitation. Any excess is carried forward and is refundable over the next five years to the extent it exceeds the amount of tax due for that year. This election would be made on an original timely filed return.
Planning Opportunities
Taxpayers should consider the impact of the NOL suspension and credit limitation on their expected taxes for the 2024-2026 tax years. Tax planning opportunities exist to help offset increased taxes, such as:
- amending open periods or reviewing accounting methods to release unused deductions; and
- claiming previously untapped credits, such as the research credit, to reduce tax liability and take potential advantage of future refundable credits.
If you’d like to explore tax planning opportunities, please reach out to one of our tax specialists for assistance.