California: Early Budget Actions That Would Restore NOLs and R&D Credits for Tax Year 2022 Announced

The 2022-2023 budget bill was signed into law on February 9, 2022. For more details, please read our alert: California 2022-2023 Budget Modifies PTE Election and Ends NOL Deductions and Business Credits Suspensions.

On January 25, 2022, California Governor Gavin Newsom announced early budget actions that include restoring tax credits, including research and development (R&D) credits, and net operating losses (NOL) for tax year 2022. Notably, the announcement indicated that the proposed budget revisions could be acted on earlier than the typical mid-year timeframe, which may bring welcome relief to California businesses impacted by the COVID-19 recession.

Other early budget action items announced include continued access to COVID-19 supplemental paid sick leave, additional funding for the California Small Business Covid-19 Relief Grant Program and state tax relief for recipients of federal relief grants for restaurants and shuttered venues (Federal Relief Grants). The proposed early budget actions would: (i) exempt Federal Relief Grant amounts from 2021 state taxable income; and (ii) permit recognition of expenses related to the Federal Relief Grant amounts for state tax purposes in tax year 2021.

Background

On June 29, 2020, Governor Newsom signed Assembly Bill 85 (AB 85) that temporarily suspended California NOL utilization and imposed a restriction on the amount of business incentive tax credits companies could utilize for tax years 2020, 2021 and 2022.

• NOL Suspension: AB 85 suspended NOL utilization for California taxpayers with net business income of $1 million or more for tax years beginning January 1, 2020 and ending before January 1, 2023. Although California NOLs are generally limited to a 20-year carryover period, any NOLs suspended as a result of AB 85 could be carried over an additional year for each year of suspension.
• Limit on Business Incentive Tax Credits: AB 85 also limited the use of business tax credits to $5 million in any one year for tax years 2020, 2021 and 2022. Importantly, the $5 million business tax credit limitation applied on a combined-group basis, thereby limiting all members of a combined reporting group to an aggregate $5 million business incentive tax credit. The carryover period for any credit disallowed as a result of this $5 million limitation increase by one year for each year of disallowance.

Governor’s Budget Summary 2022-2023

On January 10, 2022, Governor Newsom issued his Governor’s Budget Summary 2022-23 (“Governor’s 2022-23 Budget Proposal”), which proposes key tax law changes to restore NOLs and business tax credits in the 2022 tax year, one year earlier than under current law.

Other tax law changes in the Governor’s 2022-23 Budget Proposal include modification of the state’s elective pass-through (PTE) tax, creation of a new credit for qualified California-headquartered companies investing in activities and technologies that mitigate climate change, establishment of a new tax credit for the development of green energy technologies, small business assistance including waiver of fees for new businesses and additional funding for existing grant programs, and a general revision of California’s income tax treatment for grant programs described above to conform with existing federal programs. As of early February, the state legislature advanced Assembly Bill 87 and Senate Bill 113, which both echo the provisions of the Governor’s 2022-23 Budget Proposal and further evidence the state’s efforts to swiftly extend tax relief to California taxpayers.

Next Steps for California Taxpayers

The immediate restoration of NOLs and business credit utilization for tax year 2022 could have a substantial impact on California taxpayers that engage in R&D activities and other qualified activities. As discussed above, the early budget actions are expected to resolve potential uncertainty for taxpayers ahead of the state’s annual budget bill in mid-June. For this reason, taxpayers should be cognizant of how these changes could implicate other California tax planning considerations for the 2022 tax year.

BDO Can Help

BDO will continue to monitor California’s proposed early budget actions and will issue additional alerts advising on the state’s legislative updates. BDO provides comprehensive support in assisting companies with planning for and complying with California’s anticipated tax changes for the 2022 tax year.

 

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