Governor Gavin Newsom issued revisions to his budget proposals for the state’s fiscal year ending June 2021. This “May revision” is an annual opportunity for the California Governor to revise his initial budget proposals from the previous January. This year, Governor Newsom used the May revision to propose potentially significant changes for California taxpayers to help fill the budget shortfall resulting from COVID-19’s economic impact.

Governor Newsom’s May revision includes a proposal to temporarily suspend utilization of net operating losses. If adopted, this suspension would prevent taxpayers with income of $1 million or more from utilizing NOLs for taxable years beginning between January 1, 2020 and December 31, 2022. Of course, suspending NOL utilization is nothing new in California. The state took the same measure in the aftermaths of the dot-com bubble (2002-2003) and the great recession (2008-2011). It’s notable that prior suspensions included extensions of the NOL carryover period. But the FTB interpreted those carryover extensions narrowly to allow an extension only when a taxpayer could not have otherwise utilized the NOLs. We believe this interpretation is incorrect. Nonetheless, the governor’s proposal would likely present similar issues again.

The governor’s revised budget also calls for a cap of $5 million on the utilization of business tax incentives. This cap would apply to important credits that include, among others, the R&D credit, the California Competes Tax Credit, the low-income housing credit, and motion picture production credits. Many credits subject to the limitation would be carried over into the next taxable year. Of course, this limitation would have an effect of targeting in-state companies that create needed jobs in these times of economic uncertainty.

The process will now turn to the Legislature, which has until June 15 to pass a budget. It is unclear at this point whether the Legislature will pass the governor’s proposed tax changes, in full or in part.

Contact the Author: Mike Shaikh