California Tax Law Update
- Suspending the NOL deduction and limiting the use of business credits to 50 percent of a taxpayer's tax liability for tax years 2008 and 2009, except for taxpayers with net business incomes of less than $500,000 in either year;
- Limiting business tax credits and allowing corporate taxpayers to assign eligible credits to affiliated corporations that are members of the same combined reporting group;
- Reinstating and making permanent the 12-month presumption period for application of the use tax to vehicles, vessels and aircraft purchased outside California and subsequently brought into the state; and
- Requiring taxpayers to make estimated payment of the Limited Liability Company fee by June 15 of the current taxable year.
NOL deductions are disallowed for the 2008 and 2009 tax years, except for taxpayers with net business incomes of less than $500,000 in either year. For taxpayers with NOLs incurred before 2008, the 10-year period is tolled between 2008 and 2010.
NOLs incurred in prior years can generally be used to offset taxable income in future years (e.g., when a company becomes profitable). The ability to offset prior year losses against future income effectively reduces the future California tax liability of corporations with carry-forward NOLs. For corporations that rely on the NOL deduction, a suspension of the NOLs will have a significant cash flow impact — an unwelcome surprise to corporations that are not used to paying tax in California and likely pay no federal income tax.
Furthermore, the California tax law change allows for NOLs incurred on or after Jan. 1, 2008, to be carried forward up to 20 years, and NOLs incurred on or after Jan. 1, 2011, to be carried back up to two years. The carry-back provisions will be gradually phased in. Fifty percent of 2011 NOLs may be carried back to a taxable year, and 75 percent of 2012 NOLs may likewise be carried back. The full amount of NOLs attributable to a taxable year beginning on or after Jan. 1, 2013, may be carried back to a taxable year.
To reduce California tax liabilities during the NOL suspension period, taxpayers should consider strategies to defer income such as with accounting method changes and qualifying for research and development credit, employee hiring credits, and the various enterprise zone credits.
However, these planning techniques to reduce a business's California tax liability are subject to new limitations. See the next section for more detail.
Business Tax Credits
For tax years 2008 and 2009, taxpayers may not use business tax credits (including the Research and Development credit, the Enterprise Zone credit, and the Low-Income Housing credit) to reduce their tax liability below 50 percent of their net tax, before application of any other credits. This limitation does not apply to taxpayers with net business incomes of less than $500,000 in either year.
Beginning July 1, 2008, corporate taxpayers may assign "eligible credits" to affiliated corporations that are members of the same combined reporting group. Assignees may apply such credits against their tax liability for taxable years beginning on or after Jan. 1, 2010.
Increase in Corporate Underpayment Penalties
To further raise revenue, the legislative changes have also increased the corporate underpayment penalties. A penalty of 20 percent (of the amount of any corporate franchise tax underpayment in excess of $1 million) will be assessed in addition to the current 10 percent annual interest applied to these late payments.
This penalty applies to each taxable year beginning on or after Jan. 1, 2003, which remains open under the statute of limitations. Once the penalty is assessed there are no protest rights. Arguably, taxpayers included in a combined report can avoid this penalty by filing separate returns if their individual liability is under $1 million.
There is no reasonable cause exception (unlike the substantial understatement penalty under California Revenue and Tax Code Section 19164). The only way to protect against the penalty will be to have predicted what the underpayments would be, filed amended returns, and have paid the tax by May 31 of this year.
Taxpayers may avoid this underpayment penalty by placing greater importance on seeking professional tax services to ensure properly filing and paying the appropriate amount of California corporate franchise tax.
Please contact us if you have any questions on how these California tax law changes will affect your business.
Montage Services Inc. provides international and domestic tax consulting and advisory services, primarily for corporations. To inquire about a particular tax issue or seek consulting services, contact Scott Wentz, managing director, at (415) 963-4016 or firstname.lastname@example.org.