California’s 2024-2025 budget proposes blocking $1.3 billion in refunds for Water’s Edge taxpayers, suspending NOL deductions and limiting use of tax credits | Pillsbury – SeeSalt Blog

The revision of California’s 2024-2025 state budget, approved in May, aims to block approximately $1.3 billion in refund requests for past tax years and $200 million per year for the future by codifying informal guidelines recently confirmed by the Office of Tax Appeal (OTA) decision in Appeal by Microsoft Corporation and its subsidiaries (Appeal from Microsoft) and by granting the Franchise Tax Board (FTB) quasi-legislative law-making powers exempt from the procedural protections of the Administrative Procedure Act. The May revision also proposes to suspend the net operating loss (NOL) deduction and cap the claim of tax credits at $5 million per year for tax years 2025-2027; however, the legislature proposes to apply the changes to tax years 2024-2026 instead.

In the Appeal from Microsoftthe OTA held that 100 percent of repatriated dividends under the Tax Cuts and Jobs Act were gross income and must be included in the taxpayer’s revenue factor denominator. In making this determination, the OTA rejected the FTB’s reliance on FTB Legal Ruling 2006-01, which requires only net dividends to be included in the revenue factor, on the grounds that the revenue factor should only include income that generates business income included in the apportioned tax base. The OTA specifically rejected FTB Legal Ruling 2006-01 as nonbinding, unpersuasive, and inconsistent with established law. For more details, see our previous discussion here.

Reversal of the OTA’s decision in Appeal from Microsoft

The May revision includes a bill that proposes to retroactively support the denial of approximately $1.3 billion in anticipated refund claims noted above. This is done through an explicit legislative affirmation of FTB Legal Resolution 2006-01. It also adds a statute (Revenue and Taxation Code Section 25128.9) that excludes all apportionment factors related to income that is excluded, deducted, exempt, eliminated, or not apportioned for any reason. It also grants the FTB broad authority under this section to create quasi-legislative regulations and rules that are exempt from all procedural protections that would otherwise be required under the Administrative Procedure Act. The bill states that the provisions of the act do not constitute a change in law, but rather declare existing law. Therefore, the act would apply both retroactively and prospectively to all taxable years and would require only a majority vote to pass.

On May 16, 2024, members of the Senate Budget Subcommittee No. 4 stated that they had no objections to this proposal. Under the California Constitution, the legislature must pass the budget by June 15, 2024.

Suspension of net operating loss and credit limitation for tax years 2025-2027

The May revision includes a trailer bill that proposes to suspend the use of NOL deductions for taxpayers with income over $1 million and cap the amount of most business tax credits a taxpayer can claim at $5 million. The Assembly summary of the Legislature’s budget proposal and the Senate Budget Subcommittee legislative staff summary indicate that the Legislature wants to enact these changes for tax years 2024-2026. These NOL and credit limits previously applied for tax years 2020 and 2021, but were then repealed for tax year 2022. The Legislature also proposes to remove a trigger in the Governor’s May revision that would have lifted the NOL suspension if certain budget numbers were met, which was part of the previous NOL suspension.

In its presentation to the Senate Budget Subcommittee No. 4, the Office of the Legislative Analyst urged the subcommittee to consider alternatives to suspending the NOL deduction, which would result in similarly situated taxpayers being treated unequally depending on whether a taxpayer earns consistent or fluctuating profits each year, with the latter bearing a higher tax burden.

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