May Revise Proposes Major Revenue Raisers

Chris Micheli
Chris Micheli is a Principal with the Sacramento governmental relations firm of Aprea & Micheli, Inc.

On May 14, Governor Newsom submitted his May Budget Revision (i.e., the “May Revise” to his January 10 budget proposal). As part of the May Revise, the Governor offered a series of “revenue solutions,” which amount to billions of dollars of increased tax payments primarily made by business taxpayers. 

The May Revise explains, “As part of the balanced approach to managing the budget deficit, the May Revision includes two significant temporary changes to tax law, two measures to reduce the sales tax gap, and maintains three tax measures included in the Governor’s Budget.” It further provides that “These tax measures as a whole are intended to raise revenue, stimulate economic growth, and help those in need.”

The Governor’s May Revise maintains the following four tax reduction measures that he proposed in January: 

  • Continues the proposed expanded levels of the Earned Income Tax Credit.
  • Extends the sales tax exemption for diapers and menstrual products through the end of the 2022-23 fiscal year.
  • Extends the carryover period for film tax credits awarded under Program 2.0 from 6 years to 9 years.
  • Extends the current exemption from the minimum franchise tax for first year corporations to first year LLCs, partnerships, and LLPs.

The Governor also proposes to maintain from his January 10 budget a new tax on e-cigarettes based on nicotine content. While the Governor proposed changes to the cannabis tax program earlier this year, he has proposed delaying those changes to a future budget year.

Finally, in terms of raising revenue, the Governor’s May Revise primarily proposes the following two tax law changes:

  • Suspends the Net Operating Loss (NOL) deduction for the 2020, 2021, and 2022 tax years for medium and large businesses. This proposal is estimated to raise revenues of $1.8 billion the first year and $1.3 billion the second year.

Under this proposal, if a business had suffered prior year losses and was now trying to offset some or all of their increased tax liability with those prior year losses, they would be precluded from doing so, thereby increasing their tax liability during those three tax years. Proponents argue that it is only a “loss in the time value of money” because the NOLs can be carried forward to future years for use. California has done this before to help address prior state budget deficits, but the NOL deduction has been enhanced those prior two times.

An NOL suspension occurred with the state’s last economic downturn. In 2009, Assembly Bill 1452 temporarily suspended the net operating loss carryover deduction for two years; in exchange, California increased the net operating loss carryover period to twenty years and phased-in a deduction for net operating loss carrybacks for two years. Businesses with less than $500,000 in taxable income were exempt from the suspension. 

And, prior to that, the NOL deduction was suspended for tax years beginning in 2002 and 2003, but the carryover period was extended for the number of years the deductions were suspended. And, in exchange, for NOLs sustained in 2004 and thereafter, 100 percent of the NOLs incurred could be carried forward (instead of the prior limitation of 60%).

  • Limits business incentive tax credits from offsetting more than $5 million of tax liability for the 2020, 2021, and 2022 tax years. This proposal is estimated to raise $2 billion the first year and over $1.5 billion the second year.

Under this proposal, businesses that have more than $5 million in tax liability and more than $5 million in business tax credits will be limited in their ability to utilize the full value of those incentives. So, even if the business engaged in the desired activity to generate those credits, they would be limited in their ability to fully use them. We assume the credits will be carried forward for an additional three years. California’s research and development tax credit is the largest business tax incentive in the state.

 Finally, the Department of Finance described another half a billion in additional revenue will be realized the next three years due to the “interaction between the NOL suspension and the credit limitation.” Note that these proposals, if enacted next month as part of the state budget, will be retroactive to January 1, 2020 as they will take effect the 2020 tax year that begins on or after January 1.

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