A.B. 85, the revenue portion of the budget package signed Monday by Democratic Gov. Gavin Newsom, attempts to compensate for the revenue shortfalls by temporarily suspending or limiting tax breaks for larger businesses while preserving expanded individual and sales tax relief.
The budget's revenue and spending cuts reflect a grim fiscal future for the nation's most populous state as virus cases rise and tax revenue falls. Newsom revised initial budget projections in May to reflect a drop of more than $41.2 billion in state tax revenue as a result of the economic collapse caused by the novel coronavirus, which causes COVID-19, a respiratory disease.
"In the face of a global pandemic that has also caused a recession across the world and here in California, our state has passed a budget that is balanced, responsible and protects public safety and health education, and services to Californians facing the greatest hardships," Newsom said in a statement Monday.
The bill suspends net operating loss deductions for individuals and corporations with business income exceeding $1 million from 2020 through 2022, according to a bill analysis. The measure also limits business incentive credits that offset more than $5 million in tax liabilities for the same period, with the exception of low-income housing credits.
Those business tax limits will bring the state an additional $4.4 billion for the 2020-21 fiscal year, according to Newsom's budget summary.
The budget also expands an exemption from the $800 minimum tax for limited liability companies, partnerships and limited liability partnerships in their first year of business. This provision applies from Jan. 1, 2021, to Jan. 1, 2024.
Individual income tax benefits are largely left untouched by the budget, which preserves prior expansions of the state's earned income tax credit and expands credit eligibility to undocumented filers with young children.
Additional tax relief measures in the budget extend the state sales tax exemption for diapers and menstrual hygiene products to July 1, 2023, and boosts the carryforward period for film and television tax credits from six to nine years.
Under the bill, licensed used car dealers must remit sales taxes alongside registration fees within 30 days of a sale. Dealers will be subject to interest, penalties and withheld vehicle registrations if they fail to do so.
The two spending bills that make up most of the spending provisions of the state budget, A.B. 89 and S.B. 74, also attempt to balance the deficit by drawing from $8.8 billion in reserves and redirecting long-term funding, as well as borrowing and deferments. The budget will make up the rest of the deficit in spending cuts unless additional federal aid comes through.
The budget as enacted omits Newsom's proposed tax on vaping, at $2 per 40 milligrams of nicotine in the product, which was estimated to raise about $33 million in 2020-21. Newsom's budget summary says his administration will continue to work with the Legislature on that proposal.
Timothy Gustafson, a state and local tax attorney for Eversheds Sutherland who focuses on California, told Law360 that the state had previously suspended net operating loss deductions, though this time the state offered few benefits in return to companies facing financial hardships.
"Ultimately, it's unfortunate but it's not unexpected, given the current situation with the pandemic and the financial issues the state is having," Gustafson said. "Here, though, from the taxpayer's perspective, nothing is received in turn. It's all stick, no carrot."
Katie Talbot, a spokeswoman for Assembly Speaker Anthony Rendon, said in an email to Law360, "As noted by the Legislative Analyst's Office, suspending NOLs and business tax credits may be less burdensome to Californians than raising taxes."
Other leaders for the majority and minority in the state Assembly and Senate, as well as Newsom, did not immediately respond to requests for comment Tuesday.
--Additional reporting by Maria Koklanaris. Editing by Robert Rudinger.
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