California passes significant tax law amendments

As part of AB 85 signed in the summer of 2020, the use of state net operating losses (NOLs) and business tax credits was limited for tax years 2020, 2021, and 2022. For those years, California NOLs were suspended for utilization by taxpayers with California net business income of $1 million or more and state business tax credits could only reduce the applicable tax by no more than $5 million. Such credits include the R&D credit, jobs tax credit, and California competes credit among others. SB 113 reinstates the state NOL deduction and credit usage with no limitation for taxable years beginning on, or after, January 1, 2022 – one year earlier than planned.

SB 113 included significant modifications to the California PTET, including:

• Repealing the tentative minimum tax limitation on the PTET. Prior to SB 113, the PTET could have only been used to offset the difference between a partner’s tax liability (top bracket being 13.3%) and the tentative minimum tax rate of 7%. With the passage of SB 113, this limitation is no longer in place.
• Amending the definition of a qualified entity to include those pass-through entities with a pass-through entity as owner.
• Requiring that the PTET be used against the net state income tax after the credit for taxes paid to other states.
• Allowing for a single-member LLC that is a pass-through entity owner to claim the PTET credit.
• Allowing for the inclusion of guaranteed payments as qualified net income for purposes of the PTET.  

Missing in action

While many of these changes are welcomed by those doing business in California, what is still left unaddressed is the taxability of PPP forgiveness income for loans made after March 31, 2021. As the law currently stands, expenses paid for by PPP loans are deductible (regardless of when the loan was made) so long as the business is not publicly traded and it meets the 25% gross receipts reduction qualifications, while forgiven PPP loan proceeds are only excluded from gross income to the extent they were made prior to March 31, 2021.

In other words, PPP forgiveness from loans made after March 31, 2021 are included in gross income but the related expenses paid with forgiven PPP loan amounts may still be fully deducted so long as the 25% gross receipts reduction qualification has been met.

Mazars’ insight

In light of these amendments,  pass-through entities doing business in California should re-evaluate whether to elect into the PTET, as the benefits are now greatly enhanced.  Those taxpayers that already opted into the PTET should review their payments made for PTET purposes, if any, for any true-ups needed to be paid in as a result of the legal changes. On the other hand, California taxpayers (S corporations, C corporations, and individuals) should reassess their 2022 projected tax liability and future estimated payments due to now being able to fully utilize NOLs and business credits.

Mazars will continue to monitor all developments from the California legislature related to the possibility of forgiven PPP loan proceeds from loans made after March 31, 2021 being excluded from gross income.

Please contact your Mazars professional for additional information. 

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.