Flush with funds, state should now end 2020 business tax hikes

As part of the 2020-21 state budget accord, the governor and Legislature enacted AB 85,  a budget trailer bill that enacted several tax law changes, including a three-year suspension of the net operating loss deduction and a cap on the use of business tax credits.

Suspending these provisions amounts to a series of tax increases, and they should not only be repealed, they should be repealed retroactively. Repealing them retroactively means a refund to those businesses that paid them.

At the time of the enactment of AB 85, which was authored by the Assembly Budget Committee, California’s leaders believed the state’s General Fund was facing a potential $54 billion deficit.

To make matters worse, the three-year suspension of the net operating loss and the cap on the use of business tax credits were made retroactive to Jan. 1, 2020,

Of course, with the state’s progressive tax structure and an influx of federal stimulus dollars, the State of California had an unprecedented  $75 billion surplus the following year.

What exactly did AB 85 do?  Here are the details. It gets a bit wonky, but it’s worth examining

In Section 6 of AB 85 (amending Revenue and Taxation Code Section 17039.3), the bill suspends an array of  business credits that are otherwise allowable under any provision of Chapter 2 (commencing with Section 17041).

Those include the carryover of any business credit under a former provision of that chapter, for the taxable year shall not reduce the “net tax,” as defined in Section 17039, by more than $5 million. This code section also is found in the personal income tax law.

For purposes of this section, “business credit” means a credit allowable under any provision of Chapter 2 (commencing with Section 17041) other than the following credits — those can still be used up to the $5 million cap.

Those include credits for earned income, a young child, household and dependent care, adoption costs, the renter’s tax credit, personal exemption, dependent parent, qualified senior head of household, low-income housing, refunds related to unemployment insurance.

In Section 8 of AB 85 (adding Revenue and Taxation Code Section 17276.23), the bill generally disallows a net operating loss deduction for any taxable year beginning on or after Jan. 1, 2020, and before Jan. 1, 2023. This code section also is found in the personal income tax law.

In Section 14 of AB 85 (amending Revenue and Taxation Code Section 23036.3), the bill provides that the total of all business credits otherwise allowable under any provision of Chapter 2 (commencing with Section 17041), including the carryover of any business credit under a former provision of that chapter, for the taxable year shall not reduce the “net tax,” as defined in Section 17039, by more than $5 million. This code section is found in the corporation tax law.

In Section 15 of AB 85 (amending Revenue and Taxation Code Section 24416.23), the bill, with some exceptions, bars a net operating loss deduction for any taxable year beginning on or after Jan. 1, 2020, and before Jan. 1, 2023. It would extend the carryover period for a net operating loss deduction disallowed by that provision. This code section is found in the corporation tax law.

To make matters worse, the three-year suspension of the net operating loss and the cap on the use of business tax credits were made retroactive to Jan. 1, 2020, even though AB 85 was not enacted until June 2020 and the proposal was made in May 2020, where were obviously well after the start of the tax year beginning Jan. 1, 2020.

When the Legislature reconvenes on Jan. 3, 2022, the state’s taxpayers will be entering their third and final year of these tax increases.

Nonetheless, in light of the continuing massive budget surpluses California is enjoying (the Legislative Analyst expects a $31 billion surplus this fiscal year), as well as the continued struggles that the business community is experiencing in this state, not only should the governor and Legislature repeal these tax increases, but also they should do so retroactively to Jan.1, 2020 and eliminate the tax increases all together.

Can the Legislature and governor do this – that is, provide retroactive tax relief? Yes.

Although retroactive tax law changes that grant tax relief do not happen regularly, they can be made.

Existing state constitutional law (Section 6 of Article XVI on Public Finance) prohibits the Legislature from making any gift, or authorizing the making of any gift, of any public money or thing of value to any individual, municipal, or other corporation. This constitutional provision comes into play when the Legislature determines that a retroactive tax law change should be made.

The courts in this state have determined that a retroactive tax law change that results in tax savings (e.g., a tax credit, exemption, deduction, etc.) constitutes a gift of public funds. However, the state’s courts have also ruled that the Legislature may make such a determination so long as the bill contains a finding that such a retroactive tax law change is warranted.

Specifically, the bill must contain certain legislative findings and declarations that its provisions serve a public purpose. An example of language found in a California bill during the 2021 Session is the following:

The Legislature hereby finds and declares that the deductions and other tax benefits authorized by the amendments to Sections 17131.8 and 24308.6 of the Revenue and Taxation Code made by this bill serve the public purpose of providing California businesses relief from taxation on expenses made with Paycheck Protection Program loans and do not constitute a gift of public funds within the meaning of Section 6 of
Article XVI of the California Constitution.

So, the Legislature and governor can repeal AB 85’s tax increases and do so retroactively as they were never needed to assist the state’s General Fund close a perceived gap in revenue.
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Editor’s Note: Chris Micheli is a Sacramento attorney and lobbyist with Aprea & Micheli, and an adjunct law professor at McGeorge Law School.