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Uhler Brian

Budget and Policy Post
October 5, 2020

The 2020-21 Spending Plan:

Tax Changes

The 2020‑21 budget package included several tax policy changes. Overall, the budget package assumes these changes will result in a net revenue increase of about $4 billion in 2020‑21. Starting in 2023‑24, the net effect of these changes are expected to reduce revenues below what they otherwise would have been.

Business Tax Changes

Suspend Net Operating Loss (NOL) Deductions. When the expenses of a corporation or another business exceed its revenue in a year, it generates a NOL equal to the amount by which its expenses exceed its revenues. The business can then deduct the NOL from its taxable income the following year, reducing its taxes in that year. Corporations and individuals may carry forward unused NOLs for up to 20 years. Under the budget package, corporations and individuals that have net business income over $1 million are not allowed to use NOLs to reduce their taxes for 2020, 2021, and 2022. The 2020‑21 Budget Act assumes suspending NOLs increases revenues by $1.8 billion in 2020‑21.

Limit Business Credits. Businesses may earn credits if they take actions the state wants to encourage, such as spending money on research and development. Tax credits reduce a business’s tax bill directly, on a dollar-for-dollar basis. If a business has earned more credits in a year than it can use, it can carry them forward to a future year. Under the budget package, businesses may not claim more than $5 million in tax credits per year in 2020, 2021, and 2022. The 2020‑21 Budget Act assumes that limiting credits increases revenues by $2 billion in 2020‑21.

Interaction Between Suspending NOLs and Limiting Credits. Some corporations have both NOLs and credits. If the state restricts the use of one, such corporations will increase the use of the other. For this reason, placing limits on both NOLs and credits results in a larger revenue effect than limiting just one or the other. The 2020‑21 Budget Act assumes that this interaction increases revenues by an additional $600 million in 2020‑21.

Creates Small Business Hiring Tax Credit. Chapter 41 of 2020 (SB 1447, Bradford) created a new Small Business Hiring Tax Credit. The budget package allocates $100 million General Fund for this new credit. The credit—which is available on a first-come, first-served basis—is equal to $1,000 per each net new employee, up to $100,000 per business. A business is eligible for the credit if it (1) has fewer than 100 employees and (2) experienced a 50 percent or greater decline in gross income during the second quarter of 2020. The credit can reduce a business’ personal income tax, corporation tax, or sales tax bill. The credit expires December 31, 2021.

Expands the First-Year Exemption From the Minimum Franchise Tax. Corporations, limited liability companies (LLCs), and many partnerships must pay an $800 minimum franchise tax annually, regardless of their net income. Prior law exempted new corporations from the minimum franchise tax in their first year of business. The budget package expands this exemption to LLCs and certain partnerships in their first year. This expanded exemption expires in 2024. The 2020‑21 Budget Act assumes that this exemption reduces revenues by $50 million in 2020‑21 and $100 million in 2021‑22.

Extends Carryforward Period for Film Tax Credits. The budget package increases the number of years a taxpayer can carry forward the film tax credit from six years to nine years. Extending film tax credit carryforward would reduce revenue by $1 million per year beginning in 2022‑23.

Earned Income Tax Credit

Expands Eligibility for California Earned Income Tax Credit (EITC). The California EITC is a personal income tax credit that is intended to reduce poverty by increasing the after-tax income of California’s poorest working households. Families with children under 6 who are eligible for the EITC also can receive an additional Young Child Tax Credit (YCTC) of up to $1,000. The budget package expanded eligibility for the EITC and YCTC to taxpayers who do not have a Social Security Number and instead use an Individual Taxpayer Identification Number (ITIN) to file their tax return. (Budget-related legislation enacted in June expanded the EITC and YCTC to ITIN filers with children under 6, but additional legislation in August broadened this expansion to all ITIN filers.) This expansion is assumed to reduce revenues by $125 million in 2020‑21.

Sales and Use Tax Changes

Changes Timing of Sales Tax Payments by Used Car Dealers. Beginning January 1, 2021, the budget package requires used car dealers to pay sales taxes on car sales to the Department of Motor Vehicles when they pay their vehicle registration fees—which occurs shortly after a car is sold. Previously, used car dealers paid sales taxes by submitting periodic tax returns to the California Department of Tax and Fee Administration. The 2020‑21 Budget Act assumes this change will increase General Fund revenues by $12 million in 2020‑21 and $24 million in 2021‑22.

Extends Sales Tax Exemption for Diaper and Menstrual Products. The budget package postpones the expiration of existing sales tax exemptions for menstrual products and children’s diapers from January 1, 2022 to July 1, 2023. This change is expected to reduce General Fund revenue by roughly $18 million in 2021‑22 and $35 million in 2022‑23.