February of 2022 brings a variety of noteworthy California income tax developments, including:
Below, we dive into each California income tax development and what it could mean for taxpayers.
On February 9, 2022, Governor Newsom signed Senate Bill 113 (SB 113). The bill contains taxpayer-friendly provisions lifting early pandemic restrictions on net operating losses (NOLs) and expanding the scope of the Pass-through Entity Tax regime enacted in 2021.
Reinstatement of NOL and Certain Credit Usage
At the beginning of the pandemic, California suspended NOL use for taxpayers with net business income of $1 million or more and limited the use of tax credits to $5 million. The suspensions were originally applicable to calendar tax years 2020, 2021 and 2022.
The limitations were put in place to raise revenue when state policymakers projected significant revenue reductions associated with the pandemic. Today, with the state budget picture considerably better than expected (due to revenue growth and federal government COVID-19 relief funding), the NOL/Credit suspensions are lifted one year early and will no longer apply starting with the 2022 tax year.
Amendments to the Pass-through Entity Tax
In 2021, California enacted AB 150, implementing a new passthrough entity level tax election as a workaround to the federal $10,000 limitation on state and local tax (SALT) deductions for individuals. Several provisions of the original legislation were criticized as overly restrictive. For example, the original legislation limited the range of entities and owners who could participate in the SALT Cap workaround. SB 113 addresses many of these criticisms:
Taxpayers who concluded that an election was not permissible or feasible under the original legislation may wish to reconsider an election in light of SB 113.
On February 14, 2022, the FTB issued Technical Advice Memorandum 2022-01 (TAM 2022-01). The guidance limits the protection of Public Law 86-272 for internet retailers who sell products to California customers.
Public Law 86-272 (PL 86-272) is a 63-year-old federal law prohibiting the states from imposing net income taxes on sellers of tangible property when the activities of the seller are limited merely to solicitation. Many internet retailers have claimed exemption from California’s income tax because their online presence has previously been deemed to be mere solicitation.
The FTB’s new guidance limits PL 86-272 protection for online retailers. The TAM expands the list of “unprotected activities” to include many common aspects of internet retail sites, such as:
Many of these activities are integral to the operation of a retail internet site. In light of this guidance, taxpayers should review TAM 2022-1 to consider impacts to their California PL 86-272 positions.
California’s guidance closely follows the Multistate Tax Commission’s updated guidance regarding internet selling, which was issued last August. We expect many additional states to adopt similar guidance going forward. Internet retail businesses should closely monitor this activity across the states and continue to review PL 86-272 positions.
Beginning with the 2021 tax returns for partnerships (Form 565) and limited liability companies (Form 568), the FTB now requires tax basis capital to be reported on Schedules M-2 and the partner/member K-1s. This is similar to the capital reporting requirement mandated by the IRS beginning with the 2020 returns. The FTB refers 2021 filers to the Federal Form 1065 instructions for further information.
Although not directly stated by the FTB within the instructions, it appears California (rather than federal) tax basis capital should be reported because the words “Use California amounts” appear at the top of Schedule M-2 for both the partnership and LLC forms.
Certain California returns also contain new questions related to unclaimed property compliance. Last July, California adopted legislation authorizing the FTB to share taxpayer information with the State Controller’s Office. The Controller’s office administers the state’s unclaimed property program. Pursuant to the new legislation, California’s corporation, partnership, and LLC returns will now contain the following questions:
The FTB may share the responses with the Controller’s office resulting in notices or inquiries. The new inquiries reflect an increasing aggressiveness across the states related to unclaimed property non-compliance. California has a 10-year unclaimed property lookback period and a 12% interest rate applicable to unremitted items. Furthermore, California does not have a voluntary disclosure program for unclaimed property. In light of these developments, California companies should consider their historic compliance and internal controls related to unclaimed property.
Each of these new developments could have significant consequences to California income taxpayers and those looking to do business in the state of California.
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This article is provided for general informational purposes only. It is not legal, accounting or other professional advice, as it does not address any individual facts, circumstances or concerns. Before making personal or business related decisions, please consult with appropriate legal, accounting or other qualified professionals.
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