2010 California Legislative Update
California once again faced an enormous budget gap in 2010. With Republicans refusing to accept any tax increases and Democrats unwilling to make major cuts in spending, legislative gridlock pushed this year’s budget agreement to its latest resolution ever. What emerged were relatively minor changes and temporary measures that ensure California will find itself in a similar position next year.
Falling under the category of temporary measures, the legislature extended the suspension of the deduction for net operating losses (NOLs) for both personal and corporate tax purposes for another two years. When the use of NOLs resumes in tax years beginning after January 1, 2012, the state will phase-in conformity to federal carryback and carryforward rules, such that carrybacks will be allowed starting in tax years beginning on or after January 1, 2013. While the previous NOL suspension did not apply to taxpayers with less than $500,000 of net business incomes for the tax year, the threshold was lowered this time to $300,000 of modified adjusted gross income for personal income taxpayers and $300,000 of pre-apportioned income for corporate taxpayers.
Another tax law change of interest to taxpayers is the modification of the sourcing of intangibles. Beginning in 2011, a taxpayer may make an annual irrevocable election to determine its California sourced income by using either the single-sales factor or the double-weighted sales factor apportionment formula. In conjunction with that move, California was set to repeal the “cost of performance” method of sourcing sales of intangibles and replace it with a “market rule.” The change from the cost of performance method to the market rule would have required all taxpayers to include the following in the California sales factor:
- sales from services if the purchaser received the benefit of the service in the state;
- sales from intangible property if the purchaser used the property in the state (for marketable securities, sales are in the state if the customer is in the state);
- sales from the sale, lease, rental, or licensing of real property located in California; and
- sales from the sale, lease, rental, or licensing of tangible personal property located in California.
Under the provisions found in the newly-passed budget, any taxpayer electing to use the double-weighted sales factor must continue to use the cost of performance method to source sales. Taxpayers electing to use the single-sales factor starting in 2011 must use the market rule. The new provisions also clarify that sales under the market rule must be used in determining whether a taxpayer is subject to tax in the state. A taxpayer with 25% or $500,000 of its sales in California has nexus for income tax purposes.
In November, California voters rejected Proposition 24 which would have repealed the use of the single-sales factor, NOL carrybacks, and tax-credit sharing among affiliates - all of which/were corporate tax liability lowering measures that were passed as part of the 2008 budget deal.
Tired of perpetually late budgets and the seemingly intractable gridlock in Sacramento, voters passed Proposition 25, which now requires only a simple majority of votes (from a 2/3 supermajority) to pass a budget. However, in the same breath, voters also passed Proposition 26, which requires a 2/3 supermajority vote (from a simple majority) to pass any measure that results in taxpayers paying a higher tax or fee. In addition, the proposition contains a clause that voids any law passed between January 1, 2010 and the date of the enactment of the proposition if not passed under a supermajority vote. Among the laws impacted by Proposition 26 is the one which updated California’s conformity to the federal code since it caused some taxpayers to pay a higher tax and was only passed by a simple majority. Moreover, many observers believe that the passage of Proposition 26 essentially reinstates the supermajority requirement because it covers so many of the typical budget-gap solutions. As such, California is left in the same position since structural budget deficits and legislative gridlock could plague the state for many years to come.
