Senate Bills 167 and 175, recently enacted in California, introduce several significant changes that affect Construction businesses and other businesses in the state, primarily targeting tax regulations and incentives. The overall effect will limit Construction businesses’ ability to deduct losses and use tax credits for the next three years in the state of California.
Taxes are likely to increase for businesses that are earning more than $1 million in income. In addition, construction businesses that do extensive development face limits on using Research and Development (R&D) tax credits. This new legislation will be implemented for tax year 2024, so will affect tax filings starting in calendar year 2025. The new rules affect the entire 2024 taxable year, so some startups may already have transactions that will fall under these rules.
SB 167: Limiting Net Operating Loss (NOL) Deductions
SB 167 suspends the ability for businesses to use California Net Operating Losses (NOL) deductions for tax years beginning January 1, 2024, through January 1, 2027. This suspension applies to businesses with more than $1 million in income.
NOLs typically allow businesses to offset taxable income with past losses, reducing tax liability. During the suspension, the carryforward periods for NOLs are extended: three years for losses before January 1, 2024, two years for losses between January 1, 2024, and January 1, 2025, and one year for losses between January 1, 2025, and January 1, 2026. The normal carryforward period is 20 years without additional extensions.
Key Impacts on Construction Businesses:
Higher Tax Bills: Construction projects often involve cyclical income, with periods of high revenue followed by slower periods. During slow periods, the ability to offset past losses through NOL deductions is crucial for managing cash flow. This suspension will force construction businesses to pay higher taxes during periods of low revenue, potentially straining cash flow.
Extended Carryforward Periods: While the suspension is in effect, the carryforward periods for NOLs are extended: three years for losses before January 1, 2024, two years for losses between January 1, 2024, and January 1, 2025, and one year for losses between January 1, 2025, and January 1, 2026. This means that businesses will need to hold onto their losses for a longer period before they can fully utilize them.
Compliance Costs: Construction businesses will need to adjust their accounting practices and financial reporting to comply with the new tax regulations.
SB 175: The California Climate Action Plan
This bill introduces a $5 million annual cap on the use of business incentive tax credits starting in 2024. This limitation affects various credits, including the Research and Development (R&D) tax credit.
Refundable Credit Election
SB 175 allows businesses to elect to receive a refundable credit of up to 20% of qualified credits during the three-year limitation period. This can help businesses get some benefits from their credits even with the overall limitation.
Key Impacts on Construction Businesses:
Reduced Benefit from R&D Credits: Construction companies often invest in R&D to develop innovative building methods, materials, and technologies. The $5 million cap on R&D tax credits limits the potential tax benefits for such investments. This might discourage further investment in R&D or force businesses to adjust their spending strategies.
Limited Tax Relief: The cap restricts the ability of construction businesses to offset their tax liability through credits, potentially increasing their overall tax burden.
Limitation on Business Tax Credits
Both bills limit the use of business incentive tax credits. Specifically, starting in 2024, businesses can only use these credits to offset up to $5 million in tax liability annually. This limitation affects credits such as the Research and Development (R&D) tax credit but excludes credits like the Low-Income Housing tax credit and the Pass-Through Entity Elective tax credit (which apply more to individual taxpayers rather than corporations).
Navigating the New Tax Landscape:
Construction businesses need to adapt to these changes to ensure long-term financial stability. Here are some strategies:
Strategic Timing: Explore opportunities to optimize the timing of income recognition and expense deductions to minimize the impact of the NOL suspension.
Alternative Tax Credits: Investigate other tax credits that might be available for construction businesses to offset the impact of the credit limitation.
The Bottom Line:
These legislative changes are an attempt to address California’s budget shortfalls but will likely impose additional tax burdens. Note that this applies only to the California portion of state-apportioned taxable income, rather than federal taxable income. By staying informed and implementing proactive strategies, construction businesses can better manage the financial impact of these changes and continue to thrive in the competitive California market. Contact Country Accounting Solutions to evaluate how these tax changes may impact your construction business and build a plan to navigate and manage the potential tax burden.
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