In assisting clients to prepare their latest round
of tax provisions, we've been required to take a closer look at the most recent
changes to California tax law under A.B. 1452 (Chapter 08-763). From a high level these new rules seem rather
straightforward, that is, net operating losses ("NOL") are suspended for 2008
and 2009 and business credits are limited to fifty percent of tax but may now
be shared among combined group members.
However, from an implementation level these new rules can be confusing
and difficult to apply. For example,
does the NOL suspension apply only to regular NOLs or AMT NOLs as well? Similarly, do the tax limitations apply to
all California credits or just a select group of credits? Let's take a look.
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California
Clarification 
New Rules are Harder than They Look |
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Background
If you recall from prior Clifton Douglas newsletters, last quarter A.B. 1452 was signed into law making significant changes to California's net operating loss and credit carryforwards. Specifically, California "net operating losses" are not allowed for any taxable year beginning on or after January 1, 2008, and before January 1, 2010. In addition, for each taxable year beginning on or before January 1, 2008, and before January 1, 2010, the total "business credit" is not allowed to reduce "corporate taxes" below fifty percent. Finally, the bill provides, for taxable years beginning on or after July 1, 2008, that any "credit that is an eligible credit" may be assigned to any "eligible assignee" to offset "eligible taxes."
Although these provisions appear rather basic on their face, they become increasingly complex in their application. This complexity stems from the many types of "net operating losses," "tax credits," and "corporate taxes" referenced throughout the California Revenue and Taxation Code ("RTC"). The complexity then increases once these new laws are complicated by existing California tax law, such as credit ordering rules and the Alternative Minimum Tax ("AMT") system. A thorough reading of the new statute along with its many references is required to determine exactly how these rules should be implemented. And even then, some requirements remain unclear.
Interpretation
Let's first consider the NOL carryforward suspension rules, since the requisite ordering of California tax attributes is exhaustion of NOL carryforward before credit utilization. The most significant issue here relates to whether the suspension applies to only regular California loss carryforwards or also includes AMT loss carryforwards. Although A.B. 1452 does not specifically address this issue, we believe the California Franchise Tax Board ("FTB") will interpret the legislation to apply to both regular and AMT carryforwards as this was the required application with respect to California's previous NOL suspension during 2002 and 2003.
The fifty percent tax limitation related to credits is also complex. For starters, the term "business credits" is ambiguous as California offers a variety of corporate income tax credits. The legislation defines "business credits" to be "the total of all credits otherwise allowable under any provision of Chapter 3.5 including the carryover of any credit under a former provision of that chapter." Chapter 3.5 includes most popular California credits, such as the Research and Development Credit, the Enterprise Zone Credit, the Manufacturer's Investment Credit ("MIC"), and the Low Income Housing credit. However, one frequently utilized California credit is not included in this Chapter. The Alternative Minimum Tax Credit ("AMT Credit") appears in Chapter 2.5 and, therefore, may reduce applicable California taxes below fifty percent for this time period.
The complexity increases further when California
credit ordering rules are factored. RTC §23036 (c) and (d), reviewed in
conjunction with the FTB's Technical Advice Memorandum #2000-41 (August 23,
2000), stipulate that AMT credit carryforwards must be applied before any
credits that can reduce the regular tax below tentative minimum tax. Therefore, the AMT Credit carryforward should be claimed first to offset
regular tax. Then the remaining Chapter
3.5 tax credit carryforwards are utilized to offset excess regular tax and
reduce the regular tax below tentative minimum tax.
The allowable credits, in the proper order, may
then offset only fifty percent of "corporate taxes," which adds further
ambiguity as California imposes a host of income-related taxes. The legislation provides "corporate taxes"
are those defined in RTC §23036 before application of any credits, including,
we believe, the AMT credit. Section
23036 includes an exhaustive list of income-related taxes, but the ones most
pertinent to many Bay Area companies are the general California
income/franchise tax at 8.84% and the Alternative Minimum Tax ("AMT") at 6.65%.
There are additional considerations if you are planning to share these credits among combined group members under the new rules. You should note that "eligible credits" include any credits (business, AMT, and others) earned in a taxable year beginning on or after July 1, 2008, or any credit earned in any taxable year beginning before July 1, 2008 that is eligible to be carried forward to a taxpayer's first taxable year beginning on or after July 1, 2008. You should also note that a credit assigned may only be applied by the eligible assignee against the "tax" of the eligible assignee in a taxable year beginning on or after January 1, 2010. "Tax" is defined again by RTC § 23036, which includes both regular tax and AMT, among other income-related taxes. "Eligible assignee" generally means any affiliated corporation that is treated as a member of the same combined reporting group.
Finally, the provisions of both NOL and credit carryforward limitations contain a safe harbor and do not apply to a taxpayer with "income subject to tax under this part" of less than $500,000 for the taxable year. Again, the definitions are vague with respect to this section providing little guidance as to what "income subject to tax under this part" means. However, reviewing the statutes in their totality, we believe the exemption will apply to income net of expenses (taxable income) rather than gross income.
Practical Application
In a nutshell, if your company is currently generating
losses or has taxable income of less than $500,000, then these rules will likely
have no impact. However, if your company
is generating taxable income in excess of the $500,000 safe harbor, then the
rules could have significant impact.
For most companies both regular and AMT NOLs are
suspended for 2008 and 2009, so they will have to utilize available credits to
offset any taxes imposed. AMT credit
carryforwards should be applied at 100% first to offset regular California
income/franchise tax. Any excess regular
tax or tentative minimum tax should then be offset up to fifty percent by
California business credits with the credit having the shortest carryforward
applied first (generally the MIC). And
in case your company is planning on transferring any credits to a combined
group member to ease the NOL suspension burden, then it should be noted that
the recipient will not be able to utilize the transferred credits against
regular tax or AMT until a taxable year beginning on or after January 1, 2010.
CD's Final Thoughts
Let's be careful out there until the FTB provides
further guidance regarding application of these new California rules. We recommend playing it safe for now with respect
to FAS 109 calculations applying the most conservative positions noted above. There will be time to make adjustments when
2008 California income tax returns are filed next year. |
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Clifton Douglas, LLP Certified Public Accountants
Corporate Income Tax Compliance Solutions
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 Clifton
Douglas, LLP is a trusted provider of corporate tax compliance services
for a variety of high technology companies (e.g., semiconductor,
software, life sciences, video networking) throughout Silicon Valley.
We deliver comprehensive tax provision and tax return preparation
services to public and pre-IPO corporations across a broad range of
technology industries.
We are dedicated to
delivering superior compliance solutions to our clients by specializing
in all aspects of FAS 109 and tax compliance process management:
- FAS 109 tax accounting compliance
- Federal and state income tax return compliance
- FIN 48 uncertain tax position analyses
- Tax internal control assessment and documentation
- Effective tax rate analytics and benchmarking
- Complex areas of FAS 109 requiring specialized knowledge
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As provided in Treasury Department Circular 230, this e-newsletter is not intended or written by Clifton Douglas, LLP, to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.
Clifton Douglas, LLP distributes a complimentary electronic newsletter to subscribers. Clifton Douglas, LLP's Tax Updates provide comprehensive and timely insight on a wide range of taxation issues including international tax, state and local tax, incentives and current issues. Readers are reminded that they should not consider these documents to be a recommendation to undertake any tax position, nor consider the information contained therein to be complete. Before any item or treatment is reported, or excluded from reporting on tax returns, financial statements, or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in these releases may not continue to apply to a reader's situation due to changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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Authors
Douglas M. Sayuk, CPA
Partner
(408) 293-2401 Ext. 200
Matthew H. Fricke
Partner
(408) 293-2401 Ext. 201
Shamen R. Dugger, Esq., CPA
Director
(408) 293-2401 Ext. 204
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