On February 9, 2022, California Governor Gavin Newsom signed Senate Bill 113 into law. SB 113 changes several provisions of California’s tax laws that affect family businesses and offer valuable tax planning opportunities that business owners may wish to take advantage of. Specifically, SB 113 reinstates the business tax credits and net operating loss (“NOL”) deductions previously limited by enactment of Assembly Bill 85 in 2020. SB 113 also expands California’s pass-through entity tax to apply to more forms of California business entities.
Reinstatement of NOL Deductions and Tax Credits
AB 85 suspended the use of NOLs in tax years 2020 and 2021 for taxpayers with California sources of taxable income of $1 million or more. AB 85 also limited the use of certain business tax credits, including R&D credits, to $5 million annually for the same tax years. SB 113 removes these limitations for tax year 2022 and future years.
Expansion of Elective Pass-Through Entity Tax
The elective pass through entity tax was California’s response to the $10,000 cap placed on state and local tax deductions by the enactment of the federal Tax Cuts and Jobs Act of 2017 (“Act”). The initial state law allowing the pass through entity tax was passed in 2021 as Assembly Bill 150, but the business community largely felt the legislation fell short in providing the relief required after enacted the federal Act.
SB 113 is seen as the answer to those continued complaints. Prior to its passage, qualifying pass through entities could elect annually to pay entity-level state tax on income. The tax credit passed through to qualified taxpayers holding an interest in the entity, thus reducing the individual taxpayer’s California income tax.
SB 113 expands the benefits of the elective pass through entity tax and who may take advantage of it. Business entities structured as partnerships, limited liability companies (“LLC”) or corporations are now eligible to make the election. Certain disregarded entities, including single-member LLCs, may meet the requirements for a “qualified taxpayer.” The tax credit is applied to reduce net income tax after factoring in credits for taxes paid to other states, effective for the tax years beginning on or after January 1, 2022. The tentative minimum tax limit applicable to the pass through entity tax is repealed for the tax years beginning on or after January 1, 2021.
Planning Opportunities for Family Businesses
Family business owners should consult with their tax advisors to determine whether removal of the limits on NOLs and business tax credits provide an opportunity for tax savings in the 2022 tax year. In addition, the changes to the elective pass through entity tax may allow more family businesses to become eligible for the election.
If a particular family business is structured in such a way as to make it ineligible for the new tax benefits – even with the more liberal requirements becoming effective – there may be ways to adjust the business’ structure to allow the enterprise to qualify for the new tax benefits. Depending on the extent of the tax benefits that could be gained by the individual owners if their family business became eligible under the new law, updates to the entity’s structure may be well worth the effort.
Finkel Law Group, with offices in San Francisco and Oakland, has more than 25 years of experience advising privately held businesses, including family-owned businesses, on a wide array of legal issues, including business entity formation and restructuring, as well as corporate and individual tax matters. When you need intelligent, insightful, conscientious and cost-effective legal counsel to assist you with a business transaction or investment you may be contemplating for your privately owned business, please contact us at (415) 252-9600, (510) 344-6601, or info@finkellawgroup.com to speak with one of our attorneys about your matter.