California budget includes significant tax provisions

Update: The California Department of Tax and Fee Administration issued guidance in September 2024 clarifying that the bad debt deduction will still be available for retailers after January 1, 2025. Lenders or affiliated entities will remain ineligible to receive bad debt deductions for all transactions after January 1, 2025.

Update: S.B. 167 was signed into law on June 27, 2024. For information on subsequent budget legislation (S.B. 175), see PwC's Insight, here.

In brief

What happened?

California budget “trailer” legislation passed by the Legislature on June 13 suspends NOL deductions and limits credit utilization for 2024-2026, seeks to retroactively overturn judicial findings with respect to apportionment representation for deductible income, and suspends the sales tax bad debt deduction for retailers, among other provisions. [S.B. 167, passed Assembly and Senate, 6/13/24] 

Why is it relevant? 

The budget legislation may impact taxpayers with NOLs or significant California tax credits, water’s-edge filers with foreign dividend income, certain oil and gas energy companies, and retailers applying the sales tax bad debt deduction, among other taxpayers. 

Actions to consider 

Companies might consider actions in response to the NOL and credit limitations, such as amending tax returns for open years or making prospective accounting method elections. Taxpayers also may consider refund claims or original filing positions taken in reliance on precedent concerning apportionment representation for deductible income, such as foreign dividends. Retailers may consider the applicability of the sales tax bad debt deduction for charge-offs taking place prior to January 1, 2025, the effective date of the bad debt deduction suspension.  

Apportionment of deductible income 

The legislation provides that a transaction or activity, to the extent that it generates income or loss not included in “net income” subject to apportionment, is excluded from the applicable apportionment formula. "Not included in ‘net income’” means income from transactions and activities that is not included in net income subject to apportionment for any reason, including, but not limited to, exclusion, deduction, exemption, elimination, or nonrecognition. These changes are applicable to tax years beginning before, on, or after the effective date of the legislation. 

Observation: These changes are a response to the Office of Tax Appeals’ decision in Appeal of Microsoft Corp. and Subsidiaries, No. 21037336 (7/27/23), finding that the full amount of deductible foreign dividends are includable as gross receipts in the California sales factor. (Click here for PwC’s Insight on this decision.) Rehearing in that case was denied on February 14; however, the decision was issued as nonprecedential.  

For consideration: Taxpayers should consider the impact of this legislation on any refund claims or original filing positions taken in reliance on the Microsoft decision and any potential challenges to the retroactive nature of these provisions. The stated intent of the Legislature is that its position “does not constitute a change in, but is declaratory of, existing law,” in particular, FTB Legal Ruling 2006-1. 

The legislation grants the Franchise Tax Board the authority to adopt regulations that are “necessary or appropriate to carry out the purpose” of these changes, “which is to prevent inclusion within the apportionment formula of transactions and activities that give rise to income that is not subject to apportionment.” The Administrative Procedure Act (APA) will not apply to "any regulation, standard, criterion, procedure, determination, rule, notice, guideline, or any other guidance established or issued by the Franchise Tax Board” pursuant to this authority.  

Observation: These provisions are a response to the California Superior Court decision in Am. Catalog Mailers Ass’n v. Franchise Tax Bd., Cal. Super. Ct., No. CGC-22-601363, (2/13/24), in which the court found certain FTB guidance to be invalid because it failed to go through the rulemaking procedures laid out in the APA.  

Sales tax bad debt deduction limitation and suspension 

The legislation amends the retailer definition for purposes of the bad debt deduction from sales and use tax. Prior to January 1, 2025, the term "retailer" includes any entity affiliated with the retailer.   

Beginning January 1, 2025, a retailer cannot claim a bad debt deduction. The disallowance of the bad debt deduction sunsets on January 1, 2028. However, the reinstated bad debt deduction does not apply to an entity affiliated with a retailer.  

Observation: Up until January 1, 2025, California allows retailers, lenders, and retailers’ affiliates to claim a bad debt deduction. According to the Governor’s Budget Summary, California joins “the majority of states in disallowing deductions for non-retailer lenders for sales tax paid on bad debts.” 

Be aware: These provisions do not impact charge-offs taking place prior to January 1, 2025. Current and future claims for accounts charged-off up to and including December 31, 2024 are still eligible for the sales tax bad debt deduction for retailers and lenders, alike.