Net operating loss suspensions are a temporary restriction on a taxpayer’s ability to use accumulated NOLs and are often implemented when a state faces budget constraints or wants to increase short-term tax revenues. California has suspended NOLs during two different time periods in the last five years. First, during the 2020 and 2021 tax years. The second time was earlier this year, when California enacted SB 167 and suspended NOLS for the 2024 through 2026 tax years.
What is a net operating loss suspension?
Net operating loss suspension periods vary in duration and scope and generally require taxpayers to defer their NOL deductions until after the suspension period expires. However, the underlying NOL carry forwards generally retain their full value and original expiration dates. California’s SB 167 suspends NOLs for taxable years beginning on or after January 1st, 2024, and before January 1st, 2027.
The suspension does not apply to businesses subject to the personal income tax if they have net business income or modified adjusted gross income of less than $1,000. This means that personal income taxpayers are subject to the suspension only if both their modified AGI and their net business income is 1 million or more. And the suspension does not apply to businesses subject to the corporation income tax if their business income subject to California taxation is less than one million dollars.
How does California’s 2024 NOL suspension relate to business income?
Business income, for purposes of the $1M threshold is defined as income from a trade or business whether conducted by the taxpayer or a partnership or S corporation owned directly or indirectly by the taxpayer, from a rental activity, or attributable to a farming business. Modified adjusted gross income for purposes of the one million dollar threshold is the taxpayer’s federal AGI without regard to the NOL deduction.
For any NOL or NOL carryover disallowed as the result of the NOL suspension during the 2024 through 2026 tax years, the 20-year maximum carryover period will be extended as follows.
- One year for NOLs incurred during the 2025 taxable year
- Two years for NOLs incurred during the 2024 taxable year
- Three years for NOLs incurred prior to the 2024 taxable year
Net operating loss (NOL) suspension and estimated tax underpayment
When planning for a taxpayer affected by an NOL suspension, remember that California law provides an exception to the estimated tax underpayment penalty that results when a law change retroactively increases a taxpayer’s estimated tax payments. The exception applies to California law changes chaptered during the taxable year of the underpayment.
This means California taxpayers are not subject to estimated tax underpayment penalties for the 2024 tax year to the extent that the underpayment results from the NOL suspension for the 2024 tax year. However, you may need to increase you estimated tax payments for the 2025 tax year to account for the NOL suspension during the 2025 tax year. We recommend consulting with your tax professional, like those at MBS Accountancy, so you can plan for the optimal tax outcomes for your personal situation and business circumstances.
Where does this leave you during tax season?
Although the legislature may eliminate the 2025 NOL suspension, at this stage, this is only a possibility. Taxpayers should not plan on being able to claim an NOL deduction for the 2025 tax year when calculating their estimated tax payments. California conforms to the federal NOL provisions with significant modifications, including those related to carrybacks and the carryover period. In addition, it’s worth remembering that California does not conform to the 80% taxable income limitation. If you need help with your tax planning, contact our team today!