The Personal Income Tax Law and the Corporation Tax Law, in modified conformity to federal law, allow taxpayers to utilize net operating losses and carryovers and carrybacks of those losses for purposes of offsetting their tax liabilities. Existing law allows net operating losses attributable to taxable years beginning on or after January 1, 2013, to be carrybacks to each of the preceding 2 taxable years, as provided. Existing law allows for a credit against estimated tax of an overpayment of tax for a preceding year. Federal income tax law includes provisions that allow a taxpayer to file an application for a tentative carryback adjustment of the tax for the prior taxable year affected by a net operating loss carryback, as provided.

This bill would additionally conform to those federal provisions, as provided. provided, but would allow for the suspension of the tentative carryback and refund adjustments pursuant to a proclamation issued by the Governor, as described.

The Personal Income Tax Law and the Corporation Tax Law, in modified conformity to federal law, allow taxpayers to utilize net operating losses and carryovers and carrybacks of those losses for purposes of offsetting their tax liabilities. Existing law allows net operating losses attributable to taxable years beginning on or after January 1, 2013, to be carrybacks to each of the preceding 2 taxable years, as provided. Existing law allows for a credit against estimated tax of an overpayment of tax for a preceding year. Federal income tax law includes provisions that allow a taxpayer to file an application for a tentative carryback adjustment of the tax for the prior taxable year affected by a net operating loss carryback, as provided.

This bill would additionally conform to those federal provisions, as provided.

The Personal Income Tax Law and the Corporation Tax Law, in modified conformity to federal law, allow taxpayers to utilize net operating losses and carryovers and carrybacks of those losses for purposes of offsetting their tax liabilities. Existing law allows net operating losses attributable to taxable years beginning on or after January 1, 2013, to be carrybacks to each of the preceding 2 taxable years, as provided. Existing law allows for a credit against estimated tax of an overpayment of tax for a preceding year. Federal income tax law includes provisions that allow a taxpayer to file an application for a tentative carryback adjustment of the tax for the prior taxable year affected by a net operating loss carryback, as provided.

This bill would additionally conform to those federal provisions, as provided.

SENATE COMMITTEE ON APPROPRIATIONS

Senator Anthony Portantino, Chair

2017 - 2018 Regular Session

AB 2855 (Brough) - Income taxes: net operating losses: carrybacks: overpayments: estimated tax

This bill meets the criteria for referral to the Suspense File.

Bill Summary:

AB 2855 would enact an expedited process for refunds generated by net operating loss carrybacks for specified purposes.

Fiscal Impact:

The Franchise Tax Board (FTB) estimates that the bill would result in aggregate General Fund revenue losses of $50 million in 2019-20, and $4.5 million in 2020-21. The bill would result in a net revenue gain of $3.3 million in 2021-22, and further modest annual revenue gains thereafter. These net figures reflect three distinct revenue impacts (See Staff Comments). Staff notes that the $50 million net revenue loss in 2019-20 cited above largely reflects an acceleration of refunds that would, on the natural, have occurred in subsequent years.

FTB would incur a first-year implementation cost of $571,000 in 2018-19, and annual costs of $179,000 thereafter, to develop, program, and test revisions to its information technology existing systems for this bill (General Fund).

Background:

California law generally does not automatically conform to changes to federal tax law. Instead, the Legislature must affirmatively conform to federal changes. Conformity legislation is introduced either (1) as individual tax bills to conform to specific federal changes, or (2) as one omnibus bill that provides that state law conforms to federal law as of a specified date, currently January 1, 2015.

Under state and federal law, business taxpayers generate a net operating loss (NOL) when they have taxable income less than zero in a given taxable year. Until 2008, taxpayers could only apply NOLs as a deduction against income realized in future taxable years, called a “carry forward.” However, the Legislature further expanded the use of NOLs when it suspended taxpayers from using NOLs in the 2008 and 2009 tax years. Specifically, the Legislature (1) extended carry forwards from 10 to 20 years, and (2) authorized NOL “carrybacks” beginning in the 2011, where taxpayers take losses from the current year and use them as a deduction against past income, receiving a refund for previous taxes paid (AB 1452, Committee on Budget, 2008). AB 1452 provided for two-year NOL carrybacks according to specified restrictions. In response to further fiscal crises, the Legislature pushed the above effective dates out by two years as part of the agreement enacting the 2010-11 state budget (SB 858, Committee on Budget and Fiscal Review, 2010).

Under federal law, taxpayers can obtain an expedited refund for NOL loss carrybacks by filing an application for tentative refund (ATR). Taxpayers must file the ATR on or after the return filing date, but no later than 12 months after the end of the taxable year in which the taxpayer files the return with the loss. Computation of interest on overpayments begins on this date. The Internal Revenue Service (IRS) must perform a limited examination of the ATR within 90 days from the date on which an ATR is filed, or the last day of the month of the extended due date for the loss year return. IRS may disallow the ATR if there are any material omissions or any errors of computation that are not corrected within the ATR processing period. If IRS finds no omissions or errors, the refund is applied against any tax or installment due, and then refunds any amount remaining to the taxpayer.

In December 2017, the federal government enacted wholesale changes to the federal income tax, including the repeal of NOL carrybacks for federal purposes, except for farms and property and casualty insurance companies.

Proposed Law:

This bill, beginning with taxable year 2019, would enact an expedited process for refunds generated by NOL carrybacks for state purposes. Specifically, the bill would:

• Allow taxpayers to file an ATR similar to federal law to report an NOL carryback within 12 months of the end of the taxable year in which the NOL was generated.
• Direct FTB to process the application within 180 days of receiving the ATR, or the last day of the month of the extended due date, whichever is later.
• Considers amounts carried back as overpayments.
• Conform to federal law’s provisions regarding the trigger date for calculating interest, and providing the same statute of limitations, but allow for the suspension of the tentative carryback and refund adjustments pursuant to a proclamation issued by the Governor, as specified.
• Allow the Governor to suspend the ATR process, as specified.

Related Legislation:

AB 1984 (Harkey, 2014) would have conformed to the federal provisions that allow a taxpayer with NOL carrybacks to obtain a tentative refund of taxes paid in prior tax years by filing a tentative carryback adjustment application, and allow a corporation to apply to extend the time for payment of taxes for the immediately preceding taxable year. The bill was held under submission on the Suspense File of the Assembly Appropriations Committee.

Staff Comments:

This bill would enact an expedited process for refunds generated by NOL carrybacks for state purposes. FTB developed its revenue estimate of the bill using data on carryback refunds claimed by taxpayers against taxes paid from 2011 through 2015.

As noted above, this bill would change the date that FTB must begin interest accrual to be the original filing date for the return that generated the NOL, exclusive of extensions. This change would reduce the amount of interest paid on these refunds by approximately one year for NOLs carried back one year, and by approximately two years for NOLs carried back two years. Based on an analysis of carrybacks reported on corporate tax returns, FTB assumes that 70 percent of losses in a year are carried back two years and 30 percent one year. The applicable corporate and personal overpayment interest rates are applied to these refund claims allowed by FTB, resulting in an annual revenue gain of $2.2 million per year.

Currently, if FTB allows a refund for a carryback, and later audits the loss year and reduces the NOL amount, it may be precluded by the statute of limitations (SOL) from adjusting the refund amount. FTB assumes that five percent of amounts refunded as carrybacks would be reversed by audits after the SOL expires. This proposal would enable FTB to recoup these refunds. The resulting annual revenue gain from this change would be $3.5 million.

When FTB receives a refund request based on an NOL carryback, it quickly examines the return to identify issues that may affect the refund amount. Currently, FTB releases $30 million in refunds after this initial examination, and retains $50 million in refund requests pending further examination. This bill would require the FTB to release refunds within 180 days of receiving a carryback ATR, or the last day of the month of the extended due date for the loss year return. For refunds that the FTB ultimately approves, this accelerates the date of the refund, resulting in an initial cash outflow and a later, offsetting cash inflow. For refunds that FTB ultimately denies, this results in a refund that would not have been issued under current law followed by a repayment from the taxpayer after an audit assessment, also resulting in an initial cash outflow and a later, offsetting cash inflow. The initial net outflow of revenue from this proposal is $50 million.

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SENATE COMMITTEE ON GOVERNANCE AND FINANCE

Senator Mike McGuire, Chair

2017 - 2018 Regular

Income taxes: net operating losses: carrybacks: overpayments: estimated tax

Enacts an expedited process for refunds generated by net operating loss carrybacks for state purposes.

Background

California law does not automatically conform to changes to federal tax law, except for specific retirement provisions. Instead, the Legislature must affirmatively conform to federal changes. Conformity legislation is introduced either as individual tax bills to conform to specific federal changes, like the Regulated Investment Company Modernization Act (AB 1423, Perea, 2011), or as one omnibus bill that provides that state law conforms to federal law as of a specified date, currently January 1, 2015 (AB 154, Ting, 2015).

Net Operating Losses. Under state and federal law, business taxpayers generate a net operating loss (NOL) when it has negative taxable income in a taxable year. For many years, taxpayers could only deduct a percentage of an NOL from income for state purposes for the next ten taxable years, known as a carryforward, until the Legislature allowed 100% NOL deductions for the 2004 taxable year and thereafter as part of a measure that suspended taxpayers from applying NOLs in the 2002 and 2003 taxable years enacted as part of the 2002-03 State Budget (AB 2065, Oropeza, 2002).

Until 2008, taxpayers could only apply NOLs as a deduction against income realized in future taxable years, called a “carry forward.” However, the Legislature further expanded the use of NOLs when it again suspended taxpayers from using NOLs in the 2008 and 2009 tax years. The Legislature extended carry forwards from 10 to 20 years, and authorized NOL “carrybacks” beginning in the 2011 taxable year, where taxpayers take losses from the current year and use them as a deduction against past income, receiving a refund for previous taxes paid (AB 1452, Committee on Budget, 2008).

AB 1452 provided for two-year NOL carrybacks according to the following restrictions:

• For NOLs generated in the 2011 taxable year, taxpayers may carry back 50% of the loss to the 2009 and 2010 taxable years.
• For NOLs generated in the 2012 taxable year, taxpayers may carry back 75% of the loss to the 2010 and 2011 taxable years.
• For NOLs generated in the 2013 taxable year and thereafter, taxpayers may carry back 100% of the loss to the 2011 taxable year and thereafter.

In response to further fiscal crises, the Legislature pushed the above effective dates out by two years as part of the agreement enacting the 2010-11 Budget Act (SB 858, Committee on Budget and Fiscal Review, 2010).

Expedited Refunds. Under federal law, taxpayers can obtain an expedited refund for NOL loss carrybacks by filing an application for tentative refund (ATR). Taxpayers must file the ATR on or after the return filing date, but no later than 12 months after the end of the taxable year in which the taxpayer files the return with the loss. Computation of interest on overpayments begins on this date. The Internal Revenue Service (IRS) must perform a limited examination of the ATR within 90 days from the date on which an ATR is filed, or the last day of the month of the extended due date for the loss year return. IRS may disallow the ATR if there are any material omissions or any errors of computation that are not corrected within the ATR processing period. If IRS finds no omissions or errors, the refund is applied against any tax or installment due, and then refunds any amount remaining to the taxpayer.

On December 22nd, 2017, President Trump signed HR 1, which enacted fundamental changes to the federal income tax. Among them, HR 1 repeals net operating loss carrybacks for federal purposes, except for farms and property and casualty insurance companies.

Seeking quicker refunds, the author wants to enact an expedited process for refunds generated by net operating loss carrybacks for state purposes.

Proposed Law

AB 2855 enacts an expedited process for refunds generated by net operating loss carrybacks for state purposes. Specifically, the bill:

• Allows taxpayers to file an ATR similar to federal law to report an NOL carryback within 12 months of the end of the taxable year in which the NOL was generated.
• Directs FTB to process the application within 180 days of receiving the ATR, or the last day of the month of the extended due date, whichever is later.
• Considers amounts carried back as overpayments,
• Conforms to federal law’s provisions regarding the trigger date for calculating interest, and providing the same statute of limitations.

AB 2855 allows ATRs beginning on January 1, 2019.

State Revenue Impact

FTB estimates that AB 2855 results in revenue losses of $50 million in 2019-20 and $4.5 million in 2020-21, with revenue gains of $3.3 million in 2021-22.

Comments

1. Purpose of the bill. According to the author, “AB 2855 will expedite tax refunds so businesses will have timely access to capital owed as a result of a net operating loss. Claiming a net operating loss resolves the inequity that comes from businesses experiencing revenue losses and profits according to timeframes that differ from tax deadlines. AB 2855 accelerates the issuance of the refund, providing a tremendous benefit to cash-strapped businesses or established businesses considering expansion by leveling out their income and losses over time, and increasing the availability of capital. Enacting this change would benefit taxpayers to allow them to resolve their refund claim more quickly, while also reducing interest on those claims paid by the state.”

2. One of many. As noted above, California only conforms with federal law through January 1, 2015. Since then, Congress has enacted several changes to federal tax law, including HR 1, the most significant alternation since 1986. AB 2855 leaves these changes aside to instead conform to a process for accelerated refunds for NOL carrybacks that serves little purpose other than accelerating payments to firms sufficiently sophisticated to file ATRs. AB 2855 would increase the value of a carry back by accelerating payments resulting from NOL carrybacks, which are generally considered poor tax policy, so much so that Congress recently repealed them for federal purposes. Additionally, FTB states that 2855 will lead to $50 million in refund payments that will subsequently be denied in audit which taxpayers will have to repay, resulting in an initial cash outflow and a subsequent offsetting cash inflow. The Committee may wish to consider that to the extent conforming state law with federal law in this case is desirable, and whether AB 2855 should be enacted instead of other federal changes.

3. Priorities. In 2009, Controller John Chiang suspended tax refunds, student grants and other payments because the state lacked the cash. More than half of those payments were tax refunds. Later that year, the state began issuing IOUs in lieu of tax refunds. While the financial crisis and the resulting issuance of IOUs occurred almost ten years ago, Governor Brown often warns of an incipient economic recession, and Congress may cut vital state assistance programs such as Medi-Cal to balance its burgeoning deficit. If such a crisis were to occur, accelerated payments to taxpayers sufficiently sophisticated to claim NOL carrybacks would seem to be a less merited use of finite cash. The Committee may wish to consider amending AB 2855 to allow the Director of Finance to suspend AB 2855’s accelerated payments whenever a fiscal emergency is declared.

Assembly Actions

Assembly Revenue and Taxation Committee: 8-0

Assembly Appropriations Committee: 16-0

Assembly Floor: 78-0

Support and Opposition

(6/22/18)

Support: California Apartment Association, California Association of Winegrape Growers, California Beer and Beverage Distributors, California Business Properties Association, California Chamber of Commerce, California Retailers Association, California Society of Enrolled Agents, California Tax Reform Association, California Taxpayers Association, Camarillo Chamber of Commerce, CompTIA, Franchise Tax Board, Greater Irvine Chamber of Commerce, North Orange County Chamber of Commerce, Orange County Business Council, San Gabriel Valley Economic Partnership, Spidell Publishing, Inc.

Opposition: Unknown.

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ASSEMBLY THIRD READING

ATR Bill Id:AB 2855

Author:(Brough)

As Amended Ver:April 18, 2018

Majority vote

SUMMARY: Establishes an Application for Tentative Refund (ATR) process for obtaining a tentative refund based on a net operating loss (NOL) carryback, and specifies the trigger date for statute of limitations (SOL) and interest accrual applicable to an NOL carryback. Specifically, this bill:

1. Conforms to Internal Revenue Code (IRC) Section 6411, relating to the ATR, on or after January 1, 2019.
2. Allows the Franchise Tax Board (FTB) to assess amounts applied, credited, or refunded based on a tentative carryback adjustment application as an overpayment of a credit if the amounts are determined to be in excess of the overpayment attributable to the carryback.
3. Provides that the SOL for claiming a refund based on an NOL carryback would generally be the same as the SOL for the return that generated the NOL, including extensions. The SOL applies to claims for refunds filed on or after January 1, 2019.
4. Provides that the SOL for assessing a deficiency attributable to an NOL carryback would generally be the same as the SOL for the return that generated the NOL, including extensions. The SOL applies to deficiency assessments mailed on or after January 1, 2019.
5. Provides that the trigger date for interest accrual would be the same as the original filing date for the return that generated the NOL, not including extensions.
6. Makes technical changes to the extension of time for payment of taxes related to the ATR.

EXISTING FEDERAL LAW:

1. Limits the NOL deduction for losses arising after December 31, 2017, to the lesser of the following:
   1. The aggregate of the NOL carryover losses to such year plus the NOL carrybacks to such year; or,
   2. 80% of taxable income. Carryovers to other years are adjusted to apply this limitation and may be carried forward indefinitely.
2. Prevents, in general, NOLs arising in taxable years after December 31, 2017 from being carried back to a taxable year preceding the loss. NOL carrybacks have generally been eliminated for most taxpayers.
3. Allows NOLs to be carried forward indefinitely.
4. Provides for an expedited refund for NOL carrybacks for losses arising in a taxable year before December 31, 2017, or for carrybacks related to certain disaster-related farming losses, or carrybacks of losses arising from a property or casualty insurance company by allowing taxpayers to file an ATR resulting from a carryback or an overpayment of tax due to a claim of right adjustment.
5. Requires the ATR to be filed on or after the return filing date, but no later than 12 months after the end of the taxable year in which an NOL, net capital loss, unused credit, net contracts loss, or claim of right adjustment arose.
6. Requires the Internal Revenue Service (IRS) to perform a limited examination of the ATR to discover omissions and errors of computation within the later of either:
   1. 90 days from the date on which an ATR is filed; or,
   2. The last day of the month of the extended due date for the loss year return.
7. Allows the IRS to deny the ATR if there are any material omissions or any errors of computation that are not corrected within the ATR processing period.

EXISTING STATE LAW:

1. Allows, generally, taxpayers to calculate an NOL in accordance with federal rules under IRC Section 172. NOLs attributable to taxable years beginning on or after January 1, 2008, may be carried forward 20 years.
2. Conforms to the federal law allowing NOL carrybacks for NOLs attributable to taxable years beginning on or after January 1, 2013.
3. Allows NOLs generated in taxable years beginning on or after January 1, 2013, and later, to be carried back to the two preceding taxable years. For NOLs attributable to taxable years beginning before January 1, 2013, NOL carrybacks are unavailable. No NOL may be carried back to years beginning before January 1, 2011.
4. Lacks an expedited ATR process.
5. Allows, on or after January 1, 2015, an extension of time for payment of taxes by corporations expecting an NOL carryback for the immediately preceding taxable year. Extends the time for payment of taxes until the end of the month that the return for the taxable year of the expected NOL is required to be filed, including extension.
6. Allows interest to be accrued beginning in the year in which the NOL is carried back to instead of the year in which the NOL is incurred.
7. Provides that the SOL begins to run in the year in which the NOL is carried back to instead of the year in which the NOL is incurred.

FISCAL EFFECT: According to the Assembly Appropriations Committee:

1. Accelerated revenue loss from the ATR refund process because refunds are provided faster than under current law. General Fund (GF) revenue losses will be $60 million in 2019-20, $10 million in 2020-21, and $2.4 million in 2021. There will be revenue gains in later years.
2. Increased revenue as a result of the statute of limitations and interest accrual provisions. Annual GF revenue gains will be $5.5 million in 2019-20, $5.7 million in 2020-21, and $5.8 million in 2021-22.
3. One-time administrative costs of $571,000 in 2018-19 and ongoing costs of $179,000 for the FTB to implement and run these new processes.

COMMENTS:

1. The author has provided the following statement in support of this bill:

Amending state law to be similar to the federal expedited refund enhances taxpayers' ability to equalize income over time consistent with the intent of the Net Operating Loss deduction while protecting the state's interest by limiting the process to single-issue amended returns. Modified conformity would benefit taxpayers, by eliminating confusion during filing, and allowing them to resolve their claim more quickly. This is especially important for smaller businesses that often experience losses during the first years of business.

Amending state law regarding statute of limitations and interest trigger-date would appropriately tie these dates to the year the loss was generated rather than to a time when the loss did not yet exist. This change reduces the risk of an expired statute of limitations preventing the department and taxpayers from correcting a previously reported deduction.

1. Committee Staff Comments:
   1. Background: On September 30, 2008, the Governor signed into law AB 1452 (Budget Committee), Chapter 763, Statutes of 2008, to implement provisions of the 2008-09 Budget agreement. Among other things, AB 1452 suspended the NOL deduction for the 2008 and 2009 tax years, except for taxpayers with net business income of less than $500,000 in either year, authorized NOL carrybacks for losses incurred in 2011 or later tax years, and expanded the NOL carryforward period from 10 years to 20 years for losses incurred after January 1, 2008. AB 1452 authorized taxpayers to use carrybacks to offset their income during the two prior tax years. The carryback provisions were scheduled to phase in, with 50% of any 2011 NOLs available for carryback, 75% of any 2012 NOLs, and full carryback for NOLs in subsequent years.

Two years later, when the Legislature was facing another difficult budget, SB 858 (Senate Budget and Fiscal Review Committee), Chapter 721, Statutes of 2010, was enacted into law. SB 858 further suspended the NOL deductions for the 2010 and 2011 taxable years and delayed the implementation of the NOL carrybacks provisions, among other changes. Specifically, SB 858 disallowed NOL carrybacks for any NOLs attributable to taxable years beginning before January 1, 2013. Consequently, under existing law, the carryback provisions phased in with 50% of any 2013 NOLs available for carryback, 75% of any 2014 NOLs, and full carryback for NOLs attributable to tax year 2015 and thereafter. In 2015, California passed AB 154 (Ting), Chapter 359, Statutes of 2015, and conformed to federal provisions allowing a corporation expecting an NOL carryback to extend the time for payment of taxes for the immediately preceding taxable year.

• 1. Federal Changes: Public Law No. 115-97, known as the Tax Cuts and Jobs Act, was signed into law on December 22, 2017. The law made sweeping changes to the tax code. Among those changes were major modifications to the federal treatment of NOLs. In general, NOLs generated in a taxable year ending after December 31, 2017 will no longer be allowed to be carried back, but are allowed to be carried forward indefinitely. In addition to the carryforward and carryback provisions, the NOL deduction for losses generated in a taxable year ending after December 31, 2017, is limited to the lesser of the aggregate of the NOL carryover losses to such year plus the NOL carryback to such year, or 80% of taxable income (determined without regard to the deduction). The provisions of this bill conform to federal provisions that are generally no longer available at the federal level for NOLs generated in a taxable year ending after December 31, 2017.
  2. NOL: The basic rationale for allowing losses to be carried forward and back flows from recognition that businesses are established with the goal of making a profit over a business cycle rather than in any particular year. The NOLs help smooth out the income and taxes paid over a business cycle, thereby allowing a business to make efficient decisions regarding financing and investment. For example, consider two firms, one with a $100 loss in year one and a $300 gain in year two, the second with a $100 gain in each of the two years. Without a NOL deduction the first firm would report $300 taxable income, while the second would report $200, even though each had $200 in net income. [Department of Finance (DOF), Annual Tax Expenditure Report, 2008-09.]
  3. Tentative Refund: Federal law provides corporations with the ability to file Form 1139 to apply for a refund of NOL carrybacks. In general, the corporation must file for a refund within 12 months of the end of the tax year of incurring an NOL. The IRS will process the application within 90 days from the date the application is filed or 90 days from the last day of the month in which the taxpayer is required to file a tax return. This bill would conform California to the federal process of obtaining a refund, but would allow the FTB 180 days to process the application. It is important to remember that the refund is considered to be a tentative adjustment of the taxpayer's tax liability – it is not a settlement of liability for the year or a formal claim for refund, and the adjustment could lead to a post-refund examination. The refund would provide businesses with cash without precluding FTB's ability to process and audit the tax filing.
  4. Payment of Interest: A taxpayer may amend a return to carryback a NOL to a year in which taxes were paid. This bill clarifies that the trigger date for the accrual of interest would be the same as the accrual of interest for the original filing date for the return that generated the NOL. This would ensure that interest does not begin accruing in the year in which the NOL is carried back to.
  5. SOL on Claims for Refund and Deficiencies: In general, existing law requires that every notice of proposed deficiency assessment be mailed to the taxpayer within four years after the return is filed, and bars a claim for refund after four years from the date the return is filed. This bill clarifies that the SOL for assessing a deficiency, or claiming a refund, based on an NOL carryback would generally be the same as the SOL for the return that generated the NOL.

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098 FN: 0003113

Date of Hearing: May 2, 2018

ASSEMBLY COMMITTEE ON APPROPRIATIONS

Lorena Gonzalez Fletcher, Chair

ABPCA Bill Id:AB 2855

Author:(Brough) – As Amended Ver:April 18, 2018

Urgency: No State Mandated Local Program: No Reimbursable: No

SUMMARY:

This bill establishes an Application for Tentative Refund (ATR) process for obtaining a tentative refund based on a net operating loss (NOL) carryback and specifies the trigger date for the statute of limitations (SOL) and interest accrual applicable to an NOL carryback.

FISCAL EFFECT:

1. Accelerated revenue loss from the ATR refund process because refunds are provided faster than under current law. GF revenue losses will be $60 million in 2019-20, $10 million in 2020-21, and $2.4 million in 2021. There will be revenue gains in later years.
2. Increased revenue as a result of the SOL and interest accrual provisions. Annual GF revenue gains will be $5.5 million in 2019-20, $5.7 million in 2020-21, and $5.8 million in 2021-22.
3. One-time administrative costs of $571,000 in 2018-19 and ongoing costs of $179,000 for the Franchise Tax Board (FTB) to implement and run these new processes.

COMMENTS:

1. Background. NOL provisions allow business taxpayers to apply certain losses against past tax payments (carryback) or future tax liabilities (carryover). In the case of carryback, a taxpayer may receive a refund if the carryback offsets taxes already paid. The rationale behind NOL is that businesses are established with the goal of making a profit over a business cycle rather than in any particular year. NOLs help smooth out the income and taxes paid over a business cycle, which in theory allows a business to make efficient decisions regarding financing and investment.

In general, a California taxpayer calculates an NOL in accordance with federal law as of January 1, 2015. NOLs attributable to taxable years beginning on or after January 1, 2013, are allowed to be carried back to two preceding taxable years.

1. What this bill does. This bill brings California into modified conformity with federal law regarding certain aspects of NOLs. Specifically, the main provisions include:
2. A new state ATR process. Federal law allows certain corporations to apply for a quick refund of NOL carrybacks, which is also called the ATR. The taxpayer must file for the refund within 12 months of the end of the tax year in which the NOL was incurred, and the Internal Revenue Services must process the application within 90 days from the date the application is filed. AB 2855 creates a similar process for NOL carrybacks at the state level.
3. Revised SOL and interest accrual dates. Under current law, a taxpayer may amend a return to carryback a NOL to a year in which taxes were paid. However, current law does not specify that the SOL and interest trigger date on a refund are determined based on the filing date of the return that generated the NOL. This has inadvertently led to less time for taxpayers and FTB to correct an NOL carryback and a longer time over which interest accrues on a refund resulting from a NOL carryback. AB 2855 conforms to federal law to clarify these provisions.
4. Federal tax reform. The Tax Cut and Jobs Act (TCJA), signed into law in December, 2017, made sweeping changes to the tax code. Among those changes were major changes to the federal treatment of NOLs. In general, NOLs generated in a taxable year ending after December 21, 2017, will no longer be able to be carried back, but are allowed to be carried forward indefinitely. As a result, AB 2855 makes conforming changes to parts of federal law that will no longer be relevant to the federal treatment of NOLs. For example, the federal ATR process, which allows for a quick refund of NOL carrybacks, will no longer apply in most situations because of the elimination of the carryback option.

Analysis Prepared by: Luke Reidenbach / APPR. / (916) 319-2081

Date of Hearing: April 9, 2018

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Autumn R. Burke, Chairwoman

ABPCA Bill Id:AB 2855 (

Author:Brough) – As Introduced Ver:February 16, 2018

Majority vote. Fiscal committee.

SUBJECT: Income taxes: net operating losses: carrybacks: overpayments: estimated tax

SUMMARY: Establishes an Application for Tentative Refund (ATR) process for obtaining a tentative refund based on a net operating loss (NOL) carryback, and specifies the trigger date for statute of limitations (SOL) and interest accrual applicable to an NOL carryback. Specifically, this bill:

1. Conforms to Internal Revenue Code (IRC) Section 6411, relating to the ATR, on or after January 1, 2019.
2. Allows the Franchise Tax Board (FTB) to assess amounts applied, credited, or refunded based on a tentative carryback adjustment application as an overpayment of a credit if the amounts are determined to be in excess of the overpayment attributable to the carryback.
3. Provides that the SOL for claiming a refund based on an NOL carryback would generally be the same as the SOL for the return that generated the NOL, including extensions. The SOL applies to claims for refunds filed on or after January 1, 2019.
4. Provides that the SOL for assessing a deficiency attributable to an NOL carryback would generally be the same as the SOL for the return that generated the NOL, including extensions. The SOL applies to deficiency assessments mailed on or after January 1, 2019.
5. Provides that the trigger date for interest accrual would be the same as the original filing date for the return that generated the NOL, not including extensions.
6. Makes technical changes to the extension of time for payment of taxes related to the ATR.

EXISTING FEDERAL LAW:

1. Limits the NOL deduction for losses arising after December 31, 2017, to the lesser of the following:
   1. The aggregate of the NOL carryover losses to such year plus the NOL carrybacks to such year; or,
   2. 80 percent of taxable income. Carryovers to other years are adjusted to apply this limitation and may be carried forward indefinitely.
2. Prevents, in general, NOLs arising in taxable years after December 31, 2017 from being carried back to a taxable year preceding the loss. NOL carrybacks have generally been eliminated for most taxpayers.
3. Allows NOLs to be carried forward indefinitely.
4. Provides for an expedited refund for NOL carrybacks for losses arising in a taxable year before December 31, 2017, or for carrybacks related to certain disaster-related farming losses, or carrybacks of losses arising from a property or casualty insurance company by allowing taxpayers to file an ATR resulting from a carryback or an overpayment of tax due to a claim of right adjustment.
5. Requires the ATR to be filed on or after the return filing date, but no later than 12 months after the end of the taxable year in which an NOL, net capital loss, unused credit, net contracts loss, or claim of right adjustment arose.
6. Requires the Internal Revenue Service (IRS) to perform a limited examination of the ATR to discover omissions and errors of computation within the later of either:
   1. 90 days from the date on which an ATR is filed; or,
   2. The last day of the month of the extended due date for the loss year return.
7. Allows the IRS to deny the ATR if there are any material omissions or any errors of computation that are not corrected within the ATR processing period.

EXISTING STATE LAW:

1. Allows, generally, taxpayers to calculate an NOL in accordance with federal rules under IRC Section 172. NOLs attributable to taxable years beginning on or after January 1, 2008, may be carried forward 20 years.

1. Conforms to the federal law allowing NOL carrybacks for NOLs attributable to taxable years beginning on or after January 1, 2013.
2. Allows NOLs generated in taxable years beginning on or after January 1, 2013, and later, to be carried back to the two preceding taxable years. For NOLs attributable to taxable years beginning before January 1, 2013, NOL carrybacks are unavailable. No NOL may be carried back to years beginning before January 1, 2011.
3. Lacks an expedited ATR process.
4. Allows, on or after January 1, 2015, an extension of time for payment of taxes by corporations expecting an NOL carryback for the immediately preceding taxable year. Extends the time for payment of taxes until the end of the month that the return for the taxable year of the expected NOL is required to be filed, including extension.
5. Allows interest to be accrued beginning in the year in which the NOL is carried back to instead of the year in which the NOL is incurred.
6. Provides that the SOL begins to run in the year in which the NOL is carried back to instead of the year in which the NOL is incurred.

FISCAL EFFECT: The FTB estimates General Fund (GF) revenue losses of $55 million in fiscal year (FY) 2019-20, $4.5 million in 2020-21, and a GF revenue gain of $3.3 million in FY 2021-22.

COMMENTS:

1. The author has provided the following statement in support of this bill:

Amending state law to be similar to the federal expedited refund enhances taxpayers' ability to equalize income over time consistent with the intent of the Net Operating Loss deduction while protecting the state's interest by limiting the process to single-issue amended returns. Modified conformity would benefit taxpayers, by eliminating confusion during filing, and allowing them to resolve their claim more quickly. This is especially important for smaller businesses that often experience losses during the first years of business.

Amending state law regarding statute of limitations and interest trigger-date would appropriately tie these dates to the year the loss was generated rather than to a time when the loss did not yet exist. This change reduces the risk of an expired statute of limitations preventing the department and taxpayers from correcting a previously reported deduction.

1. Supporters argue that "[l]ongstanding federal law provides for a speedy refund for NOL carrybacks by allowing taxpayers to file an application for tentative adjustment, popularly known as a 'quickie refund.' This application, which is filed instead of a refund claim, must be acted on by the IRS within 90 days of receipt of the application, or 90 days from the last day of the month in which the taxpayer must file the return, whichever is later." According to supporters, "California's conformity to this federal provision would similarly allow taxpayers to receive refunds as early as 90 days after submitting an application, rather than one or two years later – providing a tremendous benefit for cash-strapped new businesses and established businesses considering expansion."
2. Committee Staff Comments:
   1. Background: On September 30, 2008, the Governor signed into law AB 1452 (Budget Committee), Chapter 763, Statutes of 2008, to implement provisions of the 2008-09 Budget agreement. Among other things, AB 1452 suspended the NOL deduction for the 2008 and 2009 tax years, except for taxpayers with net business income of less than $500,000 in either year, authorized NOL carrybacks for losses incurred in 2011 or later tax years, and expanded the NOL carryforward period from 10 years to 20 years for losses incurred after January 1, 2008. AB 1452 authorized taxpayers to use carrybacks to offset their income during the two prior tax years. The carryback provisions were scheduled to phase in, with 50% of any 2011 NOLs available for carryback, 75% of any 2012 NOLs, and full carryback for NOLs in subsequent years.
      
      Two years later, when the Legislature was facing another difficult budget, SB 858 (Senate Budget and Fiscal Review Committee), Chapter 721, Statutes of 2010, was enacted into law. SB 858 further suspended the NOL deductions for the 2010 and 2011 taxable years and delayed the implementation of the NOL carrybacks provisions, among other changes. Specifically, SB 858 disallowed NOL carrybacks for any NOLs attributable to taxable years beginning before January 1, 2013. Consequently, under existing law, the carryback provisions phased in with 50% of any 2013 NOLs available for carryback, 75% of any 2014 NOLs, and full carryback for NOLs attributable to tax year 2015 and thereafter. In 2015, California passed AB 154 (Ting), Chapter 359, Statutes of 2015, and conformed to federal provisions allowing a corporation expecting an NOL carryback to extend the time for payment of taxes for the immediately preceding taxable year.
   2. Federal Changes: Public Law No. 115-97, known as the Tax Cuts and Jobs Act, was signed into law on December 22, 2017. The law made sweeping changes to the tax code. Among those changes were major modifications to the federal treatment of NOLs. In general, NOLs generated in a taxable year ending after December 31, 2017 will no longer be allowed to be carried back, but are allowed to be carried forward indefinitely. In addition to the carryforward and carryback provisions, the NOL deduction for losses generated in a taxable year ending after December 31, 2017, is limited to the lesser of the aggregate of the NOL carryover losses to such year plus the NOL carryback to such year, or 80% of taxable income (determined without regard to the deduction). The provisions of this bill conform to federal provisions that are generally no longer available at the federal level for NOLs generated in a taxable year ending after December 31, 2017.
   3. NOL: The basic rationale for allowing losses to be carried forward and back flows from recognition that businesses are established with the goal of making a profit over a business cycle rather than in any particular year.  The NOLs help smooth out the income and taxes paid over a business cycle, thereby allowing a business to make efficient decisions regarding financing and investment.  For example, consider two firms, one with a $100 loss in year one and a $300 gain in year two, the second with a $100 gain in each of the two years.  Without a NOL deduction the first firm would report $300 taxable income, while the second would report $200, even though each had $200 in net income.  [Department of Finance (DOF), Annual Tax Expenditure Report, 2008-09.]
   4. Tentative Refund: Federal law provides corporations with the ability to file Form 1139 to apply for a refund of NOL carrybacks. In general, the corporation must file for a refund within 12 months of the end of the tax year of incurring an NOL. The IRS will process the application within 90 days from the date the application is filed or 90 days from the last day of the month in which the taxpayer is required to file a tax return. This bill would conform California to the federal process of obtaining a refund. It is important to remember that the refund is considered to be a tentative adjustment of the taxpayer's tax liability – it is not a settlement of liability for the year or a formal claim for refund, and the adjustment could lead to a post-refund examination. The refund would provide businesses with cash without precluding FTB's ability to process and audit the tax filing.

Although the FTB is able to provide taxpayers with a refund on most amended returns within 30 days, moving to a 90-day processing time for all NOLs may substantially increase workload and place a serious strain on FTB staff for certain tentative refund applications. FTB does not have the same level of staffing that is available at the IRS. Furthermore, a 90-day turnaround allows for only a very cursory examination of the application. To aid FTB's processing of the tentative refund, the Committee may wish extend the processing time to 180 days.

• 1. Payment of Interest: A taxpayer may amend a return to carryback a NOL to a year in which taxes were paid. This bill clarifies that the trigger date for the accrual of interest would be the same as the accrual of interest for the original filing date for the return that generated the NOL. This would ensure that interest does not begin accruing in the year in which the NOL is carried back to.
  2. SOL on Claims for Refund and Deficiencies: In general, existing law requires that every notice of proposed deficiency assessment be mailed to the taxpayer within four years after the return is filed, and bars a claim for refund after four years from the date the return is filed. This bill clarifies that the SOL for assessing a deficiency, or claiming a refund, based on an NOL carryback would generally be the same as the SOL for the return that generated the NOL.

REGISTERED SUPPORT / OPPOSITION:

Support

Franchise Tax Board (Sponsor)

California Society of Enrolled Agents

San Gabriel Valley Economic Partnership

Opposition

None on file

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098