New California Tax Laws Could Pose Challenges for Tech Companies

California has once again shaken up its tax landscape, introducing new laws that may significantly impact tech companies. With the passage of California bills SB 167 and SB 175, the state is tightening its grip on tax credits, suspending net operating loss (NOL) deductions, and making controversial changes to tax apportionment rules—all of which could mean a higher tax bill for many companies doing business within the state. As we head into the 2025 tax year, here’s what your tech company needs to know to stay ahead of these changes:

Tax Credit Cap

The Research and Development (R&D) tax credit is critical in helping tech companies mitigate tax liability as they become profitable. This credit, along with several other CA specific corporate and personal tax credits, are subject to a $5 million annual limitation imposed by the state for tax years 2024 – 2026. Any disallowed credits are eligible for carry over for as many years as the credit was disallowed. For disallowed refundable credits, California permits taxpayers to make an election to receive the refunds in equal installments over a five-year period beginning with the third year after the election.

NOL Deduction Suspension

Many tech companies rely on NOL deductions to offset taxable income as they continue to scale and begin generating profit. However, as California has done three times since 2002 when experiencing budget shortfalls, the state is again suspending NOL deductions. The suspension applies to businesses and individuals with California sourced taxable income of at least $1 million. The carryover period for suspended NOLs is extended by three years for losses incurred before 2024, two years for losses incurred during 2024, and one year for losses incurred during 2025.  The extended carry forward is only available if the NOL could have been used to reduce taxable income absent the suspension.

Apportionment Fix

In response to two Office of Tax Appeals rulings in favor of taxpayers, California is attempting to institute a fix to the business apportionment computation that would increase sales allocable to the state, potentially leading to higher state tax liabilities for tech companies. The new law attempts to codify previous state guidance that indicated any transaction that generates income but is not included in net income, such as exempt foreign dividends, would be excluded from the sales factor denominator, thereby increasing California-sourced income. This may impact certain tech companies that collect dividends from profitable foreign operating subsidiaries. It should be noted that there are legal challenges filed against this provision, primarily focusing on the potential retroactive applicability of the new law and the enactment’s avoidance of the usual administrative public notice and comment requirements.

California’s latest tax measures may present significant hurdles for profitable tech companies. Working with a sophisticated tax advisor that continually monitors changing tax laws can help tech companies stay ahead of these changes and incorporate planning strategies to reduce additional tax liabilities.

For more information, please contact Alan Goldenberg, Principal and Leader of the State and Local Taxation (SALT) and Tax Controversy groups, Chris Noble, Executive Partner, Leader – Professional Services and Technology Groups, Adam Pizzo, Partner or your Anchin Relationship Partner.