(May 9, 2013) A California Chamber of Commerce-opposed “job killer” bill that creates an inequality in the tax structure, thereby harming struggling small businesses and start-ups, was held this week in the Assembly Revenue and Taxation Committee pending review of the bill’s fiscal impacts.
AB 769 (Skinner; D-Berkeley) harms struggling small businesses and start-ups by repealing the Net Operating Loss (NOL) carryback deduction, a lifeline that helps employers stay afloat, retain employees, and continue investing in their businesses in an economic downturn.
Tax Structure Inequity
California businesses of all sizes and structures report and pay tax on their net income based on an arbitrary 12-month reporting period. An NOL occurs when a taxpayer’s business expenses exceeds revenue during that arbitrary 12-month reporting period. The NOL deduction allows a business taxpayer to offset current losses against future taxable income (carryover) or prior liabilities (carryback).
The purpose of an NOL deduction is to recognize that the “business cycle” (the period of time from capital investment to profit recognition on that investment) does not align with the government’s 12-month timeframe for filing taxes. For some businesses, that cycle is relatively short, for others it can be very long. Without an NOL deduction, the income tax fails to adequately match investment expense with revenue earned on that investment, essentially penalizing capital investment. The NOL therefore serves to ensure that taxable income more closely resembles the actual net income of the business enterprise.
NOLs are not economic incentive tools; they are integral to a fairly applied net income tax regime.
NOL Carryback Helps Struggling Businesses
The NOL carryback allows a company experiencing losses to amend the prior two years’ tax returns to offset tax liability going backward in time, making cash immediately available for paying bills and employee salaries, and for making business investments. This makes the carryback a lifeline to businesses struggling to deal with the current downturn, and which, without it, might not be able to last long enough to take advantage of the carryforward deduction. The carryback deduction is particularly critical for new businesses that struggle with profitability during their initial years, and need help to get off the ground.
California is not alone in seeing the value of an NOL carryback deduction — the federal government also provides one. In fact, the federal government recently expanded the carryback period from two to five years for small businesses, and will allow all businesses to carry back their 2009 losses for five years. AB 769 would cut off this lifeline for California businesses at a time when California’s economic growth continues to lag.
Unpredictability Deters Investors
Predictability is as important to employers as overall tax burden to economic investment. Employers cannot adequately evaluate potential costs if they cannot predict future tax liabilities. The NOL carryback was included in the 2008 budget package to help partially offset the harm to California businesses caused by a two-year suspension of the NOL deduction. The promise of a positive change in the near future helped demonstrate that California is committed to keeping employers in the state, despite the hit to businesses that year. Unfortunately, California again suspended the NOL deduction for the 2010 and 2011 tax years.
AB 769 not only reverses the 2008 compromise just as the taxpayers’ benefit from that agreement begins to materialize; it reinforces with employers that California’s taxing environment is unpredictable. Lack of predictability adds to risk, and increased risk adds to the overall cost of doing business, further hindering California’s economic recovery .
AB 769 will be considered by Assembly Revenue and Taxation at the suspense file hearing in mid-May and may be voted off the suspense file at that time and sent to the full Assembly for a vote.