California’s tax rules saw major changes with the signing of Senate Bill 113 (SB 113) on February 9, 2022. Governor Gavin Newsom’s approval of this legislation brought relief to businesses and individuals by lifting restrictions on net operating loss (NOL) deductions and business tax credits while also broadening the elective pass-through entity (PTE) tax.
These reforms provide tax-saving opportunities for companies, LLCs, partnerships, and high-income taxpayers navigating California’s complex tax environment.
Reinstatement of NOL Deductions and Business Tax Credits
Under Assembly Bill 85 (AB 85), California had suspended the use of NOLs for tax years 2020–2022 for taxpayers with taxable income of $1 million or more. The law also capped annual business tax credits, such as research and development (R&D) credits, at $5 million.
SB 113 reverses these limitations starting in tax year 2022. Eligible taxpayers can once again claim full NOL deductions and business credits, shortening the original suspension period and delivering immediate financial relief.
Expansion of California’s Elective Pass-Through Entity (PTE) Tax
California’s PTE tax regime—originally enacted for tax years 2021 through 2025—allows qualifying pass-through entities to pay an entity-level tax while providing their owners with a personal income tax credit.
SB 113 significantly enhances this program with changes designed to broaden eligibility and increase tax planning flexibility.
Key Updates Under SB 113:
- Guaranteed payments now count as qualified net income subject to the PTE tax.
- Expanded eligibility includes entities with partnerships as partners, members, or shareholders.
- Qualified taxpayer definition extends to disregarded LLCs meeting specific requirements.
- PTE tax credit application may now reduce liability below the tentative minimum tax.
- Revised credit ordering rule requires that credits for taxes paid to other states be applied before the PTE elective tax credit (effective January 1, 2022).
Why These Tax Changes Matter
For California taxpayers—especially high-income individuals, partnerships, and LLCs—SB 113 offers substantial tax planning advantages.
- Businesses regain the ability to carry forward NOLs and maximize tax credits.
- The expanded PTE framework provides a valuable workaround to the federal SALT deduction cap.
- Collectively, these changes make California a more attractive state for pass-through businesses and growth-focused taxpayers.