Allegedly there are two things certain in life: death and taxes. Death is irrevocable. Taxes are subject to change, especially in California, where significant new tax provisions have been enacted into law recently. They range from new net operating loss (NOL) suspension and credit utilization limitations to increased penalties for under-payments of estimated quarterly tax payments. The provisions will not affect all companies, but sorting out which ones they do can be confusing. In some cases, enlisting the help of professional financial advisers might be advisable.
“If a company has the capability to analyze its tax situation, it can do that,” says Gary Hui of Burr, Pilger & Mayer. “But, if it needs outside help, working with professional advisers might save it time, money and aggravation.”
Smart Business spoke with Hui about how and when companies should start preparing for the changes.
Are all California companies affected by the new tax provisions?
No. Corporations with taxable income less than $500,000 in 2008 and 2009 tax years are not affected by the new NOL deduction suspension or credit utilization limitation provisions. The revised California NOL carryover provision will impact all ‘loss’ companies, though. In short, any state NOL generated by a corporation in a tax year beginning on or after Jan. 1, 2008, will have a carryover period of 20 years as compared to 10 years in the prior law. It is especially useful for life science companies due to their long development cycle and regulatory approval process.
Finally, aside from the fiscal impact to a company, the new law will also have impact on a company’s accounting for income taxes for SEC reporting purposes, if the company is publicly traded.
Are all life science companies exempt from the underpayment penalty?
The new 20 percent underpayment penalty, which is in addition to any other existing penalties, specifically targets corporations with unpaid taxes in excess of $1 million in tax years beginning on or after Jan. 1, 2003. With a California corporate tax rate of 8.84 percent, that translates to taxable income of at least $11.3 million. Life science corporations in the development stage are unlikely to have that level of taxable income.
How will these tax provisions affect California companies?
Corporations with taxable income of $500,000 or more in 2008 and 2009 will not be able to use their net operating losses generated in prior years to reduce their taxable income in those years. However, if the corporation has California research tax credits, which is most likely in a life science corporation, it may use the available credit to reduce up to 50 percent of its state tax liability. Consequently, a California corporation with taxable income not less than $500,000 in 2008 and 2009 will have to pay at least 50 percent of the tax liability in those years, even if it may have net operating loss and/or research tax credit carryforwards that would otherwise reduce the CA tax substantially.
When should California companies begin preparing for these tax provisions?
They should start immediately to assess whether the NOL suspension and credit utilization limitation provisions would affect them, since these provisions have direct cash flow impact. Also, if the new 20 percent penalty applies to any of the prior year tax filings, the corporation is allowed up to May 31, 2009, to amend the affected tax return and pay the additional tax to mitigate or eliminate the penalty.
Will these tax provisions have a detrimental effect on California companies if they do not prepare properly for their implementation?
Yes, any underpayment of tax will trigger penalty and interest. Any potential underpayment of tax and the related penalty and interest will have to be included and disclosed in the audited financial statements of a publicly traded company.
Are there any other new tax provisions of which companies should be aware?
Several. The first two quarterly estimated tax installments will carry higher percentages for tax years beginning on or after Jan. 1, 2009. Tax credit may be assigned to other combined group members for them to reduce their tax liabilities in tax years beginning on or after Jan. 1, 2010. In the old law, the tax credit was attached with the combined group member that earned the credit and could not be utilized by other members of the combined group.
Other NOL related provisions do not have immediate cash flow impact on a corporation in 2008. For example, the carryover periods for NOLs generated prior to 2008 are extended by two additional tax years and by one additional tax year for the NOL generated in 2008. A new NOL carryback provision will allow a limited carryback of NOLs generated in a tax year beginning in or after 2011 up to two preceding tax years.
Incidentally, for California LLCs, the payment date of the LLC fee has been accelerated to the 15th day of the sixth month of the taxable year, instead of the 15th of the fourth month of the following tax year.
GARY L. HUI, CPA, is tax senior manager with Burr, Pilger & Mayer. Reach him at (415) 677-3324 or firstname.lastname@example.org.