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Preserving California Tax Losses for Life Sciences and Technology Companies

Jun 21, 2023

As many California businesses and owners are aware, California generally allows for taxpayers to carryforward operating losses from the year incurred to future tax years to reduce income and the resulting tax in such future years.   These carryforward losses are referred to as “net operating loss carryforward losses” or “NOL carryforwards.”  In general, California allows NOLs to be carried forward for up to 20 tax years, at which point any unused losses expire and can no longer be carried forward. 

A lesser-known rule in the startup community is that California requires businesses that have established a presence in another state or foreign jurisdiction to “apportion” their income or losses, using a formula called the “single sales factor” or “SSF.” The SSF formula is equal to sales in California divided by sales everywhere.  As an example, a business with an employee working in another state or foreign country must apportion its losses.  If that business has zero revenues, it has a zero percent sales factor.  Thus, using the standard rules, the taxpayer is left with zero “apportioned” losses to carryover. 

The Franchise Tax Board (FTB) acknowledged in an October 2016 Tax News publication1 that the requirement to apportion losses using the SSF for businesses with no revenues is a requirement that generally does not fairly represent those taxpayers’ activity in the state of California.  The FTB recommended that such taxpayers consider submitting a “petition for alternative apportionment” to the state to request an alternative to the SSF to compute their NOL carryovers.  The Franchise Tax Board has discretion to approve or deny petitions for alternative apportionment submitted by taxpayers.  When a petition is granted by the FTB, taxpayers are able to use an alternative, more favorable formula to preserve almost all of their losses. This alternative formula may often be used retroactively to compute loss carryovers from earlier years, as well as prospectively to compute losses in future years.  Once the circumstances change and the taxpayer begins to generate revenue, the SSF would then be required.  Obtaining written approval can help taxpayers document the treatment of NOLs on their financial statements and may also be valuable to an acquirer.  If a taxpayer were the target of an acquisition, the acquirer could potentially use the losses following the acquisition.  We advise taxpayers that are subject to apportionment, with zero receipts, to submit petitions as soon as possible, since an income event or an acquisition could give rise to the need to use losses, and losses would only be available if approval had previously been obtained.   

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John Clausen

John Clausen is a Tax Partner in the firm's State and Local Tax Group. With 30-years of experience in public accounting, John’s expertise focuses on state and local income taxation.

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