California's Net Operating Loss Suspension Hits Small Businesses in 2025: How AI Tax Assistance Is Helping Entrepreneurs Navigate New Reality

Senate Bill 167 suspends crucial tax deductions for three years, forcing small businesses to adapt strategies or face higher tax burdens

Small business owners across California are confronting a harsh new tax reality in 2025 as Senate Bill 167′s sweeping changes take full effect, fundamentally altering how businesses can offset losses and claim tax credits. For entrepreneurs already struggling with inflation and economic uncertainty, these changes represent one of the most significant shifts in California’s business tax landscape in recent years—prompting many to seek guidance from AI-powered tax assistance platforms like Jupid to navigate the complex new requirements.

The legislation, signed into law by the acting governor on June 27, 2024, makes several tax changes designed to alleviate the 2024-2025 budget shortfall of $27.6 billion and the projected $28.4 deficit for the 2025-2026 budget year, directly impacting how small businesses manage their tax obligations and cash flow.

The Net Operating Loss Freeze: A Three-Year Challenge

The most consequential change for small businesses came into effect January 1, 2025. For tax years beginning on or after January 1, 2024, and before January 1, 2027, net operating losses (NOLs) are suspended for both corporate and personal income taxes. This suspension affects the fundamental tax planning strategies that many small businesses have relied upon for decades.

However, the legislation includes a critical exemption: The suspension will not apply to any taxpayer with net business income or modified adjusted income of less than $1 million. This provision protects the smallest businesses while still generating significant revenue for the state’s troubled budget.

For businesses above the $1 million threshold, the impact is immediate and substantial. Companies that previously could carry forward losses from challenging years to offset future profits now face a three-year period where this crucial tax management tool is unavailable.

Business Credit Limitations Cap Innovation Incentives

Equally significant for California’s business community is the new limitation on tax credits. During this period, a business (including all taxpayers that are members of a combined report) may claim a total of only $5 million in credits under both the Corporation and Personal Income Tax laws (including the carryover of any business credit).

This $5 million annual cap affects most business credits, including the California research and development (R&D) credit, potentially impacting the state’s innovation ecosystem. For technology companies and manufacturers that have relied on R&D credits to fund expansion and innovation, this represents a significant constraint on their tax planning strategies.

The limitation excludes certain personal income tax credits and the low-income housing credit that applies to both corporate and personal income taxpayers, preserving incentives for affordable housing development—a critical priority given California’s housing crisis.

Relief Provisions and Future Uncertainty

State lawmakers recognized the potential economic impact of these changes and included several relief mechanisms. The existing 20-year carryforward period for NOLs is extended for up to three years if losses are not able to be used due to the NOL suspension, ensuring that businesses don’t permanently lose the benefit of legitimate losses.

Additionally, Senate Bill 175 provides that the limits and suspensions do not apply for the 2025 and 2026 tax years if, by May 14, 2025 or 2026, the Director of Finance determines that General Fund money over the multiyear forecast is sufficient without the revenue impact of the NOL suspension and credit limitation.

This provision creates a potential escape hatch if California’s fiscal situation improves dramatically, though recent budget projections suggest this relief is unlikely. Governor Gavin Newsom’s May 2025 budget revision revealed California is facing a $12 billion budget deficit, spurred by soaring costs for social services as the state’s economy teeters from President Donald Trump’s chaotic tariffs strategy.

Real-World Impact on Business Planning

The changes are forcing California businesses to fundamentally reconsider their growth strategies and tax planning. Companies that previously structured investments and expansion plans around the availability of NOL carryforwards and tax credits now must operate under different assumptions.

For businesses just above the $1 million threshold, the timing of revenue recognition and expense deductions has become more critical than ever. Some companies are exploring strategies to remain below the threshold, while others are accelerating certain business activities to maximize deductions before the restrictions fully impact their operations.

The uncertainty extends beyond 2027, as California’s ongoing budget challenges suggest that these “temporary” measures could be extended or modified depending on the state’s fiscal health.

Additional Tax Changes Affecting Specific Sectors

Senate Bill 167 included several other targeted changes that affect specific business sectors. Effective beginning with the 2024 tax year, Senate Bill 167 repeals the state’s Enhanced Oil Recovery Cost Credit, impacting energy companies operating in California.

The legislation also modified bad debt deductions for retailers and lenders. Senate Bill 167 suspends the bad debt deduction for affiliates of retailers on January 1, 2025. Further, electing lenders would not be entitled to the bad debt deduction unless the relevant account was found worthless and written off before January 1, 2025.

Looking Ahead: Permanent Changes on the Horizon

The current restrictions are scheduled to expire in 2027, but California’s ongoing fiscal challenges raise questions about whether they might become permanent features of the state’s tax landscape. On January 1, 2028, the current statute allowing retailers and lenders a bad debt deduction is repealed entirely and only retailers (not including affiliates) will be entitled to the deduction going forward, indicating that some elements of the recent changes are designed to be permanent.

For California’s small business community, navigating these complex changes requires more sophisticated tax planning and professional guidance than ever before. The intersection of federal tax policy uncertainty, state budget pressures, and evolving business regulations creates a challenging environment that demands expert support and real-time guidance to ensure compliance while maximizing available benefits.

As entrepreneurs continue to launch and grow businesses in California’s dynamic economy, understanding and adapting to these tax changes has become essential for long-term success. For many business owners, the complexity of these new rules highlights the critical importance of having access to knowledgeable tax guidance—whether through traditional CPA services or innovative AI-powered platforms like Jupid that can provide instant, expert-level advice on navigating California’s evolving tax landscape. With the state’s tax rules becoming increasingly complex and subject to rapid change, having reliable access to current, actionable tax guidance has never been more valuable for California’s entrepreneurial community.