AMENDED IN ASSEMBLY APRIL 29, 2026

CALIFORNIA LEGISLATURE— 2025–2026 REGULAR SESSION

98

TAX LEVY

Introduced by Assembly Members Connolly, Elhawary, and Lee

(Coauthors: Assembly Members Rogers, Addis, Bryan, Garcia, Mark González, Haney, Harabedian, Jackson, Kalra, McKinnor, Ortega, Pellerin, Schultz, and Zbur)

February 10, 2026

An act to amend Sections 25106.5, 25110, and 25113 of the Revenue and Taxation Code, relating to taxation, to take effect immediately, tax levy.

Vote: 2/3   Appropriation: no   Fiscal committee: yes   Local program: no

LEGISLATIVE COUNSEL’S DIGEST

The Corporation Tax Law imposes on every corporation doing business in the state, as defined, a tax according to or measured by net income and, in the case of a corporation with income derived from or attributable to sources both within and without this state, apportions the income between this state and other states and foreign countries in accordance with a single sales formula based on the sales within and without this state, except that in the case of an apportioning trade or business that derives more than 50% of its gross business receipts from conducting one or more qualified business activities, as defined, business income is apportioned in accordance with a specified 3-factor formula. Existing federal law, for purposes of determining a taxpayer’s gross income for federal income tax purposes, requires that a person who is a United States shareholder of any controlled foreign corporation, as defined, to include in their gross income the net CFC tested income, as provided.

The Corporation Tax Law, for taxable years beginning on or after January 1, 2003, for purposes of determining income derived from or attributable to sources within this state, allows corporations to make a statutory election as to whether their income is determined on a “water’s-edge” basis or on a worldwide unitary basis. Under existing law, the election to report income on a water’s-edge basis remains in effect until terminated, and provides conditions for the termination of the election.

This bill, for taxable years beginning on or after January 1, 2026, would require a taxpayer that files on a water’s-edge basis to account for net CFC tested income within the water’s-edge group, as provided. The bill would require a taxpayer that files on a water’s-edge basis to include all income and apportionment factors of any corporation, other than a bank, whose sales factor, instead of the average of 3 factors, in the United States is at least 20%. The bill would also terminate all water’s-edge elections for the first taxable year beginning on or after January 1, 2028, and would not allow a taxpayer to make a water’s-edge election, or file on a water’s-edge basis, for taxable years beginning on or after January 1, 2028. The bill would authorize any taxpayer that has made a water’s-edge election to terminate that election without the consent of the Franchise Tax Board for taxable years beginning on or after January 1, 2026, and before January 1, 2028.

This bill would include a change in state statute that would result in a taxpayer paying a higher tax within the meaning of Section 3 of Article XIIIA of the California Constitution, and thus would require for passage the approval of ⅔ of the membership of each house of the Legislature.

This bill would take effect immediately as a tax levy.

The people of the State of California do enact as follows:

SECTION 1.

The Legislature finds and declares all of the following:

(a) Multinational corporations continue to shift income earned in California out of the country.

(b) The water’s-edge election has not been updated to conform with developments in federal corporate tax law aimed at combating such shifting.

(c) Mandatory worldwide combined reporting is the most efficient and fairest way to tax the income of large multinational corporations.

(d) In order to facilitate the transition to worldwide combination, this bill would allow taxpayers that have made a water’s-edge election to continue to file on a water’s-edge basis for two years if the water’s-edge election calculation is modified, as provided. The measure would also allow taxpayers to terminate an existing water’s-edge election and file on a worldwide basis sooner if they choose.

SEC. 2.

Section 25106.5 of the Revenue and Taxation Code is amended to read:

25106.5.

(a) The Franchise Tax Board may adopt regulations necessary to ensure that the tax liability or net income of any taxpayer whose income derived from or attributable to sources within this state which is required to be determined by a combined report pursuant to Section 25101 or 25110 of this chapter, and of each entity included in the combined report, both during and after the period of inclusion in the combined report is properly reported, determined, computed, assessed, collected, or adjusted.

(b) Notwithstanding subdivision (a), the Franchise Tax Board shall not adopt regulations under the authority of this section which shall in any manner determine, prescribe, or otherwise affect either of the following:

(1) The inclusion or exclusion in the combined report of those entities whose income and apportionment factors are to be taken into account pursuant to Sections 25101 and 25110 of this chapter.

(2) After the period of inclusion, cause the income or expenses of an entity which is excluded from a combined report pursuant to Sections 25101 and 25110 of this part to be included in a combined report.

(c) The Legislature finds and declares the following relating to the combined reporting method:

(1) All persons that are part of a unitary business shall be included in the combined report. Determination of a unitary business shall be governed by the unitary business principle which shall be applied to the greatest extent allowed by the United States Constitution.

(2) A combined return shall include the income and apportionment factors of any captive insurers that are part of the unitary business. For purposes of this paragraph, a “captive insurer” is an insurance company that satisfies both of the following:

(A) Is owned or controlled by a member or members of the unitary group.

(B) Is used for the insurance of risks of the parent organization and affiliated persons.

(3) All income and factors of a combined group shall have their income and factors combined even if the state has a special apportionment regime for any particular entity if considered separately. A taxpayer may use the special apportionment regime for a particular entity, with the consent of the Franchise Tax Board, if the taxpayer demonstrates by clear and convincing evidence that failure to use the special formula will result in an unfair representation of income produced in this state.

(4) If any member of the unitary business is subject to a net income tax or a tax measured by net income under some other provision of the laws of this state, then such tax liability shall be a credit against any tax liability as a result of this part.

SEC. 3.

Section 25110 of the Revenue and Taxation Code is amended to read:

25110.

(a) Notwithstanding Section 25101, a qualified taxpayer, as defined in paragraph (2) of subdivision (b), that is subject to the tax imposed under this part, may elect to determine its income derived from or attributable to sources within this state pursuant to a water’s-edge election in accordance with the provisions of this part, as modified by this article. A taxpayer, that makes a water’s-edge election on or after January 1, 2006, shall take into account that portion of its own income and apportionment factors and the income and apportionment factors of its affiliated entities to the extent provided below:

(1) The entire income and apportionment factors of any of the following corporations:

(A) Domestic international sales corporations, as described in Sections 991 to 994, inclusive, of the Internal Revenue Code and foreign sales corporations as described in Sections 921 to 927, inclusive, of the Internal Revenue Code.

(B) Any corporation, other than a bank, regardless of the place where it is incorporated if its sales factors within the United States is 20 percent or more.

(C) Corporations that are incorporated in the United States, excluding corporations making an election pursuant to Sections 931 to 936, inclusive, of the Internal Revenue Code. or formed under the laws of any state, the District of Columbia, or any territory or possession of the United States.

(D) Export trade corporations, as described in Sections 970 to 972, inclusive, of the Internal Revenue Code.

(2) (A) With respect to a corporation that is not described in paragraph (1), as provided in any of the following clauses or a combination thereof:

(i) The income and apportionment factors of that corporation to the extent of its income derived from or attributable to sources within the United States and its factors assignable to a location within the United States in accordance with paragraph (3) of subdivision (b). Income of that corporation derived from or attributable to sources within the United States as determined by federal income tax laws shall be limited to, and determined from, the books of account maintained by the corporation with respect to its activities conducted within the United States.

(ii) The income and apportionment factors of that corporation that is a “controlled foreign corporation,” as defined in Section 957 of the Internal Revenue Code, to the extent determined by multiplying the income and apportionment factors of that corporation without application of this subparagraph by a fraction not to exceed one, the numerator of which is the “Subpart F income” of that corporation for that taxable year and the denominator of which is the “earnings and profits” of that corporation for that taxable year.

(iii) Forty percent of net CFC tested income, as that term is defined in Section 951A of the Internal Revenue Code, relating to net CFC tested income included in gross income of United States shareholders, is included as business income. No factors of any controlled foreign corporation, as defined in Section 957 of the Internal Revenue Code, relating to controlled foreign corporations, shall be included as a result of including that income.

(B) For purposes of this paragraph, both of the following apply:

(i) “Subpart F income” means “Subpart F income” as defined in Section 952 of the Internal Revenue Code.

(ii) “Earnings and profits” means “earnings and profits” as described in Section 964 of the Internal Revenue Code.

(3) The income and apportionment factors of the corporations described in this subdivision shall be taken into account only to the extent that they would have been taken into account had no election under this section been made.

(4) The Franchise Tax Board shall prescribe regulations to coordinate implementation of subparagraph (A) of paragraph (2) to prevent multiple inclusion or exclusion of income and factors in situations where the same item of income is described in both clauses.

(b) For purposes of this article and Section 24411, all of the following definitions apply:

(1) An “affiliated corporation” means a corporation that is a member of a commonly controlled group as defined in Section 25105.

(2) A “qualified taxpayer” means a corporation that does both of the following:

(A) Files with the state tax return, on which the water’s-edge election is made, a consent to the taking of depositions, at the time and place most reasonably convenient to all parties, from key domestic corporate individuals and to the acceptance of subpoenas duces tecum requiring reasonable production of documents to the Franchise Tax Board, as provided in Section 19504, by the State Board of Equalization, as provided in Section 5005 of Title 18 of the California Code of Regulations, or by the courts of this state, as provided in Chapter 2 (commencing with Section 1985) of Title 3 of Part 4 of, and Chapter 9 (commencing with Section 2025.010) of Title 4 of Part 4 of, the Code of Civil Procedure. The consent relates to issues of jurisdiction and service and does not waive any defenses that a taxpayer may otherwise have. The consent shall remain in effect as long as the water’s-edge election is in effect, and shall be limited to providing that information necessary to review or adjust income or deductions in a manner authorized by Section 482, 861, Subpart F of Part III of Subchapter N, or similar provisions, of the Internal Revenue Code, together with the regulations adopted pursuant to those provisions, and for the conduct of an investigation with respect to any unitary business in which the taxpayer may be involved.

(B) Agrees that, for purposes of this article, dividends received by any corporation whose income and apportionment factors are taken into account pursuant to subdivision (a) from either of the following are functionally related dividends and shall be presumed to be business income:

(i) A corporation of which more than 50 percent of the voting stock is owned, directly or indirectly, by members of the unitary group and which is engaged in the same general line of business.

(ii) Any corporation that is either a significant source of supply for the unitary business or a significant purchaser of the output of the unitary business, or that sells a significant part of its output or obtains a significant part of its raw materials or input from the unitary business. “Significant,” as used in this subparagraph, means an amount of 15 percent or more of either input or output.

All other dividends shall be classified as business or nonbusiness income without regard to this subparagraph.

(3) The definitions and locations of property, payroll, and sales shall be determined under the laws and regulations that set forth the apportionment formulas used by the individual states to assign net income subject to taxes on, or measured by, net income in that state. If a state does not impose a tax on, or measured by, net income or does not have laws or regulations with respect to the assignment of property, payroll, and sales, the laws and regulations provided in Article 2 (commencing with Section 25120) shall apply.

Sales shall be considered to be made to a state only if the corporation making the sale may otherwise be subject to a tax on, or measured by, net income under the Constitution or laws of the United States, and shall not include sales made to a corporation whose income and apportionment factors are taken into account pursuant to subdivision (a) in determining the amount of income of the taxpayer derived from or attributable to sources within this state.

(4) “The United States” means the 50 states of the United States and the District of Columbia.

(c) All references in this part to income determined pursuant to Section 25101 shall also mean income determined pursuant to this section.

SEC. 4.

Section 25113 of the Revenue and Taxation Code is amended to read:

25113.

(a) Except as provided in subdivision (f), for taxable years beginning on or after January 1, 2003, the election provided for in Section 25110 shall be made on an original, timely filed return for the year of the election. The election will be considered valid if both of the following conditions are satisfied:

(1) The tax is computed in a manner consistent with a water’s-edge election.

(2) A written notification of election is filed with the return on a form prescribed by the Franchise Tax Board. Pursuant to regulations promulgated under this section, the Franchise Tax Board may accept the filing of other objective evidence that supports the conclusion that a water’s-edge election was intended in lieu of notification on the designated form.

(b) Except as otherwise provided, a water’s-edge election shall be effective only if made by every member of the self-assessed combined reporting group that is subject to taxation under this part.

(1) An election made on a group return of a self-assessed combined reporting group shall constitute an election by each taxpayer member included in that group return, unless one of those taxpayers files a separate return in which no election is made and paragraph (2) does not apply.

(2) A taxpayer that fails to make an election on its own timely filed original return shall be deemed to have elected if either of the following applies:

(A) It has a parent corporation that is an electing taxpayer that included the income and apportionment factors of the nonelecting taxpayer in the self-assessed combined reporting group reflected in the electing parent’s timely filed original return, including a group return.

(B) The income and apportionment factors of the nonelecting taxpayer are reflected in the self-assessed combined reporting group of a timely filed original return of an electing taxpayer, and the notification of election filed by the electing taxpayer pursuant to paragraph (2) of subdivision (a) is signed by an officer or other authorized agent of either a parent corporation of the nonelecting taxpayer or another corporation with authority to bind the nonelecting taxpayer to an election.

(3) For purposes of this subdivision, a “parent corporation” of the taxpayer is a corporation that owns or constructively owns stock possessing more than 50 percent of the voting power of the taxpayer as determined under subdivisions (e) and (f) of Section 25105.

(4) If a corporation that is a member of a combined reporting group is not itself subject to taxation under this part in the year for which the water’s-edge election is made, but subsequently becomes subject to taxation under this part, that corporation shall be deemed to have elected with the other taxpayer members of the combined reporting group.

(5) If a unitary corporation not incorporated in the United States that is not itself subject to taxation under this part in the year for which the valid water’s-edge election is made, but subsequently becomes subject to taxation under this part solely due to subdivision (b) of Section 23101 in a taxable year beginning on or after January 1, 2021, that corporation shall be deemed to have elected with the other members of the unitary combined reporting group.

(6) A taxpayer that is engaged in more than one apportioning trade or business as defined in paragraph (6) of subdivision (d) of Section 25128 may make a separate election for each apportioning trade or business.

(c) A water’s-edge election shall remain in effect or be terminated in accordance with this subdivision.

(1) Except as otherwise provided in this subdivision, if one or more electing taxpayer members of a combined reporting group later become disaffiliated or otherwise cease to be included in the combined reporting group, the water’s-edge election shall remain in effect as to both the departing taxpayer members and any remaining taxpayer members.

(2) If an electing taxpayer and a nonelecting taxpayer become members of a new unitary affiliate group, the nonelecting taxpayer shall be deemed to have elected if the value of the total business assets of the electing taxpayer, and its component unitary group, if any, is larger than the value of the total business assets of the nonelecting taxpayer, and its component unitary group, if any. Otherwise, the water’s-edge election shall be automatically terminated at the time the electing members become part of the combined report. For purposes of applying paragraphs (9) and (10), the commencement date of the deemed election shall be the same as the commencement date of the electing taxpayers.

(3) If taxpayers filing under water’s-edge elections with different commencement dates become members of a new unitary affiliate group, the earliest election date shall be deemed to apply to all electing taxpayers if the total business assets of the earlier electing taxpayer, and its component unitary group, if any, is larger than the value of the total business assets of the later electing taxpayer, and its component unitary group, if any. Otherwise, the later election commencement date shall apply to all electing taxpayers.

(4) (A) If a taxpayer with an election that has been terminated under paragraph (9) or (10) becomes a member of a new unitary affiliate group that includes another electing or nonelecting taxpayer not affected by those paragraphs, any water’s-edge election of the other taxpayer member, if applicable, shall terminate, and any restrictions on making a new water’s-edge election, relating to an election terminated under those paragraphs, shall apply to all taxpayer members of the new unitary affiliate group if the total business assets of the taxpayer with the terminated election, and its component unitary group, if any, is larger than the other taxpayer, and its component unitary group, if any. Otherwise, paragraph (2) shall apply, if applicable. If paragraph (2) does not apply, all taxpayer members of the new unitary affiliate group will be treated as nonelecting taxpayers that are not subject to any restrictions on making a new water’s-edge election.

(B) If two nonelecting taxpayers with different termination dates under paragraph (9) or (10) become members of a new unitary affiliate group, the earliest termination date shall be deemed to apply to all nonelecting taxpayers, as well as any restrictions on making a new water’s-edge election relating to that termination, if the total business assets of the earlier terminating taxpayer, and its component unitary group, if any, is larger than the value of the total business assets of the later terminating taxpayer, and its component unitary group, if any. Otherwise, the later termination date, and the related restrictions on making a new water’s-edge election, shall apply to all taxpayer members of the new unitary affiliate group.

(5) (A) Except as provided in subparagraph (B), if one or more electing taxpayers did not report their income and apportionment factors as members of a combined reporting group with one or more nonelecting taxpayers, and, pursuant to a Franchise Tax Board audit determination, the nonelecting taxpayers, taxpayers are properly in the same combined reporting group as the electing taxpayers, the water’s-edge election of the electing taxpayers shall remain in effect and the nonelecting taxpayers shall be deemed to have made a water’s-edge election. The commencement date of the deemed water’s-edge election shall be the same as the commencement date of the electing taxpayers.

(B) Subparagraph (A) may not apply if the value of total business assets of the electing taxpayers does not exceed the value of total business assets of the nonelecting taxpayers. In that event, the water’s-edge election of each electing taxpayer is terminated as of the date the nonelecting taxpayers are, pursuant to the audit determination described in subparagraph (A), properly included in the same combined reporting group as the electing taxpayers.

(C) For purposes of applying the business asset test of this paragraph, the term “business assets” shall have the same meaning as subparagraph (A) of paragraph (6), except that the business assets of other members of the unitary affiliate group that are not taxpayers shall not be taken into account.

(D) Notwithstanding subparagraph (A), nonelecting taxpayers may not be deemed to have made a water’s-edge election if the Franchise Tax Board audit determination described in subparagraph (A) is withdrawn or otherwise overturned.

(6) For purposes of paragraphs (2) to (5), inclusive, the following shall apply:

(A) “Business assets” are assets, including intangible assets, other than stock of a member of the unitary affiliate group, which are used in the conduct of the business of the unitary affiliate group or would produce business income to the unitary affiliate group, if an election were not in place, if the assets were sold. Business assets shall be valued at net book value.

(B) The phrase “unitary affiliate group” refers to all of those corporations that would constitute a unitary group if a water’s-edge election were not made.

(C) The phrase “new unitary affiliate group” refers to a unitary affiliate group that is created by a new affiliation of two or more corporations, or by the addition of one or more new members to an existing unitary affiliate group.

(D) The phrase “component unitary group” means that portion of a group of corporations that have become members of a new unitary affiliate group that were members of their own respective unitary affiliate group prior to entering the new unitary affiliate group, disregarding any corporations that did not become part of the new unitary group.

(7) In the application of paragraphs (2) to (4), inclusive, a series of acquisitions as steps of a single transaction shall be aggregated as a single change of membership.

(8) In the event of a merger or consolidation, the water’s-edge status and election commencement date or termination date of the surviving corporation shall be consistent with the result that would have been obtained under paragraphs (2) to (4), inclusive, if the surviving corporation had acquired the stock of the transferor corporation.

(9) A water’s-edge election may be terminated without the consent of the Franchise Tax Board after it has been in effect for at least 84 months. The termination shall be made on an original, timely filed return for the first year in which the water’s-edge election is to be terminated. To be effective, the termination shall be made by every taxpayer that is a member of the water’s-edge group in the same manner as the election provided under subdivisions (a) and (b).

(10) A water’s-edge election may be terminated before the 84-month period described in paragraph (9) has elapsed, but only with the consent of the Franchise Tax Board. A request for termination shall be made at the time and in the manner specified by the Franchise Tax Board.

(A) The request may be granted for good cause. For purposes of this section, good cause shall have the same meaning as specified in Treasury Regulations Section 1.1502-75(c).

(B) The Franchise Tax Board shall consent to a termination requested by all members of a water’s-edge group, if the purpose of the request is to permit the state to contract with an expatriate corporation, or its subsidiary, pursuant to paragraph (2) of subdivision (b) of Section 10286 of the Public Contract Code. A water’s-edge election terminated pursuant to this subparagraph shall, however, be effective for the year in which the expatriate corporation, or its subsidiary, enters into the contract with the state.

(11) Except for deemed elections as provided in paragraphs (2), (4), and (5), if a water’s-edge election is terminated under paragraph (9) or (10), another election may not be made under this section for any taxable year that begins within the 84-month period following the last day of the election period that was terminated. The Franchise Tax Board may waive the application of this prohibition period for good cause.

(12) A water’s-edge election shall remain in effect until terminated.

(13) Notwithstanding paragraphs (9) and (10), a taxpayer may terminate any water’s-edge election without consent of the Franchise Tax Board for the any taxable year beginning on or after January 1, 2026, and before January 1, 2028.

(14) Every water’s-edge election is terminated as of the first taxable year beginning on or after January 1, 2028.

(d) For purposes of this section, the following shall apply:

(1) A “combined reporting group” means those corporations whose income and apportionment factors are properly considered pursuant to this chapter in computing the income of the individual taxpayer that is derived from or attributable to sources within this state, taking into account a valid water’s-edge election.

(2) A “group return” refers to the single return which taxpayer members of a combined reporting group may elect by contract to file, in the form and manner prescribed by the Franchise Tax Board, in lieu of filing their own respective returns.

(3) A “self-assessed combined reporting group” means that group of corporations whose income and apportionment factors are reflected in a combined report prepared pursuant to this chapter in a timely filed return, taking into account the effects of a purported water’s-edge election, whether or not the membership of the corporations in that combined report was correctly determined.

(e) The Franchise Tax Board may prescribe any regulations as may be necessary or appropriate to carry out the purposes of this section.

(f) To the extent that a taxpayer would have been required to file on a water’s-edge basis in its first taxable year beginning on or after January 1, 2003, pursuant to a water’s-edge election made in a prior year under Section 25111, the terms of Section 25111 may not apply and the election shall be deemed to have been made under the terms of this section. However, the commencement date of the election made in a prior year under Section 25111 shall continue to be treated as the commencement date of the water’s-edge election period for purposes of applying this section.

(g) For taxable years beginning on or after January 1, 2028, a taxpayer shall not make a water’s-edge election under this section, and no taxpayer shall file on a water’s-edge basis.

SEC. 5.

This act provides for a tax levy within the meaning of Article IV of the California Constitution and shall go into immediate effect.