Behind closed-door discussions, the state would temporarily take away the ability of companies to write off their net operating losses.
That would boost state coffers an extra $1 billion and help close California's enormous budget deficit. In exchange, Legislative sources say the Schwarzenegger Administration wants to allow businesses, like banks, to amend previous tax returns that at the urging of lenders and other corporate interests.
"If you're going to take something, incentives away from business in the form of this tax credit, we do feel that they need to be made whole in the future," said Beth Mills from the California Bankers Association.
Banks could amend tax returns from their record-profit years of 2005 and 2006 by writing-off their record-losses from the current foreclosure crisis.
Those financial institutions would ultimately get tax refunds from the state totaling more than $400 million in 2010 when the companies would be entitled to them.
"It's certainly a bail-out. I don't think that you'll see checks getting written to homeowners to help them out on their mortgages as a result of this," said Jean Ross from the California Budget Project.
Assemblyman Ted Lieu, who is spear-heading a crackdown on sub-prime lenders, can't even stomach the proposal, given the massive cuts to state programs.
"We're trying to protect healthcare, preserve education. Giving tax breaks to subprime lenders should be nowhere on the priority," said Lieu (D) Torrance.
Republicans are entertaining the idea as part of a bigger economic stimulus package.
"The key right now is to focus on those who are in homes that are in a tenuous position and how do we benefit them, that's the key. If we can do that by helping the tax code, that's one thing we can look at," said Minority leader (R) Mike Villines.
The Governor's aides didn't want to talk about the proposal. But it is the latest sticking point that threatens to drag negotiations for a budget that is now seven weeks late.