United States: State Tax Implications Of Federal Tax Reform

Federal tax reform will have a significant and possibly unexpected impact on state taxes, including on individual deductions and, for corporations, reporting methods and limitations regarding net operating losses and interest expense.

On December 22, 2017, US President Donald Trump made tax reform official, inking his signature to HR 1, the 2017 tax legislation formerly known as the Tax Cuts and Jobs Act (the Act). The new law represents one of the most sweeping overhauls to the Internal Revenue Code (IRC) in US history.

The president touted simplifying the IRC and promoting the US economy as the major goals of the Act.1 The Act's federal income tax implications are of course substantial, but the state tax implications of the Act are equally vast. This is because most states conform to the IRC in some fashion—usually starting the state corporate income tax with a version of taxable income as determined under the IRC.

The following are some of the ways the new federal tax legislation will affect state taxes.

State and Local Tax Deduction

Possibly the most widely discussed change impacting individuals is the limitation of the State and Local Tax (SALT) deduction. For tax years beginning after December 31, 2017, the SALT deduction is capped at a total of $10,000 for income, property, and other previously uncapped taxes.2

The Act specifically bars a taxpayer from prepaying 2018 state and local income taxes, but it does not limit the prepayment of real property taxes.3 This "loophole" left many taxpayers scrambling to do year-end tax planning by prepaying 2018 property taxes in order to take a full, uncapped deduction for those payments on their 2017 returns. Then, via a last-minute news release,4 the IRS claimed that a taxpayer may only take a 2017 uncapped deduction for prepaid 2018 real property taxes if the taxes were assessed before January 1, 2018 (i.e., the taxpayer could not simply estimate and pay 2018 real property taxes).5

The news release does not carry the force of law—however, several states reacted quickly to conform. For example, New York Governor Andrew Cuomo (D) signed an executive order in the final weeks of December, allowing local authorities to issue tax warrants for 2018 real property taxes.6 In addition, a group of Democrats from high-tax states have written a letter to the IRS Acting Commissioner objecting to the release. It will be interesting to see if the IRS changes its tune before the April 15 filing deadline to allow additional uncapped prepaid property tax deductions.

With the 2017 tax year behind us, many states are looking to the future impact of the SALT deduction limitation and considering alternatives. For example:

  • New York plans to challenge the law as unconstitutional double taxation of New Yorkers' income. If unsuccessful, Governor Cuomo has suggested a "major shift" away from the current New York personal income tax laws in favor of fully deductible payroll taxes imposed directly on employers.
  • California has introduced SB 227, allowing taxpayers to make donations to the "California Excellence Fund" instead of paying California income tax. Californians would compute their income tax liability, but instead of paying the tax, they could elect to donate that amount to the fund. They would then receive a fully deductible credit in the amount of the "donation" that can be used to offset federal tax liability.

It is promising that California and New York, two of the states hardest hit by the SALT limitation, have expressed the willingness and intent to act quickly on behalf of taxpayers with such deliberate and creative solutions. Bipartisan legislation to restore the SALT deduction has also been announced by two members of the House of Representatives.7

That said, these changes are complicated and will require extensive modifications to state law. We are staying close to these developments as they evolve.

Federal Conformity

Turning to corporate taxes, a linchpin factor for each state will be how it conforms to the IRC. There are two general regimes of IRC conformity among the states: fixed-date conformity and rolling conformity.8 Among these two regimes, each state has its own unique rules around conformity with specific provisions of the IRC.

  • Fixed-date conformity states like California and Virginia adopt the IRC as of a particular date.9 States like these will have to change their laws to affirmatively adopt the IRC as amended by the Act. Otherwise, taxpayers will continue to file their "fixed-date conformity" state returns based on an earlier version of the IRC.
  • Rolling conformity states like Massachusetts and New York automatically adopt the currently enacted version of the IRC.10 States like these will have to affirmatively decouple from any provisions in the Act that they do not want to adopt.

The Act lowers the federal tax rate to 21% but also purports to combat tax "base erosion" by expanding the federal income tax base. Without a corresponding decrease in a rolling conformity state's tax rate, such states will likely see an increase in corporate tax revenues because of the expanded federal income tax base, which serves as the starting point for calculation of state income taxes. Despite numerous state budget deficits across the United States, such a windfall could be politically unpopular. Each state will have to weigh the political ramifications of a windfall against the fiscal impact, and adjust its laws accordingly.

The takeaway here is that state income taxes are likely to become a much larger piece of a company's overall tax burden—especially in states with high corporate income tax rates such as California, Pennsylvania, New Jersey, and New York.

Reporting Method

It is also critically important for businesses to understand how the Act's impact can vary based on each state's required tax reporting method. State reporting methods can be put into three categories, with varying issues depending on the state's conformity with the Act:

  1. State return requires the same consolidated group as federal return

    • Issue: State still likely decouples from certain federal provisions so state tax base could differ from federal tax base
  2. State return requires combined filing that includes some, but not all, federal consolidated entities

    • Issue: Nuances for multiple unitary group filings, stacked returns, and water's-edge filings—nuances could produce varying and unexpected results
  3. State requires separate tax return for each legal entity doing business in the state

    • Issue: State still likely decouples from the federal consolidated return regulations, producing additional layers of complexity in applying the provisions of the Act, e.g., where limitations and other tax items are determined on a consolidated basis rather than separate company basis for federal income tax purposes

Interest Expense Limitation

Subject to a number of significant exceptions, the Act generally limits a corporation's deduction of business interest expense in any year to the sum of business interest income plus 30% of adjusted taxable income plus certain floor plan financing interest.11 Most states already disallow the deduction of interest paid to affiliates via laws commonly referred to as "add back" statutes or effectively disallow the deduction via combined reporting regimes. Issues could include the following:

  • Possible double counting/double taxation on interest expense paid to affiliated entities in "add back" states.
  • The new federal limitation on the interest deduction paid to unaffiliated lenders could produce state income tax increases for many taxpayers.

Net Operating Loss Carryforward Limitation

The Act imposes an 80% limitation on the net operating loss (NOL) deduction, repeals NOL carrybacks, and allows for an unlimited NOL carryforward.12 Some states currently apply their NOL carryforward deduction before apportionment, while others require that the deduction be made after apportionment. Generally, conformity to the 80% limitation will increase the state tax burden for companies that previously deducted all of their NOL carryforwards on their state returns. Other potential issues include the following:

  • Deferred tax assets related to NOL carryforwards and adjustment of valuation allowances—will this increase or decrease valuation allowances?
  • Impact of acquisitions of historical NOL companies—IRC Section 382 loss limitation calculation doesn't translate easily to post-apportionment states.
  • Add the federal 80% limitation to the post-apportionment state NOL deduction and carryforward calculations become even more complicated.

Foreign Dividends and Deemed Repatriation of Earnings and Profits

The Act provides for a participation exemption whereby certain dividends that a US corporation receives from a foreign corporation are 100% excludable from taxable income.13 The Act also reduces the dividends received deduction (DRD) percentages to reflect the economic impact of the decrease in the federal corporate income tax rate.14 While taken together these two changes present no constitutional infirmity from a federal perspective, states that adopt these provisions could run afoul of the nondiscrimination principles most notably articulated by the US Supreme Court in Kraft General Foods, Inc. v. Iowa Department of Revenue & Finance.15

On a similar note, the Act creates a deemed repatriation of previously untaxed, undistributed foreign earnings and profits (E&P) under IRC Section 965, which falls within Subpart F.16 While many states exclude Subpart F income from their taxable income calculation, states that do not exclude Subpart F income may still exclude the Act's deemed repatriation income under the state's DRD, which brings one back to the above-cited constitutional quandary.

Like-Kind Exchanges Limited to Real Property

Gains and losses from "like kind" exchanges (LKE) of non–real property (e.g., machinery, equipment, vehicles, intellectual property, and other intangible business assets) are no longer treated as nonrecognition items for federal tax purposes. Rather, LKE deferral is only permitted on the exchange of real property. This is a drastic change and taxpayers that have robust LKE programs should consider the following, among other questions and issues:

  • How do taxpayers determine what is "real property" vs. "tangible personal property"? Do they interpret this under state law or federal law?
  • Do the Act's provisions that allow for "full expensing" offset the elimination of the gain deferral? What about intangible property and tangible personal property excluded from the full expensing provision?
  • Could differing treatment in rolling conformity vs. fixed conformity states cause inconsistent accounting and reporting? Are there traps and/or opportunities for taxpayers in states without rolling conformity?

Takeaways

We don't yet know the full span of how states will react to the Act, but we can be certain of one thing: The impact on state corporate income tax burdens will be substantial, especially in states with high corporate income tax rates. Much of the complexity and uncertainty at the state level will be in the areas where state law differs from federal law—and there will certainly be both "winners" and "losers."

Footnotes

1 Trump: Tax Reform That Will Make America Great Again.

2 HR 1 § 11042; N.B. This limit applies only to individual taxpayers, not other taxpaying entities.

3 Id.

4 IRS News Release, IR-2017-210 (Dec. 27, 2017).

5 Id.

6 NY Executive Order, No. 172 (Dec. 22, 2017).

7 Press Release, Lowey, King Introduce Bill to Restore SALT Deduction (Jan. 9, 2018).

8 N.B. Some schools of thought would add a third category—specific conformity—which is a variant of either ixed-date or rolling conformity.

9 Cal. Rev. & Tax. Code § 17024.5(a)(1); Va. Code Ann. § 58.1-301.

10 Mass. Gen. Laws ch. 63, § 30; N.Y. Tax Law § 208(9).

11 HR 1 § 13301.

12 HR 1 § 13302.

13 Id. at § 14101.

14 Id. at § 13002.

15 505 U.S. 71 (1992).

16 HR 1 § 14103

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions