Q1 2018 Update on State Conformity to the Tax Cuts and Jobs Act
Q1 2018 Update on State Conformity to the Tax Cuts and Jobs Act
States appear to have been taking a cautious and deliberate approach to updating their conformity to the Internal Revenue Code (IRC) in light of the December 22, 2017, enactment of H.R. 1, known as the Tax Cuts and Jobs Act (TCJA). Yet, as the first quarter of 2018 progressed, state legislative activity picked up steam. This Alert reviews those states that have enacted IRC conformity legislation during the first quarter of 2018, as well as administrative guidance issued by a handful of states concerning deemed repatriation transition items reporting under IRC section 965 on 2017 state corporate and personal income tax returns.
With some notable exceptions, states generally fall into two categories with regard to how they conform to the IRC as an initial matter. A state may adopt “rolling” conformity, which means it conforms to the IRC as it is amended. Such a state adopts any new federal tax provisions, unless it specifically decouples. For example, a “rolling” conformity state will automatically conform to 100-percent federal bonus depreciation or the IRC section 965 deemed repatriation provisions unless it enacts legislation to decouple. A subcategory of “rolling” conformity states only adopt certain IRC provisions on an “as amended” basis.
Other states conform to the IRC on a “fixed date” basis. For example, if a state conforms to the IRC “in effect on” or “as amended through” a specific date, that state will not conform to any of the federal tax reform changes in the TCJA unless or until the state updates its conformity date or enacts legislation adopting a specific federal change. Likewise, a subcategory of such states only adopt certain IRC provisions on a specific date basis.
Among other things, a state’s method of IRC conformity helps determine a state’s federal taxable income starting point and modifications thereto. Approximately half of U.S. states statutorily start the calculation of state taxable income for corporations using federal taxable income before net operating losses and special deductions. These are the so-called “line 28” states, which is short-hand for the line item on the federal corporate income tax return (form 1120), where such statutorily described federal taxable income is reported for federal purposes. Conversely, roughly half of U.S. states statutorily start the calculation of state taxable income for corporations using federal taxable income after net operating losses and special deductions. These are the so-called “line 30” states, which is also short-hand for the line item on the federal Form 1120 where such statutorily described federal taxable income is reported for federal purposes.
First Quarter 2018 IRC Conformity Update
On March 23, 2018, Florida enacted H.B. 7093 and updated its conformity date to the IRC "as amended and in effect on" January 1, 2018. The new law also instructs the Department of Revenue to study and publish the results of its study of the effect of the TCJA on Florida revenues. Florida continues to decouple from IRC section 168(k), including now 100-percent federal bonus depreciation.
On March 2, 2018, H.B. 918 was enacted to update Georgia’s conformity date to the IRC “enacted on or before” February 9, 2018. Georgia’s IRC conformity update also conforms to the federal 80-percent net operating loss limitation, but decouples from the IRC section 163(j) net business interest expense limitation amendments made by the TCJA and applies section 163(j) as it existed prior to the enactment of the TCJA. Under H.B. 918, Georgia continues to decouple from the provisions of IRC section 168(k). H.B. 918 makes IRC section 965(a) inclusion amounts eligible for Georgia's 100-percent foreign-source dividends received deduction (DRD), but requires the add-back of the IRC section 965(c) deduction. Subsequently, on March 27, 2018, S.B. 328 was enacted by which Georgia decouples from the global intangible low tax income (GILTI) provisions of IRC section 951A. As a result, in addition to making IRC section 965(a) deemed repatriation income qualifying for the Georgia foreign-source dividends received deduction/subtraction (pursuant to H.B. 918, above), S.B. 328 provides the same treatment for "global low-taxed intangible income" under IRC section 951A. However, as with the IRC section 965(c) participation exemption, the corresponding GILTI foreign derived intangible income (FDII) deduction under IRC section 250 must be added back to federal taxable income for Georgia purposes pursuant to S.B. 328. The legislation (S.B. 328) is effective for taxable years beginning on and after January 1, 2018.
Idaho has enacted a number of bills during the first quarter of 2018 that affect the state’s conformity to and decoupling from the TCJA. Under S.B. 355, for taxable years beginning in 2017 Idaho conforms to the IRC “in effect on” December 21, 2017, so as to not conform to most of the TCJA provisions enacted on December 22, 2017. Nonetheless, Idaho will conform to IRC sections 213 and 965 as in effect on December 31, 2017. The new law also requires the add-back of the IRC section 965(c) participation exemption deduction. Under S.B. 355, Idaho continues to decouple from the provisions of IRC section 168(k). And on March 12, 2018, H.B. 463 was enacted, which, among other changes, requires the add-back of the foreign-derived intangible income deduction under IRC section 250 effective January 1, 2018.
Subsequently, on March 20, 2018, H.B. 624 was enacted, which applies IRC sections 108, 163, 168(e ), 168(i), 179D, 179E, 181, 199, 222 and 451 as in effect on February 9, 2018. Further, as a result of H.B. 624, the term "Internal Revenue Code" for taxable years beginning on and after January 1, 2018, means the IRC as amended and in effect on January 1, 2018. Therefore, for the 2017 taxable year, Idaho generally does not conform to the TCJA (except for IRC sections 965 and 213), but does generally conform to the IRC “in effect on” January 1, 2018, for the 2018 and ensuing tax years.
With S.B. 748, effective February 28, 2018, Michigan now conforms to the IRC “in effect on” January 1, 2018. As with Michigan’s former IRC conformity statute, taxpayers have the option to apply the IRC in effect for their taxable year (although this option will now only relate to future tax years and a future IRC). Nonetheless, given the effective date of S.B. 748, any of the TCJA changes that apply to a taxable year ending on or before December 31, 2017 (e.g., IRC section 965), should not apply, as Michigan’s corporate income tax code applied the IRC “in effect on” January 1, 2012 (unless a corporate taxpayer chooses the option to apply the IRC “in effect” for the 2017 taxable year).
Michigan similarly updated its IRC conformity date for personal income tax purposes to January 1, 2018. The state’s former personal income tax IRC conformity date (applicable prior to the effective date of S.B. 748, or before February 28, 2018 or to the 2017 taxable year) was the IRC "in effect on" January 1, 1996, or the IRC in effect for the tax year at the option of the taxpayer.
For personal income tax purposes, under S.B. 22 Ohio updated its IRC conformity date to the IRC that “exist[s] on” March 30, 2018. However, for a taxable year ending after March 30, 2017, a taxpayer may irrevocably elect to use the IRC in effect for that taxable year if different than the IRC in effect on March 30, 2018.
For purposes of its bank franchise tax, South Dakota enacted H.B. 1049 on February 5, 2018, and updated the state’s IRC fixed-date IRC conformity to the IRC "as amended and in effect on" January 1, 2018.
Solely with respect to those provisions of the TCJA that affect the computation of federal taxable income of corporations (or adjusted gross income of individuals) and only for taxable years beginning after December 31, 2016, and ending before January 1, 2018 (i.e., the 2017 calendar tax year), Virginia updated its IRC conformity date with the enactment of S.B. 230 to February 9, 2018. Under S.B. 230, Virginia continues to decouple from the provisions of IRC section 168(k).
Effective January 1, 2018, pursuant to H.B. 4135 (with respect to the corporation income tax) and H.B. 4136 (with respect to the personal income tax), West Virginia has updated its IRC conformity date to the IRC “amendments prior to” January 1, 2018.
Not every state is conforming, however. Indiana’s proposed IRC conformity statute (S.B. 242), although it passed the House, failed in the Indiana Senate and the legislature has adjourned. Kentucky’s tax reform bill (H.B. 366), proposed IRC conformity and made a number of other tax changes, including single sales factor apportionment, market-based sourcing, and rate reductions. H.B. 366 was vetoed by the governor on April 9, 2018.
What’s Happening with IRC section 965 in the States?
As mentioned, both Georgia and Idaho will conform to the IRC section 965 deemed repatriation provisions with respect to the 2017 taxable year, but also make the IRC section 965(a) inclusion amount eligible for these states’ 100-percent and 85-percent foreign-source dividends received deductions, respectively. Consistent with the deductibility of section 965(a) amounts, S.B. 918 for Georgia and S.B. 355 for Idaho provide that the corresponding IRC section 965(c) participation exemption deduction is added back to federal taxable income when determining state taxable income.
Connecticut, Illinois, and Tennessee have recently issued administrative guidance on reporting IRC section 965 items, while Pennsylvania has issued “draft” guidance that is anticipated will be issued in final form any day.
On March 13, 2018, the Internal Revenue Service issued “FAQs” regarding the mechanics of reporting the IRC section 965(a) inclusion amount, the IRC section 965(c) participation exemption amount, and installment tax payment deferral elections. Briefly, a corporation does not report these amounts on its Form 1120. Rather, the income and deduction amounts (and making of installment payment elections) is to be made on a Form 965 Transition Tax Statement. Federal tax is to be computed on the “net amount” of the section 965(a) inclusion minus the section 965(c) deduction. For its 2017 taxable year, a corporation will make two federal income tax payments – the payment of the section 965 deemed repatriation transition tax with the Form 965 Transition Tax Statement, and the payment, if any, of its regular federal corporation income tax with its Form 1120. S corporations, partnerships, and other pass-through entities will issue K-1s reflecting each shareholder’s, partner’s, or member’s share of the entity’s IRC section 965(a) income inclusion amount and share of the entity’s IRC section 965(c) participation exemption deduction amount. Individual taxpayers will report the “net amount” on their federal Form 1040, line 21 “other income.”
Illinois, Pennsylvania, and Tennessee (but not Connecticut) are relying on the IRS FAQs “net” reporting mechanics for their section 965 reporting treatment.
In Information Bulletin 2018-03, the Illinois Department of Revenue released guidance regarding the Illinois treatment of the IRC section 965 deemed repatriation for corporation income tax and replacement tax (but not personal income tax) purposes. For a corporate taxpayer (or S corporation or other pass-through entity for the replacement tax) that has IRC section 965(a) deemed repatriation income, the “net” amount from the federal Form 965 Transition Tax Statement (IRC section 965(a) less the IRC section 965(c) deduction) is reported on Illinois Schedule M, line 10. A corporation may deduct a percentage of the IRC section 965 “net” income amount based on its ownership percentage in the controlled foreign corporation (CFC). If the corporation owns 80 percent or more of the CFC, a 100-percent deduction is allowed for the IRC section 965 “net” income amount. An S corporation (in computing its replacement tax) may deduct a percentage of the IRC section 965 “net” income amount based on the same ownership and deduction percentages as applicable for corporate income tax purposes. However, a partnership is not entitled to deduct the IRC section 965 “net” income in computing its Illinois replacement tax.
In draft guidance, DRAFT Information Notice 2018-1, the Pennsylvania Department of Revenue recognizes that (1) the IRC section 965(a) inclusion amount qualifies for the Pennsylvania corporate income tax dividends received deduction (DRD), and (2) that the IRC section 965(c) participation exemption deduction is not a special deduction (and, therefore, should be separately available to a Pennsylvania corporate income taxpayer). However, the Department’s draft guidance will limit the DRD to the IRC section 965 “net amount.”
Like Illinois and Pennsylvania, Tennessee’s exclusion or deduction related to IRC section 965 is limited to the “net amount” and also dependent on the legal entity form of the recipient of the deemed repatriation. Pursuant to Important Notice 18-05, for C and S corporations (which are subject to Tennessee franchise and excise tax “as if” a C corporation), the “net amount” reported on the Form 965 Transition Tax Statement is excluded from Tennessee net earnings, as well as the Tennessee sales factor. A partnership or other pass-through entity (which is also subject to Tennessee franchise and excise tax) must include the “net amount” reported on the Form 965 Transition Tax Statement in Tennessee net earnings. If the partnership or other pass-through entity owns 80 percent or more of the deemed distributing CFC, then the “net amount” qualifies for Tennessee’s 100-percent DRD. If not, then the full “net amount” is included in taxable Tennessee net earnings and the sales factor (although the Notice does not explain how the deemed “net amount” is sourced).
Conversely, Connecticut’s recent issuance of Office of Commissioner Guidance, OCG-4 (April 6, 2018) instructs for corporation business tax (CBT) purposes that the full IRC section 965(a) inclusion amount (from line 1 of federal Form 965 Transition Tax Statement), and not the "net" amount, is reported on the CBT return. The amount of this inclusion is eligible for Connecticut’s foreign-source DRD (100 percent if the CFC is 20-percent owned or more; 70 percent for CFCs that are less than 20-percent owned). Further, the Connecticut guidance provides that the IRC section 965(c) deduction is "disregarded" and neither added-back nor taken as a separate Connecticut deduction.
Guidance on Installment Elections for Tax Payment Deferral
Based on Information Bulletin 2018-03, even if a federal election is made, Illinois will not allow payment of any increase in Illinois corporation income tax or replacement tax liability as a result of an IRC section 965 "net" inclusion in installments, nor will S corporation shareholders be permitted to defer payment of their Illinois personal income tax liability until a "triggering event" occurs. Likewise, in OCG-4, Connecticut tax payment deferral will not be permitted.
On March 21, 2018, Utah enacted S.B. 244 to allow Utah corporate taxpayers that have a Utah inclusion of IRC section 965(a) deemed repatriation amounts and make a federal election to pay the increase in federal tax liability in installments to make the same installment payment election for Utah tax purposes. Utah’s installment deferral payment conformity, however, only applies to corporate taxpayers and is not extended to individuals.
We anticipate that enactments of state IRC conformity (and decoupling) legislation will accelerate into Q2. As discussed, about half of the states are “rolling” IRC conformity states and do not have to do anything to automatically conform to the TCJA. As the second quarter of 2018 commenced, Arizona (H.B. 2647), Oregon (S.B. 1529), and Wisconsin (A.B. 259) have enacted IRC conformity legislation. Wisconsin’s legislation also decouples from IRC sections 163(j), 168(k), 199A, 245A, 951A, and 965. Among other changes, Oregon’s legislation updates the IRC conformity date, amends the DRD statute to reference IRC section 965, and provides a non-refundable tax credit with respect to increases in corporate income or excise tax as a result of the partial inclusion of section 965 amounts.
Kentucky’s tax reform legislation (S.B. 366) included an updated IRC conformity date, but was vetoed by the Governor. On April 13, 2018, the Legislature overrode the veto. In addition to updating its IRC conformity date, S.B. 366 reduces corporate and personal income tax rates, moves Kentucky to a single sales factor apportionment formula, adopts market-based sourcing, and imposes an economic nexus standard for sales and use tax purposes. A “clean-up bill” (H.B. 487) that makes further changes, including some technical changes to S.B. 366, passed the Legislature on April 14, 2018, and is awaiting action from the Governor.
New York’s FY 2019 budget legislation (A9509-C/S7509-C) was signed by the Governor on April 12, 2018. The budget bill includes an optional payroll tax and charitable contributions fund, like California, as an attempt at helping New York resident individuals with their now-limited federal state and local tax deduction. The New York budget bill also reinforces that the IRC section 965(a) inclusion amount qualifies as “exempt CFC income,” but also requires that the section 965(c) deduction must be added back to the New York federal taxable income starting point. Although the bill does not expand the definition of “exempt CFC income” to include GILTI under IRC section 951A, it still requires the add-back of the federal FDII deduction under IRC section 250. New York’s budget bill will be the subject of another SALT Alert.
With the exception of Franchise Tax Board, studies and proposed legislation concerning charitable contributions of California taxes (in response to the TCJA’s $10,000 limit on the federal state and local tax deduction for individuals), perhaps the most significant “fixed-date” conformity state, California, has so far been relatively quiet.
We will address the second quarter of 2018 IRC conformity (or decoupling) developments for these and other states in a future Alert.
- Suffice to say, it will be an eventful year for state tax legislation (and administrative guidance) in light of the federal TCJA.
- BDO will continue to monitor state legislative and administrative developments in connection with federal tax reform and will update this Alert during the second quarter of 2018.
- Taxpayers affected by the IRC conformity and decoupling developments addressed in this Alert should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures.