Small Business Accounting - On
December 22, 2017, President Trump signed into the "Tax Cuts and Jobs
Act", P.L. 115-97 (the Act). While this is a significant event for federal
taxation, it will also have far-reaching effects on state taxation.
Income taxes. Almost all state income
taxes piggyback on the federal system by using a federal starting point for
calculating state taxable income. As a result of this federal conformity,
states incorporate a lot of federal provisions into their own state tax bases.
States generally conform to varying versions of the Internal Revenue Code, with
a few exceptions. Roughly half of the states imposing an income tax conform to
the Internal Revenue Code as of a specific date (e.g., as of December 31, 2016)
that the state legislature updates annually or periodically, while the other
half conform to the current code on a rolling basis without need for
legislative action. If federal income is changed due to tax reform, state
taxable income may be as well, depending on the provision and the state.
States will not be directly impacted by the new federal tax
rates because states use their own rates. States that impose a gross receipts
tax in lieu of a net-income based tax may not be as significantly impacted by
the Act.
Timing will be the overriding consideration for state conformity
to federal tax reform. State legislatures will not be back in session until
next year to even begin to respond to the sweeping federal changes. States that
have static conformity dates will still conform to previous versions of the
Code (absent legislative action), resulting in increased compliance burdens for
taxpayers who have to compute a hypothetical federal starting point based on
the old Code.
Changes to federal corporate deductions will impact states that
conform to those provisions. Most states conform to Code Sec. 163, so the new
federal limitations on interest deductions may result in a broader state tax
base in those states. Similarly, changes to federal net operating loss (NOL)
provisions may impact states that conform to the federal provisions. However,
many states already decouple from the Code Sec. 172 federal NOL deduction and
instead use a state-specific NOL. Elimination of the federal Code Sec. 199
deduction will also create a broadened tax base in states that conformed to the
deduction.
Many state decisions to conform to or decouple from federal tax
reform will be budget-driven. Unlike the federal government, nearly all states
have to maintain balanced budgets. Therefore, they may not be able to afford to
conform to federal provisions that would result in a revenue reduction for the state.
For example, states may choose to decouple from or limit the new provisions
allowing immediate expensing of capital investments. Many states have
historically decoupled from special federal depreciation provisions, like bonus
depreciation, because of revenue concerns. It will be interesting to see
whether states consider the net impact of conformity to interest expense caps
in conjunction with potentially disallowing the new expensing regime.
State conformity to the international provisions in the Act may
be more complicated. Conformity to the foreign-source dividend exemption and
repatriation of offshore earnings will depend on a state's treatment of foreign
income. The impact may be ameliorated in combined reporting states where
certain foreign dividends are already eliminated as intercompany transactions.
Further, unlike the federal government, states are constitutionally limited in
their ability to treat foreign dividends in a different manner than domestic
dividends.
Both state and federal practitioners should carefully consider
unintended state consequences of new federal planning opportunities that may
arise from tax reform. For example, service providers may acquire new revenue
streams or property to qualify for or increase the amount of the pass-through
deduction. However, adding new business operations or property to a
pass-through entity may trigger nexus for the entity or its owners in a new
state or affect the apportionment factors used to calculate state tax
liability.
The Act may also impact individual taxation at the state level.
In states that use federal taxable income as the starting point for computing
state taxable income, the state would conform to the federal increased standard
deduction and the federal elimination of personal exemptions. States may or may
not conform to other changes to federal personal income tax provisions. In
later years, states will need to decide whether to conform to the expiration of
these changes as well.
Limitations on the federal state and local tax (SALT) deduction
may impact individuals indirectly at the state level. Inability to deduct more
than $10,000 of state and local taxes for federal purposes will increase the
cost of those taxes for individuals, especially in high-tax states. Notably,
the Act does not allow taxpayers to pre-pay state income taxes to take
advantage of higher deduction amounts in 2017 and avoid the 2018 cap. While
there is no equivalent restriction relating to property or sales and use taxes,
the structure of these taxes and local rules may limit the effectiveness of
prepayment as a tax reduction strategy.
Estate taxes. While few states impose an
estate tax, some states may see reduced revenues to the extent those states
conform to the new federal exemption amount.
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Amare
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