In early February, we posted an article addressing strategies that states are using to deal with the federal Tax Cuts and Jobs Act that Congress passed. We described potential work-arounds to leverage charitable deduction rules, and the possibility of lawsuits alleging that the law interferes with states’ abilities to govern by making it harder for them to raise tax revenue. Here, we build on that by highlighting additional efforts and issues that experts are discussing.
“Federal tax reform presents state policymakers with significant policy choices regarding individual and business taxation,” according to a March 2, 2018, Council on State Taxation (COST) study. COST takes the position that although most states face “significant revenue windfalls” by conforming their tax codes to the federal provisions, it is important that they “avoid using federal tax reform conformity as a vehicle for increasing the overall business tax burden, disadvantaging certain business sectors or entity types, or harming the state’s economic competitiveness.”
To this end, COST endorses certain principles that states can incorporate to fix existing inequities in taxing businesses and to help improve states’ business climates. Among these are managing conformity to achieve revenue neutrality and avoid increasing the state’s business tax burden, eschew selectively conforming to revenue-increasing federal law changes only, and being aware of unintended consequences and policy deviations between federal and state outcomes.
As this suggests, whether and how states conform may be controversial. For example, if they have not adopted federal tax reform provisions designed to cut taxes, such as lower marginal tax rates, then they also should refrain from adopting other provisions designed to raise revenue.
Beyond charitable deduction work-arounds, here are some additional responses to the Tax Cuts and Jobs Act that states have undertaken so far:
Bonus depreciation: The Tax Cuts and Jobs Act allows a 100 percent deduction for the adjusted basis of qualified property acquired and placed in service before 2023, in the year the property is placed in service. The deduction phases down by 20 percent each year for property placed in service after 2022, and is fully phased out for property placed in service after 2026.
Pennsylvania recently proposed legislation that follows the federal provisions, by way of H.B. 2017. This measure would reverse previously issued administrative guidance, namely Bulletin 2017-02, under which an asset does not get a depreciation deduction until the asset is disposed of or sold. In his co-sponsorship memorandum, Rep. Ryan claimed that “[u]nder the new law, [H.B. 2017], bonus depreciation doubles from 50 to 100 percent for property purchased between Sept. 27, 2017, and Jan. 1, 2023 (or January 1, 2024, for a small category of property). After that date, at 20 percent phase-down takes effect. Also, bonus depreciation amount is now permitted for the purchase of used property, in addition to new property. This is a common tax plan strategy used by virtually all businesses at some point in time, both large and small.”
Payroll taxes: This was one of a number of topics at the American Payroll Association’s annual Capital Summit, held on March 12 and 13. Bloomberg’s coverage of the event quoted the president of the National Payroll Reporting Consortium, who noted that “[s]tates have a variety of issues to consider with the tax code overhaul, including …whether to adopt the federal Form W-4. States are likely to make changes this year and in 2019 and 2020 because of the time needed to analyze and carry out modifications.” The W-4 is the Employee's Withholding Allowance Certificate that lets employers know how much income tax to withhold from employee paychecks.
Bloomberg also reported that the IRS plans to update Form W-4, and its instructions, in August or September to conform to the 2017 tax code overhaul, such as simplifying the process of reporting new-hire dates, with more updates expected for the 2019 filing season. In addition, the Labor Department is launching a program that will allow employers to self-audit and self-report payroll violations.
As it currently stands, 12 states require the use of the federal Form W-4. Jurisdictions that accept the W-4 but have their own personal exemptions will have to decide whether to continue using the federal form.
One-time repatriation tax: The Tax Cuts and Jobs Act “uses Internal Revenue Code Subpart F to impose a one-time toll charge on the undistributed, previously untaxed post foreign earnings of certain foreign subsidiaries of U.S. companies,” as Bloomberg has explained.
Illinois is one state that has recently issued administrative guidance to help taxpayers work through these complexities, including the one-time repatriation tax discussed on untaxed foreign earnings and profits. The Illinois bulletin explains that the new rule increases federal taxable income, which affects Illinois business income tax returns, and that the “Illinois subtraction modification for foreign dividends will exclude a portion of the increase from Illinois base income for certain taxpayers.”
Along these lines, the Council on State Taxation recommends that states “not conform to new foreign source income provisions that would expand the state tax base beyond the water’s edge.” There is a myriad of such provisions that could impact taxation of foreign sourced income:
- A one-time transition tax under a special subpart F classification on accumulated foreign earnings held overseas.
- A tax on certain earnings of a U.S. corporation’s foreign affiliates, referred to as global intangible low-taxed income, known as GILTI.
- A base erosion anti-avoidance tax, referred to as the BEAT provision, which imposes a tax generally on the amount of deductions large U.S. corporations take for payments they make to related foreign affiliates foreign earnings held overseas.
- A reduced tax rate on certain income that U.S. companies earn from servicing foreign markets, known as foreign-derived intangible income, or FDII.
- The new requirement for the amortization of research and experimental expenditures that favors domestic production over foreign production.
There are additional complexities for individuals shareholders of multinational corporations as well. The Bloomberg piece explains that the Tax Cuts and Jobs Act contains provisions that could allow states to classify some foreign source income as dividends to individual shareholders. “The intricacies of the law are complicated, particularly for states that use federal taxable income as the starting point for taxable income, as opposed to adjusted gross income.”
Ohio and Michigan
Beyond these provisions, Ohio and Michigan, and nearly every other state, have taken action with respect to the Tax Cuts and Jobs Act. In Ohio, for example, Substitute S.B. 22 passed the House on Feb.28, 2018, and on March 21, 2018 in the Senate. According to the House Committee’s bill analysis, the bill would expand “Ohio's 529 education savings plan so that, as recently authorized in federal law, plan earnings used for K-12 education expenses are tax-exempt, and so that amounts contributed to Ohio's 529 plan are eligible for Ohio's tax deduction even if ultimately used to pay K-12 education expenses.”
And in Michigan, two measures that Gov. Rick Snyder approved on Feb. 28, 2018, SB 748 and 750, enact amendments to increase as well as preserve personal exemptions. This was based on the belief that the act’s reduction of the personal exemption rate to $0 “would have negated the ability of Michigan taxpayers to claim personal exemptions on State and city income tax returns.”
This is likely just the beginning. COST counsels states to “prepare for additional complexities in state income tax compliance caused by conformity with federal tax reform provisions.”