With the turn of the new year and a new decade, it is only natural to try to predict what state tax legislation may become law in 2020. Many factors can affect the nature and pace of state tax legislation, but perhaps the two leading drivers are the state economy and the state gubernatorial election cycle. It is safe to say that state economics have significantly stabilized, and many states have even seen gains. (1) On the political front, 2020 will see eleven gubernatorial contests, with ten incumbents seeking reelection. (2) In a presidential election year with high turnout expected, the gubernatorial elections in the states in play are not deemed to be high-risk. That said, one can never predict how elections will play out. One thing to be said about gubernatorial elections is that no governor wants to be on the record as having raised taxes in an election year.
Barring economic meltdowns and mutiny in the eleven states where the governor's seat is up for election, it's likely that other forces will drive state legislation this year. Ferreting out what they are and predicting what legislation we will see in the coming year are daunting tasks. However, one's chances of accurately predicting what lies ahead can often be improved by examining past legislative trends. Hence a brief look back at the past twenty years is worthwhile.
Early in the twenty-first century, state taxing authorities were still preoccupied with closing down intercompany licensing and lending practices that generated tax benefits through increased deductions to the tax base. The states attacked these perceived gratuitous planning schemes in three ways: 1) states enacted economic nexus provisions to impose tax on the affiliated member in the group that was recognizing the income (e.g., licensing revenue or interest income); (3) 2) states enacted expense add-back provisions designed to deny the deductibility of certain purely intercompany transactions (e.g., intercompany loans of funds with no infusion of funds from third-party lenders); (4) and 3) states enacted combined or unitary filing regimes to solve the problem more simply and assuredly through the principles of intercompany eliminations. (5)
Then we witnessed a shift in strategy whereby states went on the offensive. To encourage in-state businesses to stay and expand their operations, states began to enact statutes that shifted the burden of taxation historically borne by in-state companies to out-of-state companies. States largely accomplished this by enacting factor presence nexus standards, single sales factor apportionment, and market-based sourcing.
These laws passed in state legislatures with relative ease as they shifted the burden of taxation to out-of-state companies which, coincidentally, were not part of the states' electorate. Further fueling the widespread adoption of these strategies was what we'll call "state paranoia" or the "lemming effect." In short, states often looked to neighboring states' tax policies to ensure that they were keeping competitive, or at least not being left behind. Hence, by the end of 2019, nearly thirty states had enacted some form of economic nexus law, thirty-five states had enacted single sales factor methodologies, and twenty-five states enacted market-based sourcing provisions.
Last, since 2017 two events have significantly influenced state tax legislation and will likely continue to do so well into 2020. They are the enactment of the Tax Cuts and Jobs Act (TCJA) (6) and the Supreme Court's holding in the South Dakota v. Wayfair case. (7)
With that backdrop, a look to what may be on the state tax legislation horizon is in order. But for a few outlier states, most state legislatures are going into legislative sessions in January or February 2020. (8) Often tax legislation originates from the governor's proposed budget but can also emerge from the legislative branch through various finance or ways-and-means committees.
Whatever the source of the legislation, we believe that we are likely to see the legislation outlined below in 2020. We will start with the low-hanging fruit, then move toward the more challenging issue of predicting legislation. All the while we recognize that predicting state tax legislation is often akin to predicting the direction of the wind during a winter snow squall.
Updating Conformity to the Internal Revenue Code
Since many states require taxpayers to compute their state corporate income tax using federal taxable income as a starting point, it's important to understand what version of the IRC is being used. The IRC is a living, breathing document that is routinely amended. To keep current, states adopt the IRC in generally one of three ways.
First, "rolling conformity" states automatically adopt the IRC as currently in effect. (9) These states may then enact specific provisions decoupling from the IRC so as to avoid certain unwanted outcomes. (10) Second, states that adopt a version of the IRC as of a certain date fall into the "static conformity" category. (11) In static conformity, most states routinely adopt the IRC as in effect on the last day of the preceding year. However, some states have not updated...