Reforming SALT: Assessing the Impact of Tax Reform on States; Since each state has its own approach to corporate taxation, impacts are likely to vary.

AuthorEberle, Maria P.
PositionState and local taxation

Unless you have very recently awakened from a lengthy hibernation (and if you have, we hope it was restful), you are no doubt familiar with the federal tax reform bill known as the Tax Cuts and Jobs Act (hereinafter called "federal tax reform"), the most comprehensive tax legislation passed since Congress overhauled the federal income tax code in 1986. The breadth of federal tax reform is simply staggering, and it materially alters many key aspects of federal corporate income taxation in the United States. It also introduces several new concepts that are intended to move the United States from a worldwide to a territorial tax system and to make the country more business-friendly, with a more competitive tax environment.

To add to the excitement, cue U.S. state and local corporate income taxes. Since each U.S. state has its own approach to corporate taxation (e.g., different rates, starting points, apportionment rules, exemptions, deductions, and exclusions), the impact of federal tax reform on the states is likely to vary from state to state. Although approaches differ, each state with a corporate income tax draws upon the Internal Revenue Code (IRC) in some way, and as a result the impact of federal tax reform on the states must and should be examined. In this article, we will examine how the most significant corporate income tax provisions of federal tax reform may affect U.S. state and local corporate income taxation.

No Uniformity in IRC Conformity

The critical first step in understanding how federal tax reform will affect how a particular state's corporate income tax is computed is to consider how that state conforms to the IRC. States conform to the IRC in different ways, including:

  1. Static conformity. States under this option conform to the IRC as of a fixed date, which may or may not be the most recent version of the IRC. For example, Texas has adopted the IRC as of January 1, 2007. Changes to the IRC after this date do not apply in Texas.

  2. Rolling conformity. These states conform to the version of the IRC that is currently in effect. For example, Massachusetts is a rolling conformity state and, as such, will automatically adopt any changes to the IRC unless it specifically decouples from those changes or from the affected provisions.

  3. Selective conformity. These states conform only to specific IRC sections and not to the IRC as a whole. Further complicating this picture, these selective states can choose to conform to the adopted provisions on either a static or rolling basis. For example, California adopts some IRC provisions on a static basis.

What's more, although states may conform to the IRC itself, they may not conform to federal interpretations of the IRC. This means that to the extent that the U.S. Department of the Treasury issues substantive guidance (regulations, rulings, etc.) regarding any of the federal tax reform provisions, an additional threshold question exists as to whether such guidance applies in those states.

Finally, it is important to remember that IRC conformity is usually relevant only for computing a taxpayer's state tax base and does not affect the state tax rate applied to that base. In other words, while corporations will enjoy seeing the federal corporate income tax rate drop from thirty-five percent to twenty-one percent as a result of federal tax reform, their state corporate tax rates are likely to hold steady in the near term.

Assessing the Impact

The complexities of federal tax reform will affect each state differently, even when states fall into the same conformity bucket. Accordingly, a taxpayer cannot end its analysis after considering the conformity question. Simply put, there is no substitute for a state-by-state review to determine how federal tax reform will affect your business.

We have listed below some of the most important issues you may consider as you analyze the state tax impact of federal tax reform on your business. Of course, the significance of each issue will depend on your business's particular tax profile.

ediate Expensing and Interest Deductibility

One of the "gifts" to corporate taxpayers in federal tax reform is revised IRC Section 168(k), which allows a taxpayer to fully and immediately expense certain property acquired and placed into service between September 27, 2017, and January 1, 2023. This 100 percent depreciation deduction replaces bonus depreciation under prior law, which offered accelerated (but not full, 100 percent) depreciation. However, this gift comes with a limit on interest deductibility. In new IRC Section 163(j), federal tax reform limits a taxpayer's interest deduction to thirty...

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