Responses to Federal Tax Reform in Key States: Keeping pace with developing federal rules has challenged even the most sophisticated corporate tax departments.

• Author: De Jong, Dan

A tsunami of change has roiled the normally calm waters of state conformity to the Internal Revenue Code (IRC) as a result of federal tax reform. Passed in December 2017, shortly before state legislatures went into session in 2018, the Tax Cuts and Jobs Act of 2017 (PL 115-97), hereafter the TCJA, significantly altered many domestic and international tax provisions of the IRC. In 2018, the Internal Revenue Service (IRS) and the U.S. Department of the Treasury issued numerous notices, hundreds of pages of proposed regulations, and other forms of guidance to help taxpayers interpret the revised IRC. Keeping pace with developing federal rules has challenged even the most sophisticated corporate tax departments. Because state corporate tax systems heavily rely on conformity to the IRC in calculating state taxable income, these federal-level changes also have significant derivative effects on states and taxpayers alike. This article reviews responses to select provisions of the TCJA generally and in certain key states for multistate corporate taxpayers.

Incorporating the IRC into determinations of state taxable income provides efficiency, because doing so creates an established base from which states can layer in their own modifications to achieve certain policy goals and avoid constitutional pitfalls. (Both the federal constitution and state constitutions impose some restrictions on state taxing powers.) States generally conform to the IRC in one of two ways: through either "static" or "rolling" conformity. Static conformity states conform to the IRC as of a particular date and must take legislative action to update that conformity to include subsequent amendments to the IRC. States with static conformity generally update their conformity date annually. This process allows those states to review amendments made to the IRC during the previous year and make policy choices about what changes they may not want to sign on to. For example, over the years many states have legislatively decoupled from federal bonus depreciation in this manner to avoid the temporary revenue loss associated with accelerated depreciation deductions. In contrast, rolling conformity states automatically conform to the IRC, including amendments to it. These states generally review any amendments made to the IRC and respond legislatively to decouple from, or otherwise modify their conformity to, the IRC where their state legislatures deem appropriate.

The magnitude of the recent changes to the IRC has put state governors, legislatures, and departments of revenue in a precarious position as they consider whether to adopt some or all of the changes it contains. In addition to policy considerations, states must consider the fiscal impact of conforming to the amended IRC and must do so in the context of limitations and restrictions that do not exist at the federal level. For example, states generally must operate on a balanced budget and have limited or no ability to run a deficit. Also, not all state governments have the resources to crunch all the numbers needed to accurately model the budgetary effects of how the numerous complicated amendments to the TCJA would alter state tax collections in a very short timeframe. This job has been further complicated as the IRS and Treasury continually roll out guidance on the new law. Still, many state departments of revenue produced revenue estimates of conformity to certain provisions of the amended IRC. State legislatures relied, in part, on these reports in deciding how to conform to, or decouple from, the changes, and states continue to evaluate their responses to the TCJA and issue guidance of their own.

Although the TCJA has affected numerous existing provisions and created many new concepts, this article and the accompanying matrix summarizing state responses (or lack thereof) focus on the following areas of the new law that have proven especially challenging to states and taxpayers: 1) the interest deduction limitation in IRC Section 163(j); 2) the limitation on the use of net operating losses (NOLs) in IRC Section 172; 3) the deemed repatriation of deferred earnings and profits in IRC Section 965; 4) global intangible low-taxed income (GILTI) in IRC Section 951A; and 5) the deduction in IRC Section 250 related to GILTI and foreign-derived intangible income (FDII).

Limitation on Interest Deductions: IRC Section 163(j)

IRC Section 163(j) generally limits taxpayers' ability to deduct interest expenses above a specified threshold. If interest expense exceeds that threshold, taxpayers may carry forward that disallowed interest and treat it as paid or accrued in the succeeding year. The TCJA repealed the preexisting limitation and replaced it with a new limitation based on a percentage of a taxpayer's adjusted taxable income (ATI), which is a new concept in the tax law. Under the amended IRC Section 163(j), a taxpayers interest deduction for a tax year (excluding floor plan financing) is generally capped at thirty percent of ATI for taxpayers with an average of more than $25...