The law known as the Tax Cuts and Jobs Act (TCJA) (1) has forever changed the landscape of the taxation of foreign earnings. In 2017, Sec. 965 created "repatriated earnings" by requiring corporations to pay a "transition tax" on previously untaxed foreign earnings as if those earnings were distributed by a controlled foreign corporation to its U.S. parent. States needed to scramble in a short amount of time to issue guidance on how this repatriated income would be taxed. By and large, with some exceptions, the states quickly assembled themselves and treated it as Subpart F income includible in the state tax base and permitted a dividends-received deduction (DRD) for those amounts on the state return under a Kraft (2) analysis. This made sense.
Then, in 2018, enter the concepts of global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII), which were created by the TCJA. GILTI, under Sec. 951A, is designed to discourage corporations from situating high-value, intangible assets off-shore and repatriating the related income tax-free. Corporations are now required to include certain types of this income related to high-value intangible assets currendy on their federal income tax returns. However, the Code allows a 50% deduction from GILTI, resulting in an effective federal rate of 10.5%, half of the 21% corporate tax rate. Similarly, FDII, under Sec. 250, is designed to encourage the use of foreign-generated intangible property inside the United States. As a result, a special deduction is permitted for FDII; and GILTI and FDII work in tandem to provide U.S. corporations a deduction for these activities equal to 37.5% of FDII and 50% of GILTI.
Taxpayers and preparers may not realize it, but that is the easy part. Now enter the states. In the authors' opinion, the GILTI and FDII scenario for state purposes is more akin to the Wild West of the 19th century. The Western cinema favorite The Good, the Bad and the Ugly with Clint Eastwood comes to mind. The states, at least for now, fit into those three buckets:
* The good: States that have clear rules providing for income inclusion but an income deduction as well;
* The bad: States that may or may not have clear rules regarding the inclusion of income but do not permit a deduction; and
* The ugly: States that have no clear rules, resulting in confusion around income inclusion and deductions, sometimes even creating an unconstitutional result.
However, the authors avoid being too critical of the states in the ugly bucket. These are complex rules at the federal level; the states, which tie to lines 28 or 30 of IRS Form 1120, U.S...