While states appeared to take a deliberate approach to update their conformity to the Internal Revenue Code (IRC) in light of Tax Cuts and Jobs Act (TCJA) as the first quarter of 2018 began, state legislative activity picked up steam as the first quarter (Q1) closed and we moved into the second quarter (Q2) of 2018. Q2 will go down as one of the most active quarters for state tax legislation in decades. This Alert reviews the substantial amount of state legislative activity that occurred during the second quarter of 2018, as well as administrative guidance issued by some states concerning reporting of deemed repatriation transition items under IRC Section 965 on 2017 state corporate and personal income tax returns.
In addition to state conformity, or decoupling as the case may be, with federal tax reform and the TCJA, a number of states enacted their own comprehensive changes to their corporate income tax systems. In prior Alerts, we discussed tax legislation enacted in Kentucky, Missouri and North Carolina. Connecticut and New York enacted their own versions of new pass-through entity tax regimes.
Most recently, on July 1, 2018 (technically a third quarter development), New Jersey enacted a major and controversial corporation business tax legislation.
In Q2, state tax legislation has been a challenge to stay abreast of, as developments have moved quickly. For example, on June 26, 2018, North Carolina enacted a technical corrections bill (S.B. 335) to correct the state’s omnibus budget bill enacted two weeks prior (S.B. 99). Among other corrections, S.B. 335 corrected the sourcing of receipts from intangibles for purposes of the North Carolina sales factor. S.B. 99 had changed such sourcing by adding place of “use” of an intangible as the sourcing criteria. In a correction, S.B. 335 retained the current law for sourcing receipts from intangibles so that intangible receipts are sourced to North Carolina if “received from sources” in the state. Although a Q3 event, Missouri also enacted legislation supplementing its tax reform. In S.B. 773, enacted July 5, 2018, it was clarified that intercompany sales between affiliates filing a Missouri consolidated return are eliminated from the sales factor. In S.B. 769, also enacted on July 5, since Missouri reduced the corporate income tax rate effective for tax years beginning on or after January 1, 2020, the bank tax rate is correspondingly reduced beginning in 2020.
While many state legislatures are no longer in session, allowing taxpayers and departments of revenue to catch their breath, we anticipate that Q3 will see more administrative guidance as departments of revenue react to what has occurred in their state legislatures during Q1 and Q2.
This Alert provides brief summaries of some of the significant state corporate and personal income tax legislation that was enacted during Q2 outside of that enacted by Kentucky, Missouri, New Jersey, New York and North Carolina. The following addresses IRC conformity and decoupling, rate changes, changes in apportionment formulas, modifications of dividends received deductions (DRDs) and other tax base items, and other income tax legislation.
Second Quarter 2018 Significant State Tax Legislation Summaries
On June 4, 2018, Colorado enacted H.B. 18-1185 and adopted market-based sourcing for purposes of the sales factor and gross receipts from sales of services and sales/licenses of intangibles. Market-based sourcing will be effective for tax years beginning after December 31, 2018. Colorado’s current proportional costs of performance sourcing methodology will be repealed. Beginning with the 2019 tax year, Colorado will source gross receipts from sales of services to the state where the service is delivered to the customer. In general, receipts from licenses of intangibles will be sourced to Colorado if the intangible is used in Colorado. Receipts from sales of intangibles will generally be excluded from the sales factor unless the intangible is a contract, license, or similar intangible that authorizes the conduct of business in a specific geographic area. If a receipt cannot be sourced or if the sourcing cannot be reasonably approximated, then a “throw-out rule” will apply to exclude the receipt from the Colorado sales factor. The new legislation also changes Colorado’s definition of “apportionable income” and “non-apportionable income” and makes certain other changes.
In addition to its new “PTE tax” and other important tax base changes, on April 27, 2018, Connecticut enacted S.B. 11 that, effective retroactively to tax years beginning on and after January 1, 2017, requires 5 percent of the amount of dividends that are eligible for the Connecticut DRD (including Subpart F income and IRC Section 965(a) income) will be treated as the amount of expenses attributable to the dividends and that are disallowed as expense deductions for corporation business tax purposes.
Hawaii enacted S.B. 2821 on June 14, 2018, and updated its conformity date to the IRC “as amended as of” February 9, 2018, for tax years beginning after December 31, 2017. The new law also requires the add-back of the federal “FDII” deduction under IRC Section 250. The new law does not change Hawaii’s treatment of Subchapter N of the IRC as “not operative” for Hawaii purposes (with the exception of IRC Sections 985 to 989). Thus, IRC Sections 951A and 965 are not operative for Hawaii income tax purposes.
On May 14, 2018, Indiana enacted H.B. 1316 and a number of conforming and decoupling changes with respect to the TCJA. Effective January 1, 2018, Indiana’s IRC conformity date is updated to the IRC “as amended and in effect on” February 11, 2018. The new law requires IRC Section 965(a) income to be included in Indiana adjusted gross income of corporations, but also makes it eligible for the Indiana DRD. Likewise, IRC Section 951A “GILTI” is included in Indiana adjusted gross income, but also eligible for the Indiana DRD. However, the IRC Section 250 FDII deduction must be added back to federal taxable income in determining Indiana adjusted gross income (the new law is silent with respect to the IRC Section 965(c) participation exemption deduction). Indiana will also decouple from IRC Section 163(j) and the IRC Section 172 amendments and provides that NOLs may be carried forward, but not back, for up to 20 years.
On May 30, 2018, Iowa enacted S.F. 2417. The legislation updates Iowa’s IRC conformity date effective January 1, 2019, and applicable to tax years beginning during 2019, to the IRC “as amended and in effect on” March 24, 2018. As a result, Iowa decouples from the TCJA amendments concerning the 2017 and 2018 tax years. For tax years beginning on or after January 1, 2020, Iowa becomes a “rolling” IRC conformity state and will conform to the IRC “as amended.” S.F. 2417 also enacts corporate income tax rate reductions beginning with tax years beginning on or after January 1, 2021. The new law eliminates the federal income tax deduction for tax years beginning on or after January 1, 2022, adjusts current decoupling from IRC Section 179 for tax years beginning on or after January 1, 2018, and through December 31, 2019, conforms fully with IRC Section 179 for tax years beginning on or after January 1, 2020. The law also eliminates Iowa’s corporate AMT for tax years beginning on or after January 1, 2021.
Maryland enacted S.B. 1090 to phase-in a single sales factor apportionment formula. The new law is effective July 1, 2018, and applies to tax years beginning after December 31, 2017. The sales factor will be triple-weighted for the 2018 tax year (previously the sales factor was double-weighted). For the 2019 tax year, the sales factor will be four times weighted, then five times weighted for the 2020 tax year, six times weighted for the 2021 tax year, and then a single sales factor apportionment formula will be fully phased in for tax years beginning after December 31, 2021. A “qualified world headquarter company” may elect to apportion income using the current double-weighted three-factor formula.
On April 10, 2018, Oregon enacted S.B. 1529 and updated its conformity date to the IRC “as amended or in effect on” January 1, 2018, for tax years beginning on or after January 1, 2018. However, the new law also adopts those TCJA amendments, such as IRC Section 965, that are effective and applicable to tax years prior to January 1, 2018. In addition, S.B. 1529 repeals Oregon’s “tax haven corporation” inclusion provisions for purposes of Oregon water’s-edge unitary consolidated returns, effective for tax years beginning on or after December 31, 2016.
The new law also provides that IRC Section 965(a) income is eligible for Oregon’s DRD (80 percent DRD for a 20 percent or more owned foreign corporation), but that the IRC Section 965(c) deduction must be added back to federal taxable income. Additionally, the new law provides a tax credit for corporation excise tax and income tax purposes for Oregon tax attributable to income under IRC Section 965. The credit may not exceed the lesser of: (1) the amount of Oregon corporation excise/income tax attributable to IRC Section 965(a) income for tax years beginning on or after January 1, 2017, and before January 1, 2018; or (2) the total amount of Oregon corporation excise/income tax attributable to the inclusion of a “tax haven corporation” in an Oregon consolidated return that was required by O.R.S. Section 317.716 for all tax years beginning on or after January 1, 2014, and before January 1, 2017. The IRC Section 965 tax credit cannot exceed the taxpayer’s Oregon tax liability and any excess credit may be carried forward for up to five years. The tax credit only applies to tax years beginning on or after January 1, 2017, and before January 1, 2018.
S.B. 1056 was enacted on June 28, 2018, which overturns Corporation Tax Bulletin 2017-02, issued on December 22, 2017. In CTB 2017-02, the Pennsylvania Department of Revenue had required that federal 100 percent bonus depreciation, for property placed in service after September 27, 2017, was added back, and that no Pennsylvania deduction for depreciation was allowable for such property. As a result of S.B. 1056, for property placed in service after September 27, 2017, taxpayers will still be required to add-back federal 100 percent bonus depreciation, but will now be permitted to take a deduction for depreciation calculated under IRC Sections 167 or 168 (not including IRC Section 168(k)). The deduction is allowed until the total amount of bonus depreciation that was added back is claimed. In the year the property is sold or disposed of, an additional deduction equal to any remaining federal bonus depreciation that has not been recovered will be allowed. For property placed in service prior to September 28, 2017, an additional deduction is allowed equal to the remaining amount of federal bonus depreciation that has not been recovered. The deduction is equal to three-sevenths of the amount of the depreciation deduction allowed under IRC Section 167, excluding any federal bonus depreciation deduction. In the year the property is sold or disposed of, an additional deduction equal to any remaining amount of federal bonus depreciation that has not been recovered will be allowed. The new law is effective for tax years beginning on or after January 1, 2017.
On May 21, 2018, Tennessee enacted S.B. 2119 to decouple from IRC Section 163(j) (and IRC Section 118). With respect to IRC Section 163(j), for purposes of computing Tennessee net earnings or net loss, IRC Section 163(j), as amended by the TCJA, will not be applied. Instead, IRC Section 163(j) as it existed prior to the TCJA amendment will be applied. However, Tennessee’s decoupling from Section 163(j) is delayed and not effective until tax years beginning on or after January 1, 2020.
Tennessee also enacted apportionment legislation (S.B. 2256) under which a “financial asset management company” may elect to apportion net earnings and net worth for franchise and excise tax purposes using a single sales factor formula. The election is effective for tax years beginning on or after January 1, 2018. A “financial management company” is a publicly traded partnership that derives 90 percent or more of its gross receipts from financial management services, as defined in the new law, but excludes REITs. Once elected, the election remains in effect for a minimum of five years until revoked by the taxpayer.
On April 4, 2018, Wisconsin enacted A.B. 259 and updated its IRC conformity date. For tax years beginning after December 31, 2016, and before January 1, 2018, the IRC “as amended to” December 31, 2016, is applied. For tax years beginning after December 31, 2017, the IRC “as amended to” December 31, 2017, is applied. However, A.B. 259 decouples Wisconsin from most of the provisions of the TCJA, including IRC Sections 163(j), 168(k), 199A, 245A, 250, 951A and 965.
Update on State Administrative Guidance and IRC Section 965
During Q2, Alabama, Colorado, Connecticut, Florida, Georgia, Massachusetts, Pennsylvania and Tennessee each issued administrative guidance regarding the treatment and reporting of IRC Section 965(a) income and IRC Section 965(c) deductions for state corporate and personal income tax purposes.
In a notice regarding IRC Section 965 issued on April 27, 2018, the Department of Revenue indicated that IRC Section 965(a) income, net of related deductions, should be reported for Alabama corporate income tax purposes, but is also eligible for the Alabama DRD. Unlike most states, the Alabama notice also indicates that IRC Section 965(a) income is excluded for personal income tax purposes, but only if received directly from a foreign corporation by an individual.
On June 11, 2018, the Department of Revenue issued IRC Section 965 Supplemental Instructions. The Instructions provide that the net amount of IRC Section 965 income (Section 965(a) income less Section 965(c) deduction) is reported in Colorado income. The net amount is eligible for the Colorado foreign source income exclusion. Because the net amount is included in an individual’s federal adjusted gross income and taxable income, it is likewise included in Colorado taxable income for personal income tax purposes.
In Office of Commissioner Guidance, OCG-4, issued May 11, the Department of Revenue Services indicated that IRC Section 965(a) income (disregarding the IRC Section 965(c) deduction) is reported in Connecticut net income. The amount is eligible for Connecticut’s DRD, but net of the five percent deemed related expenses offset discussed above. Installment tax payment deferral is not followed. Individuals are required to report the IRC Section 965 net amount that has been reported and included in federal adjusted gross income.
The Department of Revenue announced in Tax Information Publication 18C01-01 on April 27, 2018, that IRC Section 965(a) income is excluded from Florida taxable income of a corporation (and the Florida sales factor) unless the income is received through a REIT or a pass-through entity. The guidance is silent regarding IRC Section 965(c) deduction.
Georgia’s Q1 legislation allows a DRD for IRC Section 965(a) income, but requires an additional modification for the IRC Section 965(c) deduction. In Policy Bulletin IT 2018-01 issued June 26, 2018, the Department of Revenue provided that, because of the federal tax reporting of these items on the IRC 965 Transition Tax Statement, there is no IRC Section 965(a) amount to subtract nor any IRC Section 965(c) deduction to add-back on the Georgia corporate income tax return. Instead, only expenses attributable to the net IRC Section 965 amount are reported on the GA return as an addition modification to federal taxable income. Individuals are required to report the IRC Section 965 net amount that has been reported and included in federal adjusted gross income.
While Massachusetts has not indicated how it will treat IRC Section 965(a) income, although it presumably should be eligible for the Massachusetts 95 percent DRD (as Subpart F income), the Department of Revenue issued TIR 18-4 on May 15, 2018, to address estimated tax penalty relief. The Department’s guidance provides that IRC Section 965(a) income is included in Massachusetts gross income, but estimated tax penalties will be waived to the extent an underpayment of estimated tax is attributable to IRC Section 965. The Department also announced that it will be issuing further guidance on the Massachusetts IRC Section 965 treatment in the future.
Information Notice 2018-1, dated April 20, 2018, states the Department of Revenue stated that the IRC Section 965 net amount is reported in PA income. The net amount is eligible for the Pennsylvania DRD and is excluded from the sales factor. To the extent the net amount is included in Pennsylvania taxable income, after application of the DRD, installment tax payment deferral is not followed (except for REITs because IRC Section 965(m) is deferral of IRC Section 965(a) income inclusion, not deferral of federal tax payments). For personal income tax purposes, since the IRC Section 965 net amount is not an actual dividend distribution, it is not included in an individual’s Pennsylvania net income for personal income tax purposes.
The Department of Revenue issued Notice 18-05 in April that announced different IRC Section 965 treatment depending on whether the U.S. shareholder is a C or S corporation or a limited partnership, LLC, or REIT. For C and S corporations the net IRC Section 965 amount is excluded from Tennessee net earnings and the sales factor. For limited partnerships and LLCs subject to franchise and excise tax, these entities must report the IRC Section 965(a) income and Section 965(c) deduction amounts in their Tennessee net earnings calculation. The IRC Section 965 net amount is eligible for the Tennessee DRD (100 percent DRD, but only if the recipient owns 80 percent-or-more of the foreign corporation). To the extent the IRC Section 965 net amount is not deductible pursuant to Tennessee’s DRD, it is included in the sales factor denominator. The same net earnings calculation and DRD is applied for REITs and any IRC Section 965 net amount included in Tennessee net earnings of a REIT that are not deductible pursuant to the Tennessee DRD are eligible for the REIT’s Tennessee dividends paid deduction.
- As evidenced by Q2’s state tax legislative activity, 2018 continues to be one of the most eventful years, if not the most eventful year, for state tax legislation and administrative guidance in light of the federal TCJA.
- Taxpayers affected by the IRC conformity and decoupling developments addressed in this Alert should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits and disclosures.