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State conformity to federal provisions: Exploring the variances
In this edition of Inside Deloitte, the potential for federal tax reform serves as a backdrop for a discussion of the various degrees in which state income tax regimes conform to or diverge from the federal income tax regime, and consequently, how the state tax implications of a transaction may differ significantly from the federal income tax characterization.
- State conformity to federal income tax provisions in various settings
- Differences between state tax regimes and the federal determination of taxable income
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State conformity to federal income tax provisions in various settings
To varying degrees, most state income tax regimes rely on the federal income tax regime, including the Internal Revenue Code and the associated Treasury regulations. Potential federal tax reform is on the horizon, and changes to the federal tax base could affect taxpayers from a state income tax perspective.
With an eye to the fluid dynamics of what federal tax reform might entail, this article reviews state conformity to federal income tax provisions in various settings—focusing on how particular aspects of a state income tax regime can create a state result that varies significantly from the federal result. These differences can arise for various reasons, such as a state’s adoption of an earlier version of the IRC, decoupling from specific federal provisions, differences in the treatment of noncorporate entities, or the application of the federal consolidated return regulations.
One classic example highlighting the potential magnitude of a state versus federal income tax variance is an intercompany transaction that creates a gain for federal income tax purposes, yet is deferred under the federal consolidated return regulations. As we will discuss, states that impose a tax on a separate legal entity basis generally do not adopt the federal consolidated return regulations. Thus, the gain deferred for federal income tax purposes is generally taxed on a current basis in these separate filing jurisdictions.
This example alone highlights the importance of identifying and understanding common federal and state conformity variances because they can have a material impact.
Differences between state tax regimes and the federal determination of taxable income
The state income tax treatment of a transaction typically derives from state law conformity to the federal treatment as modified by state-specific statutes, administrative guidance, and case law
interpretations. Although the computation of state taxable income may begin with federal taxable income, differences can be caused by variations in the conformity date, specific decoupling from federal provisions, unique treatment of disregarded entities, and the application of the federal consolidated return regulations or state combined or consolidated return concepts.
Differences highlighted in this edition of Inside Deloitte include:
- State definitions of taxable income
- IRC conformity date
- Specific decoupling
- Unique treatment of disregarded entities
- Differences in rules applicable to separate, combined, and consolidated returns
- Tax election issues
- Tax attribute carryovers
- Nonconformity to IRS determination
Download the PDF to learn more about these differences.
If you have questions regarding this edition of Inside Deloitte, please contact:
Mike Porter, principal (retired), Deloitte Tax LLP
Michael Paxton, senior manager, Deloitte Tax LLP
Elil Shunmugavel Arasu, manager, Deloitte Tax LLP
J. Snowden Rives, manager, Deloitte Tax LLP
The authors thank Matt Gareau, Shona Ponda, and Tom Cornett for their contributions to and review of this article. The authors would also like to thank Mike Porter for his contributions during his 20 years with Deloitte Tax.