Multistate tax considerations of the federal tax reform international tax provisions

Overview

On December 22, 2017, President Trump signed legislation (P.L. 115-97) commonly referred to as “The 2017 Tax Reform Act” (the Act), which is the most comprehensive tax reform legislation passed in over 30 years.¹ The Act lowers tax rates on individuals, C corporations, passthrough entities² and estates. To offset these costs, a number of deductions, credits, and incentives were reduced or eliminated.

The Act’s corporate income tax provisions and new deduction for passthrough entities will have broad implications for businesses of all sizes, but many of the far-reaching provisions pertain to the US taxation of foreign operations. Certain of these provisions, such as the deemed repatriation tax (commonly referred to as the transition tax), have immediate impacts which must be considered when filing 2017 tax returns.

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Transition tax/Deemed repatriation

The transition tax requires a US shareholder owning at least 10 percent of the vote of a foreign subsidiary (where there is at least one US corporation that is a 10 percent voting shareholder) to add to its subpart F income the shareholder’s pro rata share of the foreign subsidiary’s net post-1986 historical earnings and profits (E&P), as determined as of November 2, 2017, or December 31, 2017, whichever is higher. This income is to be reported as of the foreign subsidiary’s last tax year beginning before 2018, and is taxed at one of two rates: (1) 15.5 percent for E&P held as cash or cash equivalents; and (2) 8 percent for all other E&P.

The deemed repatriation raises a number of significant state issues, including whether and how the respective states tax subpart F income. The concept behind the deemed repatriation is that once the federal tax is paid on the deemed repatriation, the actual repatriation of these amounts will be tax-free at the federal level. One key issue for companies to consider is, to the extent a particular state does not tax the deemed repatriation, whether such a state will attempt to tax the funds upon their actual repatriation.

Another issue for companies to consider is whether the company has already paid tax on any of this E&P (i.e., by filing a worldwide state income tax return) and, if so, whether a position may exist to exclude the deemed repatriated dividends from income. Another consideration is to what degree the computation of gross income inclusion may differ from the federal computation taking into account combined group composition and/or separate filings.

Further, the potential state tax treatment of this deemed repatriation varies. Some states have a fairly straightforward approach for taxing or exempting the addition to subpart F income.

For example, a rolling (automatic) conformity state may conform to the amended IRC Section 965 immediately upon enactment, whereas states which have a static or lagging conformity approach to the IRC may not explicitly conform to section 965, leaving out the addition, or at a minimum, leaving the conclusion in question. Therefore, state conformity to the IRC—or a lack thereof—can result in varying treatment among the states. As a result, it is important for taxpayers to closely monitor a state’s conformity status.³

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Other considerations

The Act also provides that US shareholders of controlled foreign corporations must include in gross income the amount of its global intangible low-taxed income (GILTI), but is permitted a deduction equal to 50 percent of the GILTI. US corporations will also be required to include foreign-derived intangible income (FDII) in gross income, but will then be permitted a deduction on the FDII. As such, each state’s tax regime must be examined to determine if the GILTI or FDII (and the related deduction) is included in the state taxable income calculation.

For example, the New York Department of Taxation and Finance recently presented to New York Governor Andrew Cuomo a “Preliminary Report on the Federal Tax Cuts and Jobs Act” (the “Report”), in which it attempted to estimate the impact the Act would have on the tax system and economy of the State of New York.⁴ When analyzing the Act’s international tax provisions, the Report notes that Subpart F income and dividends paid by foreign affiliates to US corporations are “generally not taxed in New York.” With regard to GILTI income, however, the Report states:

Although this new GILTI income is treated similarly to Subpart F income, it is specifically not characterized as Subpart F income under the IRC and therefore would not qualify as other exempt income. Thus, the income would flow through to New York, be treated as business income, and be subject to tax.⁵

With New York weighing in, it is anticipated other state agencies may follow suit soon.

Taxpayers will also need to consider whether the foreign income under the transition tax, GILTI or FDII will be included in the sales factor numerator and/or denominator for apportionment purposes. If the foreign income is treated as a dividend, states may exclude the dividends altogether from the sales factor or only include a portion of the dividend.

Finally, because the Act allows for the repatriation of funds under beneficial terms, it is anticipated that a portion of those funds may be reinvested in the US economy. This is especially true as the Act modifies the IRC section 168 bonus depreciation rules to allow for full expensing of qualified property placed into service after September 27, 2017, and before January 1, 2023. Accordingly, companies who anticipate repatriating and reinvesting a substantial amount of E&P following the deemed repatriation should consider state and local credits and incentives opportunities for such reinvestment.

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State budgets and legislative responses

The Act represents “deficit spending” by the federal government and includes roughly $1.46 trillion in unoffset costs for the 10-year federal budget window covering 2018–2027 according to the Joint Committee on Taxation. State governments, however, cannot engage in deficit spending and generally must run balanced budgets.

Each state that imposes income taxes will therefore need to evaluate which provisions of federal tax reform that pertain to the calculation of taxable income to determine if the state can afford to conform to any federal tax provision that would reduce state revenues (or, conversely, if they can afford to disconnect from any revenue-raising provisions included in the Act.)

State conformity to the IRC is generally set by statute, and a summary of each state’s current conformity to the IRC as of January 1, 2018, is attached to this Alert as Appendix A.

States typically address conformity to the IRC through legislation, although certain states may seek to address essential details through administrative guidance as well. Legislative responses are expected throughout 2018, depending upon when each state is in session. Included below is a summary of each state’s 2018 legislative calendar (based on information currently available).

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Taxpayer considerations

While the foregoing is not an exhaustive list of all state tax issues raised by the Act’s international income tax provisions, the summary is intended to provide an overview of the range of state and local tax issues presented. Each taxpayer is encouraged to consider these state and local issues, including the ASC740 implications, when evaluating the impact of the Act on current and prospective tax planning.

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Multistate Tax alert archive

The Multistate Tax alert archive includes external tax alerts issued by Deloitte Tax LLP's Multistate Tax practice during the last three years. These external alerts highlight selected developments involving state tax legislative, judicial, and administrative matters. The alerts provide a brief summary of specific multistate developments relevant to taxpayers, tax professionals, and other interested persons.

View the list of archived Multistate Tax alerts.

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References

¹ The Tax Reform Act’s official name is, “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”

² The Act effectively reduces the tax burden paid by the owners of passthrough entities (e.g., partnerships, S corporations, etc.) by a) creating a new 20 percent deduction for “qualified business income” and b) reducing the rates imposed on individuals and C corporations.

³ A summary of each state’s conformity to the IRC as of January 1, 2018 is attached to this Alert as Appendix A.

⁴ Preliminary Report on the Federal Tax Cuts and Jobs Act, January 2018). A copy of the Report is available here.

⁵ Preliminary Report at p. 30.