Tax reform framework―multistate tax considerations
Multistate Tax alert | October 6, 2017
This tax alert highlights the federal income tax elements of the Framework and provides an overview of the associated multistate tax considerations.
This tax alert highlights the federal income tax elements of the Framework and provides an overview of the associated multistate tax considerations.3
Individual tax reform
As it relates to individuals, the Framework provides tax relief by reducing the seven current income tax brackets that range from 10 percent to 39.6 percent to three brackets of 12 percent, 25 percent, and 35 percent. An additional–unspecified–top rate may also be implemented to tax high-income taxpayers. Further, the Framework nearly doubles the standard deduction (but eliminates personal exemptions), enhances the child tax credit and provides a credit for non-child dependents, repeals the alternative minimum and estate taxes, and eliminates most itemized deductions with the exception of the deductions for mortgage interest and charitable gifts.
Business tax reform
Reduction in the corporate tax rate–The Framework lowers the federal corporate tax rate from 35 percent to 20 percent. It also limits the maximum tax rate applied to “small businesses” organized as pass-throughs to 25 percent and provides that rules will be promulgated to prevent high-income individuals from manipulating income to utilize this rate. The Framework does not, however, provide guidelines for such anti-abuse rules, though in the past Secretary Mnuchin has said that the lower rate will not be available for professional services income. Additionally, the Framework proposes eliminating the corporate alternative minimum tax (AMT), though no mechanism is specified for dealing with existing AMT credits, and it leaves the door open for a corporate integration proposal to reduce the double taxation of corporate earnings.
Expensing of capital investments–The Framework allows businesses to expense “the cost of new investments in depreciable assets other than structures made after September 27, 2017, for at least five years.”4
Interest expense–For C corporations, the deduction for net interest expense will be “partially limited” and the Framework proposes that the tax committees adopt similar rules for interest paid by non-corporate taxpayers.
Elimination of tax breaks–While only specifically naming the Domestic Production Activities Deduction (i.e., Internal Revenue Code Section 199), the Framework indicates that numerous other deductions and special exclusions will also be repealed or restricted. Excluded from repeal, however, are the research and development and low-income housing credits.
Territorial tax system–The Framework proposes to transition to a territorial system for taxing income earned by foreign subsidiaries of US multinationals. Specifically, it provides a 100 percent exemption for dividends from foreign subsidiaries in which the parent owns at least a 10 percent stake. However, to prevent US base erosion, the Framework also proposes a “reduced” tax rate on current profits earned by foreign affiliates of US multinationals. Currently, US corporate taxpayers pay US income tax on their global profits when received through operating branches, as dividends from corporations or if subject to certain anti-deferral rules under subpart F.
Repatriation tax–As part of the transition to a territorial system, the Framework proposes a one-time deemed repatriation tax on accumulated foreign earnings. The proposal suggests the tax would be imposed at one of two rates–one for earnings held in cash or cash equivalents and another (presumably lower) for accumulated foreign earnings held in illiquid assets–and would be payable over an unspecified period.
Multistate tax considerations
The potential implications of tax reform go beyond federal taxation. Depending on the provisions of a final tax reform legislative package, the multistate tax consequences of the proposals contained in the Framework may be sweeping in scope in terms of both the taxpayers and the state and local tax regimes affected. Below is a summary of some key considerations from a multistate perspective and how those considerations have changed since the Trump administration released its one-page fact sheet on April 26, 2017 (the Proposal):
Rate reduction–The Proposal recommended lowering the corporate tax rate to 15 percent, while the Framework provides for a reduction of the federal tax rate to 20 percent. In either case, state corporate income taxes will become, proportionately, a more significant factor in corporate taxation. Further, states are not required to reduce their tax rates.
Expansion of the state tax base–Under both the Proposal and the Framework, the federal tax base could become much broader as certain tax deductions/incentives may be eliminated (e.g., repeal of Internal Revenue Code (IRC) Sec. 199 deductions.) It is generally expected this may lead to an expansion of the state tax base because many states conform (to varying degrees) to the federally-defined tax base. While the federal changes include rate cuts that offset the broader base, it is uncertain whether states would take a similar approach.
Pass-through entity tax rate–The Proposal was ambiguous regarding whether the 15 percent business tax rate would apply to pass-through entities, but the Framework specifies a maximum tax rate of 25 percent on pass-through income. The Framework also provides that the tax-writing committees will draft anti-abuse rules to prevent pass-through owners from recharacterizing wage income as business income to avoid paying higher individual tax rates. To the extent a rate change and other reforms increase the use of pass-throughs, it could lead to increased tax collections by the states that impose entity-level taxes on pass-throughs (e.g., Ohio, Washington state) as well as increased complexity for pass-throughs filing composite returns and paying entity-level withholding on behalf of their owners.
Repeal of the personal income tax deduction for state and local taxes–Although the Framework does not explicitly address the personal income tax deduction for state and local taxes paid, members of the Big Six have indicated that this current-law provision should be repealed in order to offset the cost of rate cuts and other tax relief and to simplify the code. Eliminating the deduction is among the most significant and controversial issues in tax reform as it raises a substantial amount of revenue but the burden of eliminating the deduction would be primarily borne by individuals with filing obligations in high-tax states, cities, and counties.
The following multistate tax considerations are also applicable, but remain unchanged from the Proposal:
State non-conformity to the internal revenue Code–Many states conform to the IRC as of a specific date (i.e. static conformity) while others have “rolling” conformity (i.e., a state automatically adopts provisions of the IRC as they are enacted). When tax reform occurs, a situation could arise where states that have static conformity require that federal taxable income be determined under the pre-tax reform IRC for some period. States that otherwise conform to the IRC may decide to decouple from key provisions that have the potential to erode the state tax base. One example would be non-conformity to the capital expensing proposal.
Repatriation–If deemed repatriation is not included in federal taxable income, but rather is treated as a separate taxable item, questions arise as to how it will be taxed by the states. Which entity in the federal affiliated group will be the “deemed recipient” of the “deemed repatriation”? Will the repatriation of income be treated as a dividend, as a new category of miscellaneous income reported on a new subsection of the federal Form 1120, or a line one gross receipt? What will be the apportionment factor implications (i.e., will it be apportionable, allocable or potentially distortive)?
Credits & incentives on reinvestments–Given the potential magnitude of the repatriation of foreign profits, many taxpayers may use these funds domestically on capital expenditures and/or increased labor force. Exploring incentives packages related to re-investment of funds into the United States should be considered as states continue to compete to attract businesses.
Territorial system–While it is still unknown how states would respond to a territorial system, companies should consider reassessing their filing methodologies for state tax purposes, and determine whether it is beneficial to file on a “water’s-edge” or worldwide basis.
Settling audits resulting in liabilities–To the extent there is a reduction in the federal tax rate, the resolution of state tax audits prior to the reduction which result in payments may yield a permanent tax rate benefit under the higher current year federal tax rate. Because negotiating a resolution can be a time-consuming process, consideration should be given to initiating discussions with the applicable taxing authorities as soon as practical.
State reporting of federal Revenue Agent Reports (RAR) changes–For similar reasons as the last (and prior to the reduction of the federal tax rate), consideration should also be given to accelerating the reporting/payment of federal RAR changes (and otherwise agreed-upon federal adjustments in instances where a final RAR has yet to be issued) in those states where a liability may result.
If you have questions regarding the Gulf Copper case or other Texas tax matters, please contact any of the following Deloitte Tax professionals:
Valerie Dickerson, partner, WNT Multistate, Deloitte Tax LLP, Washington D.C., +1 202 220 2693
Jerry McTeague, partner, MTS tax reform–West leader, Deloitte Tax LLP, San Jose, +1 408 704 4477
Messiha Shafik, partner, MTS tax reform–National and East leader, Deloitte Tax LLP, New York, +1 212 436 6984
Jason Wyman, partner, MTS tax reform–Central leader, Deloitte Tax LLP, Chicago, +1 312 486 9418
Scott Schiefelbein, managing director, WNT Multistate, Deloitte Tax LLP, Portland, +1 503 727 5382
Bob Kovach, senior manager, Deloitte Tax LLP, Pittsburgh, +1 412 338 7925
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.
1 The “Big Six” consists of Senate Majority Leader Mitch McConnell, R-KY, Senate Finance Chairman Orrin Hatch, R-UT, House Speaker Paul Ryan, R-WI, House Ways and Means Chairman Kevin Brady, R-TX, Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn.
2 Unified Framework for Fixing Our Broken Tax Code, September 27, 2017.
3 Because the Framework is relatively undetailed and the prospects for its passage by Congress are unclear at this time, these multistate tax considerations are described in the context of the Framework concepts being ultimately enacted.
4 Unified Framework for fixing our broken tax code, September 27, 2017.
State tax legislative, judicial, and administrative developments