Federal Proposals Impacting State Taxes and State Tax Implications of Federal Tax

Reform

Seattle Regional Meeting

Douglas L. LindholmCouncil On State Taxation (COST)

Shirley K. SicilianKPMG LLP

Todd A. LardEversheds Sutherland LLP

AGENDA Federal Legislation on State Tax Issues

Federal Regulations Impacting State Taxation Drivers of Comprehensive Federal Tax Reform Congressional Action to Date on Federal Tax

Reform US House & Senate Tax Reform

Proposals State Conformity Issues and

Implications

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Federal Legislation on State Tax Issues

Senate: S. 540 was introduced by Sens. John Thune (R-SD) and Sherrod Brown (D-OH) (March 7, 2017)

House: H.R. 1393 was introduced by Reps. Mike Bishop (R-MI) and Hank Johnson (D-GA) (March 7, 2017)

Passed House on June 20, 2017 (third time’s the charm?) Creates a bright-line, 30-day threshold before state employer

withholding and personal income tax liability would apply Exceptions for entertainers, athletes, certain film production

employees & prominent public figures Many industry members and organizations (300+) support the bill 57 Senate co-sponsors

www.mobileworkforcecoalition.org

Mobile Workforce State Income Tax Simplification Act

State Remote Seller Collection Authority– Since 2005, the following legislation has been proposed:

Main Street Fairness Acts Marketplace Equity Act Marketplace Fairness Acts Remote Transactions Parity Act Online Sales Simplification Act No Regulation Without Representation Act

– Current Legislation in the Congress: Remote Transactions Parity Act (H.R. 2193)

Introduced by Rep. Kristi Noem (R-SD) on April 27, 2017 49 Cosponsors

Marketplace Fairness Act of 2017 (S. 976) Introduced by Sen. Mike Enzi (R-WY) and Dick Durbin (D-IL) on

April 27, 2017 27 Cosponsors

No Regulation Without Representation Act (H.R. 2887) Introduced by Rep. Sensenbrenner (R-WI) on June 12, 2017 11 Cosponsors

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Proposed Federal Regulations Impacting State Taxation

IRC Sec. 385 Regulations – SALT ImpactsWhen might federal 385 rules impact state taxable income?

- Many states conform to, or adopt, all or portions of the federal code, or otherwise begin the state CIT calculation with federal taxable income.- In conforming states, there will often be a state impact if there is a federal impact. - State impact is also possible in certain instances when there is no federal impact. If documentation not required, or federal review yields no adjustment? National Grid USA v. Com.

of Rev. 51 N.E.3d 492 (2016); Cf. Compt’r of Treasury v. Gannett Co., 356 Md. 699 (1999) Could some federal exceptions be undone at the state level? Federal consolidated group members treated as “one corporation” for recast purposes But certain states require the taxpayer to file “as if” it had filed separately at the federal level. Does

the RILA proposal, adopted in the final rules, negate this outcome?

- States, even if they do not specifically adopt Final Regulations, may look to them for guidance.

IRC Sec. 385 Regulations – SALT ImpactsConsolidated Group Exception

Documentation Rule Exception– Proposed Regulations: Members of a consolidated group treated as one taxpayer– Final Regulations: Rule does not apply to EGIs issued between consolidated group

members Transaction Rules Exception– Proposed Regulations:

“all members of a consolidated group (as defined in § 1.1502-1(h)) are treated as one corporation”

Treas. Reg. § 1.1502-1(h) provides that term “consolidated group” means a group filing (or required to file) consolidated returns for the tax year

– Final Regulations: Treasury adopted a change in response to a comment pointing out that regulations “could apply

to a broader range of transactions at the state level than at the federal level” “all members of a consolidated group (as defined in §1.1502-1(h)) that file (or that are required to

file) consolidated U.S. federal income tax returns are treated as one corporation”

IRS Partnership Audits - SALT Impacts Partnership Audits

COST, ABA SALT Committee, AICPA, TEI,

• Should states require same approach at state and federal levels?• Is imputed underpayment a tax on partnership, a tax payment

made on behalf of partners, something else?• Constitutional and jurisdictional issues• State SOL and RARs

Revenue Agent Reports

• Define “final determinations”• Define “report”; de-minimis exception ($250)• Amended return equals refund claim, limited to federal

adjustments • 180 days

The Drivers of Comprehensive Federal Tax Reform

Improve the International Competitiveness of the U.S. Income Tax System

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Increase U.S. Reliance on Consumption Tax-Like Principles. Share of Consumption Taxes: 33% OECD vs. 17% U.S.

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Accelerate U.S. Growth

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Source: Bureau of Economic Analysis, January 2017.

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Congressional Action to Date on Federal Tax Reform

Federal Income Tax Reform Timetable– On June 24, 2016, the House Republicans released their vision for

tax reform (the Blueprint).– On September 27, 2017, the White House and Congressional

Republicans released the Unified Framework for Fixing Our Broken Tax Code.

– On November 2, 2017, the House Ways and Means Committee approved its version of federal tax reform legislation.

– On November 16, 2017, the full House of Representatives passed the House Committee’s federal tax reform legislation with some revisions.

– On November 16, 2017, the Senate Finance Committee passed its own version of federal tax reform legislation.

– Next up: The full Senate is likely to vote on its version of federal tax reform legislation in early December.

Polling Question 1

What is the likelihood of ANY federal tax reform to be passed?

A. LikelyB. UnlikelyC. The most likely outcome is a lower rate onlyD. Unsure - by the time I’m done voting, another

revised bill will be published

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The House and Senate Business Tax Reform Proposals

Business Tax Reform Proposals – Business Tax

Corporate rate reduced from 35% to 20% (Senate: delay one year to 2019 tax year)

Immediate expensing of business investments in certain new and used assets for five years (JCT: -$84B first five years)

Limit net interest deductions to 30 percent of ATI (essentially EBITDA) –(JCT:+$172B) Senate: similar provision (+$308B)

Limit NOL deduction to 90 percent of ATI: eliminate carrybacks; unlimited carryforward (with interest)

Repeal/restrict special exclusions or deduction (e.g., IRC § 199 domestic manufacturing deduction) (JCT:+95B)

– Pass-Through Businesses 25% capped tax rate; 70% safe harbor for wage income. (JCT: -$448B); 9%

rate for some passthrough income Senate: no rate cap but 17.4% deduction for pass-through income

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The House and Senate International Tax Reform Proposals

International Tax Reform Proposals Move from worldwide to territorial tax system 100% exemption for dividends from foreign subsidiaries (at least

10% owned) Accumulated foreign earnings held overseas treated as

repatriated under special Subpart F classification, with a bifurcated rate (14%/7%) for liquid and illiquid assets (JCT:+$293B) (Senate: 10%/5% rates)

Current year inclusion of income with “foreign high returns” (JCT:+$77B)

Excise tax on outbound related party payments; ECI election (+154B)

Limits deduction of interest by members of international financing reporting group (JCT+34B)

Senate: has its own base erosion measures ($123B) and a current-year inclusion for global intangible low-taxed income ($115B).

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Polling Question 2

Will international tax reform affect your business?

A. No, we’re located solely within the U.S.B. Yes - positivelyC. Yes - negativelyD. Unsure - by the time I’m done voting, another

revised bill will be published

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The House and Senate Individual Income Tax Reform Proposals and Sunset/Trigger Provisions

Individual Income Tax Proposals – Reduce 7 tax brackets to 4 tax brackets – 12%, 25%, 35% & 39.6% (Senate: keeps 7 tax

brackets)– Eliminate AMT– Increase standard deduction (approx. double), while eliminating personal exemptions– Eliminate most itemized deductions including deduction for state income (and sales)

taxes Modify home mortgage interest deduction for newly purchased homes (capped at

$500k of value; grandfather for existing mortgages); limit property tax deduction to $10,000 (but not foreign); retain charitable deduction (JCT:+$1.26T)

Senate: keeps home mortgage interest deduction intact; eliminates entire state and local tax deduction.

– Eliminate estate tax (Senate: keeps estate tax but increases size of estates that qualify for exemption)

Sunset and Trigger Provisions – Senate: personal income tax cuts sunset after 10 years.– Senate: possibly will add a “trigger” that would impose tax increases if certain fiscal targets for

economic growth are not attained.

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State Conformity Issues

State income tax conformity to IRC

AK

HI

ME

VTNH

MANYCT

PA

WV

NC

SC

GA

FL

IL OHIN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

ORID

NV

CAVA

MD

KeyFixed

Rolling

Selective

No income tax

As of September 15, 2017

CA’s personal income tax law differs in its conformity to the IRC compared to CA’s corporate tax law.

TX’s conformity date is January 1, 2007.

RI

NJ

DE

DC

OH doesn’t have a corporate income tax; this applies to pass-through entities and personal income tax.

WA

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State Impact Based on Conformity to Federal Tax Law

Federal States

Tax rate reductions States have own rates

Special pass through entity rate States have own rates (unless change is made as a deduction)

Broadened tax base including repeal of many itemized deductions State conformity

Fully expensed investments State partial conformity

Reduced repatriation rate Modest impact

Territorial tax regime Minimal conformity

Tax on high return foreign income and other base erosion measures State partial conformity

Limitation of interest deductions State conformity

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Key State Conformity Issues Selective conformity based on revenue impact?

– Will the states conform to some new federal provisions that increase revenues (ex: limitation on net interest deductions), but not to other provisions that decrease revenues (ex: 100 percent expensing).

– This would result in additional state revenues but undercut the intent of the federal legislation to couple (and balance) these provisions.

What will states do with the treatment of pass through entities? The House legislation calls for a 25% capped tax rate on certain

business income earned by pass through entities while the Senate legislation would provide favorable treatment through a 17.4% deduction.

If the Senate version passes, states would need to opt out of the deduction to avoid providing indirect “rate relief” to pass through entities that is not provided to C Corporations (since there is no state conformity with corporate tax rate changes).

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Key State Conformity Issues (cont.) Taxation of foreign source income?

– Both the House and Senate versions include some type of a minimum tax on foreign source income and other “base erosion” provisions.– If states conform to the updated federal code, the states may end up

taxing foreign source income that was not previously included in the state income tax base.

– If this occurs, the states will need to address unique state issues such as redundancy with current state “addback” provisions, apportionment/factor relief, nexus, and constitutional issues.

– Both the House and Senate versions include a one-time tax (at a reduced rate) on accumulated foreign earnings held overseas that are treated as repatriated. – Depending on how this provision is drafted, some states may pick up

some portion of this income as subpart F income. Other states may be tempted to expand their tax base to capture some of this additional revenue.

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Some Final Observations

– Federal tax reform would result in a significant shifting of tax policy priorities. H. R. 1 has about $5.9 trillion in tax cuts offset by about $4.5 trillion

in tax increases.– States may experience short-term revenue increases, but there

could be long-term pressures on state finances As proposed, federal tax reform could reduce federal revenues by

as much as $1.5 trillion (based on static scoring). Federal debt to GDP is now at 106 percent – significantly above the

50 year average of 40 percent. The full (or partial) repeal of deductions for state and local income

and property taxes increases the after-tax costs of state and local government at a time when federal resources will be constrained.

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Thank you