Are You Prepared to Respond to Varying State Tax Changes?
Just because recent tax reform offered many favorable business tax breaks at the federal level doesn’t mean states will follow in lockstep with all the same provisions. To what extent states will adopt similar measures isn’t yet fully known. Guidance is still forthcoming, as many state legislatures seek to limit—or decouple from altogether—provisions such as immediate expensing, which they fear could erode local revenue streams.
Learn what is—and isn’t—yet clear about state response to recent tax changes, and how businesses need to prepare for state tax compliance.
1. Focus on the Major Issues
Making sense of individual state responses to the provisions of the 1,000-plus page Tax Cuts and Jobs Act will require prioritizing. Start by identifying the business’s major issues and the states in which they occur. The answer will help determine the key areas that need to be understood.
For example, if the business has sizable intercompany interest, but minimal foreign investments, it may want to focus primarily on looking at state treatment of interest add-backs versus deemed repatriation response.
Provided that economic substance is met, it would also be wise to review intercompany cost sharing arrangements in light of the new interest limitation, especially at times where the 30% tax EBITDA limit comes into play.
2. Conduct a State-by-State Review
States conform to the federal tax code in one of several ways. Those with “rolling” conformity automatically adopt the federal code and its changes as they occur, while states with “static” conformity do so as of a certain date, and thus may exclude recent changes. Finally, states adopting “selective” conformity implement only certain sections.
Understanding these nuances is critical to appropriate tax-planning. For example, the federal TCJA changes may not be adopted at all in states with a static conformity date prior to the enactment of the TCJA.
Further, specific TCJA provisions, such as the TCJA’s limitations on the deductibility of business interest expense, can be greatly complicated by varying state filing methodologies.
While some states require filing on a separate company basis, others require, or have options for combined and/or consolidated filings. Businesses must factor in this difference in makeup between a state tax return group and a federal group when computing limitations such as that on interest deductions.
Repatriated earnings is another provision that differs on the state level. While many states allow a full deduction for the ensuing dividends, other states do not. Various planning opportunities such as utilizing a holding company in a tax-favorable jurisdiction may be beneficial to mitigate some of these differences.
Generally, most states have decoupled from the new law’s 100% bonus depreciation provision. Each of these issues must be researched state-by-state.
3. Revisit Financing Options
The interest deduction limitation is one critical area where both federal and state filers face a common challenge. Simply put, the interest on debt may not be entirely tax deductible due to the interest limitation. Businesses should investigate new financing options to avoid being adversely impacted by this limitation faced at both levels.
For example, in many cases, equity financing may now be more beneficial than debt financing. In other situations, affiliated groups may desire to utilize U.S.-based affiliates for intercompany financing arrangements as opposed to foreign affiliates. The treatment of non-shareholder contributions, such as state-provided funds for a company expansion or relocation incentive, as taxable income rather than equity also will be a factor for consideration.
Count the Money
Each of these issues must be researched on a state-by-state basis. As daunting as that may sound, a manageable approach is to start by assessing where the most dollars are at stake. The answer will help pinpoint where to focus first to stay ahead of state tax compliance issues.
Business Tax Quarterly - Fall 2018