In 2017, state business taxes increased 2% on average, but corporate income tax revenue collected by states was down by 0.7%, according to a state tax burden study. The study was prepared by Ernst & Young, the Council On State Taxation, and the State Tax Research Institute.
Federal Tax Reform and State Taxes for Businesses
The Tax Cuts and Jobs Act brought about major federal tax reform designed to decrease federal business taxes beginning in 2017. State corporate income taxes collected were down by a small margin, but will they hold steady, decrease more, or increase in 2018. For 2018, we’ll see the full impact of tax reform and the states’ responses to the changes.
State Conformity to Federal Tax Law After Tax Reform
The impact of federal tax reform on state tax will depend on:
- how a state conforms to the Internal Revenue Code (IRC); and
- whether the calculation of the state’s taxable income starts with federal taxable income or adjusted gross income (AGI).
A state with rolling conformity adopts federal tax law changes as they happen.
States with fixed-date, or static, conformity pass legislation to update their fixed-date conformity date. Many fixed-date states have done this since Congress enacted the TCJA.
States may also conform by incorporating a federal statute into state tax law by:
- addressing the provision in a state tax statute; or
- specific reference to the IRC section.
Section 965 Deemed Repatriation Dividends
In 2017, according to the tax burden study, California collected $10.1 billion in corporate income tax, New York collected $11.6 billion in corporate income tax. Indiana collected $1 billion.
That year, all multinational corporate taxpayers recognized foreign deemed dividends, subject to a deduction, under IRC 965. Not all states laws conformed to the IRC when federal tax returns reporting the new repatriation dividend were due.
IRC 965 now requires corporations to include foreign earnings in income as deemed dividends every year.
State Conformity with Section 965
Indiana taxpayers start calculating their corporate income tax with federal taxable income and add back certain federal deductions. Indiana has fixed-dated conformity and enacted IRC conformity legislation in May 2018. The legislation included requiring an addback of the Sec. 965 amount.
Most states, like Indiana, treat income inclusions under Sec. 965 as dividend income. They may then let corporate taxpayers deduct the amount of the deemed dividend. Indiana allows a deduction from federal taxable income for a percentage of foreign source dividends. A section 965 dividend is a foreign source dividend.
Some states, like California, allow corporate taxpayers to exclude all IRC Sec. 965 income.
Even when a deduction is allowed, it may not “match” the deduction allowed under the IRC.
Future State Tax Burden for Businesses
The year 2018 will reveal the impact of state responses to federal tax reform on:
- state tax revenues; and
- the tax burdens of companies doing business within the various states.
By Lisa Lopata, J.D.