The Tax Cuts and Jobs Act (TCJA) (P.L. 115-97), enacted at the end of 2017, brought sweeping changes to the Internal Review Code (IRC), including reducing the tax rates, introducing new taxes and deductions, and eliminating many deductions and exemptions. In response, states are proposing or enacting legislation, adopting regulations, issuing guidance on the impact of the TCJA, and updating IRC conformity. Since most states that impose corporate and personal income taxes incorporate portions of the IRC into their own system of taxation, the 2017 federal tax law changes have implications for state revenue as well as increasing or decreasing business and personal tax burdens. As state legislators explore what the provisions of the TCJA mean for their state, this Strategic Perspective highlights the state responses to the TCJA since its enactment.
Key Tax Provisions Impacting the States
Each state has its own approach to taxation, using a combination of tax types, rates, rules, and exemptions. States conform to provisions of the IRC for various reasons, including to reduce the compliance burden of state taxation, provide consistency for those taxpayers filing in multiple states, and to reduce duplication of effort in filing federal and state taxes. Although each state has its own additions and subtractions, most of the states use federal adjusted gross income (AGI) as their starting point for calculating individual income tax liability. Some states use federal taxable income, while the remaining states which tax wage income use state-specific definitions of income.
The 2017 tax reform bill fundamentally modified the IRC. Some of those changes had the potential to alter state tax systems. Among those provisions with state impact are below.
Corporate income tax rate. Under the TCJA, the graduated corporate tax rate structure has been eliminated and corporate taxable income is taxed at a 21-percent flat rate. All states that levy a corporate income tax refer to the IRC. Most states start with taxable income from the federal Form 1120, then apply specific adjustments which vary by state. A small number of states start with federal gross receipts, while several states do not impose a tax based on net income. The impact on state corporate tax bases depends on whether all states (rolling and fixed conformity) update their conformity dates with the TCJA and remain coupled to specific provisions as has been done in the past. In “rolling conformity” states, which conform directly to the IRC as it is amended, the changes in the TCJA are already part of those states’ tax laws. In “fixed” conformity states, the TCJA changes will generally be incorporated when the state legislatures enact legislation to conform to the IRC.
Bonus Depreciation. The bonus depreciation rate is increased to 100 percent for property acquired and placed in service after September 27, 2017, and before 2023; increased expensing phases down starting in 2023 by 20 percentage points for each of the five following years; the original use requirement is eliminated; and taxpayers may elect to apply 50 percent expensing for the first tax year ending after September 27, 2017. Most of the states explicitly add back the federal bonus depreciation amounts. Of those that do not, some states conform to bonus depreciation provided under IRC §168(k).
Interest Expense Limitation. The provision, IRC §168(j), limits the deduction to the net interest expense for a business that exceeds 30 percent of adjusted taxable income (ATI) plus business interest income. Most states that levy a corporate income tax conform to this change.
Pass-through business income deduction. Under IRC §199A, an individual taxpayer may deduct up to 20 percent of certain domestic qualified business income from a partnership, S corporation, or sole proprietorship. Only a few states conform to federal taxable income and would be affected by this federal tax cut for these businesses.
Standard Deduction. The basic standard deduction amounts for individuals are temporarily increased for 2018 through 2025. The standard deduction amounts for 2018 are: $24,000 for married individuals filing jointly (including surviving spouses), $18,000 for heads of household, and $12,000 for single individuals and married individuals filing separately. Only a few states and the District of Columbia couple with this provision. This change on its own will reduce taxes for most taxpayers on the federal level. However, this result is unlikely in those few states since each of them also couple to federal itemized deductions.
Personal Exemption. For 2018 through 2025, the personal and dependency exemptions have been repealed. The elimination of the exemptions raises revenue by increasing the amount of income subject to tax.
Transition Tax. A new one-time transition tax is imposed on post-1986 accumulated foreign earnings of 10 percent owned foreign subsidiaries in periods of 10 percent corporate shareholder ownership. The tax rate is 15.5 percent on the included deferred foreign income held in cash or cash equivalents form and eight percent on the remaining deferred foreign income. Most states provide a subtraction or exclusion for Subpart F income, upon which this tax is based. This means that amounts included in federal income due to the transition tax will generally not be taxed by those states. A few states tax all of Subpart F income, while other states include a portion of Subpart F income based on ownership levels.
Global Intangible Low-Taxed Income (GILTI). A person who is a U.S. shareholder of any controlled foreign corporation (CFC) is required to include its global intangible low-taxed income (GILTI) in gross income for the tax year in a manner similar to that for Subpart F inclusions. GILTI is a new category of income that is determined on an aggregate basis for all CFCs owned by the same U.S. shareholder, with partial credits for foreign taxes attributable to the GILTI amount. Since GILTI income will be included in income that is reported on federal Form 1120, that income will be included in state taxable income in most states. However, a small number of states have specifically provided an exclusion of income included by IRC §§951 – 964 and therefore excludes GILTI levied under IRC §951A.
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